Buying Paychex For Income

Summary

• I bought Paychex because of its attractive dividend yield and long-term capital gains potential.
• The company is supported by a strong product portfolio, which is generating high organic growth and long-term potential.
• Investors get to enjoy rising dividends, a strong balance sheet, and a high but stable payout ratio.

In this article, I will tell you why I recently added Paychex (NASDAQ:PAYX) to my dividend portfolio. This Rochester, NY-based provider of staffing and outsourcing services offers a good dividend of currently 3.4%, a solid balance sheet, a healthy payout ratio, and strong fundamental growth. I added the stock as I like the higher dividend yield caused by the stock price decline and the company's future potential. While mid-term challenges will likely continue to cause volatility and potentially further stock price declines, I have little doubt this company will be a strong long-term addition to my portfolio as I expect both capital gains and increasingly higher dividend payments.

Source: Paychex

What's Paychex?

Paychex, founded in 1971, is a provider of human resource, payroll, and benefits outsourcing services for small- and medium-sized firms. The company, headquartered in Rochester, NY, employs 15,700 employees, and is a member of the S&P 500 with a market cap of $26.6 billion. The company operates with an integrated, cloud-based HCM (healthcare data management) platform and a personalized technology-enabled service model. As a result, the company is a leader in comprehensive HR outsourcing solutions and has more than 670,000 clients employing more than 12 million employees.

Growth Is Solid & Accelerating

Having an 'interesting' and promising product portfolio and business model is one thing. However, turning this into growth is another thing. As you can see below, the company has done tremendously well since the recession. Since 2010, sales have gone from $1.95 billion to $3.69 billion in 2019. Operating income has accelerated from $725 million to $1.38 billion. That's a 7.4% compounded annual operating income growth rate.

Source: TIRK.com

The most recently revealed second quarter of the 2020 fiscal year is confirming further strength. Total sales accelerated by 15% to $991 million. The organic growth rate was at a solid 6%. Operating income rose by 11% to $342 million. The two drivers of growth were PEO (professional employer organization) and insurance services and management solutions. PEO and insurance services saw 57% higher sales due to the Oasis Outsourcing Group acquisition in December of 2018, growth in total worksite employees served, and a higher number of health and benefits insurance applicants. Management solutions were up 6% due to a larger client base, a higher price realization, and increased product penetration in retirement services, HR outsourcing, and suite solutions.

In addition to that, the company launched Paychex Pay-On-Demand, which allows companies to pay their employees 'on-demand'. For example, on a weekly, or bi-weekly basis. The company also returned $222 million to shareholders in the form of dividends.

Dividends Are Strong & Rising

Dividends, that's exactly what you want as a bonus when waiting for capital gains. Or in some cases, you stay for the dividend and get capital gains as a bonus. As you can see below, the current dividend yield is 3.4%. This means that the dividend yield has been pretty much unchanged since 2014 while the stock price accelerated by more than 80%.

Data by YCharts

The only way to keep the dividend stable despite a rising stock price is by increasing dividend payments. That's exactly what the company has been doing. As you can see, it took the company a while to start the uptrend in dividends per share. Between 2010 and 2019, the dividend payments have accelerated from $1.24 per share to $2.30 in 2019. This implies an annual growth rate of 7.1%. Including the sideways trend until 2013. Also, note that the company did not cut dividends during the recession in 2007/2008.

Source: TIRK.com

With this in mind, let's look at the payout ratio. Rising dividends sound good, but do you want a company that cannot afford to pay dividends? I already mentioned it in the intro, but there is no need to worry. The company is paying roughly 65% of its operating cash flow in dividends and 80% of its net income. Note that all numbers below are on a GAAP basis. It is also worth mentioning that the payout rates have been stable since the end of the recession.

Data by YCharts

Adding to this, Paychex is managing (almost) every single year to end up with a neutral cash balance after servicing debt, paying dividends, and capital expenses. However, there are outliers. These are caused by acquisitions and financing activities and always result in stable cash flow in the next period.

Source: TIRK.com

Let's Talk Debt

Almost always, when I discuss a mature company that has shown accelerating sales and earnings, I also have to discuss an accelerating debt load. However, in this case, this is not at all what we are dealing with. Yes, total liabilities have gone up from $3.8 billion in 2010 to currently $6.1 billion. However, the company has successfully leveraged its business model. The 9-year CAGR of liabilities is at 5.2%, meaning that sales easily outperform debt growth.

In addition to that, the liquidity position has been stable as well. The closest the current ratio has come to 1.0 is in 2012 when current assets only covered 107% of current liabilities. The graph below shows both the current ratio and total liabilities as a percentage of total assets. Not only have liabilities underperformed growth, but the total ratio of debt-to-assets has also significantly declined as well.

Source: TIRK.com

Takeaway

I bought Paychex because I wanted high-quality companies and because I have a significant cash position again after completely emptying my managed dividend fund at Robeco. I wanted, and still want, to put this money to work again, and I am buying good companies that offer a solid and growing dividend yield. Paychex is such a company. The stock has declined from $92 to $73 in just 3 weeks due to coronavirus fears and an imploding oil price.

However, while these problems are mid-term problems, I am convinced that Paychex will be a good long-term investment. The company's product portfolio is generating solid organic growth while further strategic acquisitions keep innovation levels high. On top of that, we are dealing with a high payout ratio and a very strong balance sheet.

