Founded in 1949, Automatic Data Processing (NASDAQ:ADP) is a provider of cloud-based human capital management services to employers, serving more than 760,000 clients worldwide. The company positions its own business strategy as focused on three core pillars: 1) growth of a complete suite of cloud-based HCM solutions; 2) growth and scalability of HR Outsourcing solutions; and 3) leveraging of global presence to offer clients HCM solutions wherever their employment needs exist. To date, ADP remains a go-to marketplace for companies large and small, as well as the source of employment-related data for the US government.
We anticipate meaningful revenue growth and margin expansion, driven by aggressive growth in new clients. This in itself should translate into a 32x P/E multiple on 2020 earnings, which is approximately 4x-5x above sub-industry average. When we apply this multiple to our 2020 EPS estimate of $6.47 (up from $6.21), it translates into our target price of $207, up from $198.
Company Announces New Buyback Authorization: On November 12, the company announced $5 billion in a new buyback authorization, positioning itself for several more years of generous buybacks, which, we estimate, should translate into about 2.5%-2.7% annual capital return. The renewed authorization itself did not come as a surprise, since replacement of the previous authorization from 2015 has been long overdue. At the same time, the $5 billion number came about $1 billion above the analyst expectations. On our end, we did not predict a specific figure, since it's usually a shot in the dark, though it is indeed reassuring to see above-consensus buyback program.
It's Not Only the Dividend Story! ADP and Paychex have been historically grouped in the same bucket not only as human capital management companies, but also as two high-dividend players. ADP's current dividend yield is about 2%, while Paychex's is ~3%. We believe that an increase in share repurchase authorization will keep ADP within its 2% band, without having to compete with Paychex and thus having to aggressively raise a dividend. This is also more prudent from a taxation standpoint. Recall the criticism both stocks received from industry experts is that often times their solid, consistent dividend payout made them appear as stocks with a bond profile. Such criticism signaled that the companies were trying to offset the bleakness of the revenue growth profile with an attractive dividend.
Market share gains against Paychex: in recent quarters, we’ve been seeing some market share loss from Paychex to ADP Data Processing, mainly around mid-tier clients. The key driver of this market share shift is unknown to us, though most industry checks point to more attractive pricing.
Transformation Efficiencies on Track: We anticipate at least $200 MM in cost efficiency savings over time, which should translate into annual 3% EPS growth in 2020-22. This is not a huge impact, but it is a symbolic indicator that the company is adequately managing its bottom line. In addition, increased buybacks should further boost the EPS in the outer years. Per our valuation (above), we are raising our 2020 target by as much as 26 cents, which translates into a $9 increase in target price.
Expect Revenue Growth Acceleration in 2021: But it's not all about buybacks. Our 2021 model now incorporates about 50 bps of revenue growth acceleration, driven by incremental clients. We will continue to assess these new clients and may revise our 2021 acceleration estimate upward to as much as 120 bps in the coming months.
We see the following risks as potentially negatively impacting ADP’s bottom line:
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