Source: FINVIZ

While the stock is trading at 21.6x forward earnings, I think the need for yield will continue to push money towards dividend stocks. I might be wrong about the timing, but I have little doubt the company will quickly recover from any potential economic headwinds caused by the coronavirus.

Let me know what you think!

Thank you very much for reading my article. Feel free to click on the "Like" button, and don't forget to share your opinion in the comment section down below! My long-term investments are stated in my Seeking Alpha biography.

Analyst’s Disclosure: I am/we are long PAYX. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

This article serves the sole purpose of adding value to the research process. Always take care of your own risk management and asset allocation.

Comments

[Alluic]

83% payout ratio right now, hope they do not cut the div.

[KMR holder]

PAYX always has paid a large portion of their cash flow to shareholders. That is a benefit of their asset light business model. The problem for investors is that since they pay a hefty dividend income investors bid up the share price to unreasonable levels at time. That is why I wait for the occasional opportunities to load up on the shares and sell them later as the price rises and the yield drops.

[KMR holder]

I last bought PAYX back in 2011 when I believed that the world wasn't coming to an end. I paid $25.42 a share for a more than 10% sized position. That was a very good time to buy the shares. I started scaling out in 2016 and sold the last of the position last March at $78.49.

I don't think that the world is coming to an end financially today but I think $55 is still too expensive to own the shares. I will wait for a price below $50 to start buying again. If I can get those prices, a position should be relatively low risk.

[thebucketshop]

PAYX is never cheap. I would consider 17X earnings a "distressed" price. That's what it was generally during the year 2009.

I have put my order in for 22X earnings, or 3.5% yield. That works out to a price of $69. If it goes lower than that, I will buy more.

[jgrever621]

Buying PAYX today might not be the best idea, though certainly a good company.

I have wanted to add for a long time; just couldn't find the right time. And I don't think now is the time either. This due to questions about the economy for one, and the other is there are getting to be other opportunities with better prospects and higher returns. All due to the virus at this time, anyway.

Think we can wait another month or so before there is enough clarity regarding the economy rebound in the second half, and waiting to buy currently looks to provide more and better chances for safety and profit.

[Leo Nelissen]

The market is down 20%. A lot has been priced in. This stock can certainly go lower - just like the market in general. Nonetheless, I started buying some high-quality companies that I have liked for a very long time. I will continue to buy if stocks go even lower. It's just important to keep cyclical exposures low.

[usiah]

Have held PAYX for years, and it has performed well. With this downturn I'm beginning to seriously consider adding more.

Retired dividend-growth investor

[wdjax0n]

Slight headwind from FED interest rate manipulation. Interest income was about 5% of pretax operating income in 2019.

[NINK]

PAYX is a company that I have long coveted to add at the right price. However, it got cut in half during the last recession, declining 50.3% from 8/31/2007 to 2/27/2009. That recession led to a financial crisis, and people losing homes that they should not have taken the debt to buy in the first place. That brought PAYX down to under 15 times earnings.

However, PAYX is leveraged to payrolls, and, for the most part in the last recession, people did not have their jobs eliminated or suspended, except in the mortgage industry, and those guys deserved it. This time around, we're look at a true, across the board, economic recession. It's pretty hard to find an industry anywhere that will not feel the pain from this. There will be many fewer payrolls to process for a while, unless I miss my guess. The pain could be much greater for PAYX. 15 times last year's earnings gets you to roughly $46.50 a share. They are currently trading at 76.71, after the most recent corrections.

So, my question is, how certain are you that we are not about to head into a recession, led by lower employment than the last recession? Buy if you have conviction... it is a great company, they'll likely do great in the long term, but, I'm going to wait a while.

[sbally4]

I've been wanting PAYX for many years, but it is always a bit too expensive.

With a forward P/E over 21 (per the article, and almost 24 today after 3-10-20 close) I'm afraid it is cheaper than it was, but it only went from absurdly overvalued to somewhat overvalued.

[sbally4]

Finally got some PAYX in the mid 55 range! After waiting a (very) long time. P/E in the high 18.xx range.

I have a feeling that at some point in the future I'll wish that I had bought a lot more.

[Dividend payer]

PAYX is an excellent company at a fire sale price. Very little debt, excellent income statement, great dividend, with a diversified product offering. The 10 year bond is below 1% and PAYX pays a dividend yield well over 3%, taxed as capital gains vs ordinary income. A no brainer.

[siestadreamer]

I’m happily long PAYX, @Leo Nelissen, and I think you will be, too. I guess the pullback is discounting a recession, which seems unlikely to me.

[siestadreamer]

Recession now appears all but certain. Unfortunately, small businesses—PayChex’ bread and butter—are in the crosshairs.

[Gary Jakacky]

PAYX is one of those sleep-well-at-night stocks that are rarely on the bargain counter.

Exactly how some overrated Chinese Chest Cold means that businesses will suddenly do their own payroll processing escapes me.

[Leo Nelissen]

It's a great company. Ony of my favorite dividend stocks at the moment. Glad I bought low. Although it needs to be seen if this is the bottom... Either way, can't hurt to buy well below its ATH

[Gary Jakacky]

I supplement the already good income from PAYX (and some other blue blue chips) by writing calls at strikes that are comfortably above the prevailing price. (I live frugally so the premiums are fine). Yet I still manage to score most of the capital gain.