It's been quite a while since I first covered Paycom Software, Inc. (NYSE:PAYC). And even then, Paycom has been an impeccable human capital management (HCM) solutions company. But this 4Q, the company showed it had more potential to unleash. It had an impeccable performance with its substantial revenue growth and well-managed margins.
Moreover, HCM solutions see bright prospects despite macroeconomic volatility. The current and future labor market transformation may favor the company. Higher demand and consumption may be anticipated this year. It may lead to continued expansion as more companies rely on its products. Thankfully, it maintained a solid financial positioning, allowing it to sustain its operating capacity.
Meanwhile, the stock price keeps decreasing even after the massive cut last month. The downtrend is consistent with my previous article, as price metrics revealed potential overvaluation. But now, there may be changes after the sharp stock price decrease and fundamental uptrend.
The HCM solutions industry has been around in the market for a long time. But over the past decade, their importance has been highlighted as freelance jobs become more popular. Yet, it was only a portion of it. The disruptions in the past three years have paved the way for Paycom Software, Inc. to capture more demand. Many businesses were forced to embrace remote work setups amidst pandemic restrictions. Despite these massive changes, productivity and efficiency remained high. It was proof that remote work setups were as efficient as physical work. Today, hybrid work setup is the new normal in the labor market. Workers and business owners alike are geared toward it. I will discuss this part further in the next section. But the thing is, HCM solutions providers, like Paycom, are here to rule over business processes. Paycom remains a robust company. It combines its innovative software-as-a-service (SaaS) technology and mobility platform with efficient, personalized services.
It had an impressive performance in 2022. Its operating revenue reached $1.38 billion, a 30% year-over-year growth. Thanks to the increased demand for its user-friendly solutions. We can attribute it to the increased number of SMEs, its core clients. As of 2022, there were 33.2 million small businesses in the US and approximately 700,000 openings. Also, about 76% of companies in the US shifted to a hybrid work setup. With that, it was unsurprising that more companies relied on Paycom solutions.
The impeccable growth was most evident in 4Q 2022. It amounted to $370.58 million, a 30% year-over-year and 12% sequential increase. Thanks to the impact of inflation and demand influx. With that, we can see it had an inelastic demand. Businesses adapted to the changing work setups to cushion the blow of the Great Resignation. In my previous coverage, I used the study of McKinsey & Company, which revealed that 87% of employees preferred hybrid work. Also, prices were lower than in 3Q 2022 since inflation relaxed to 6.5% when the year closed.
With regard to its peers, the company remains a dwarf compared to HCM solutions giants like ADP (ADP) and Paychex (PAYX). But Paycom proved it could go head-to-head with them. Its revenue growth was way higher than the peer average of 18%. It shows that Paycom sustained its demand better than most of them. Also, it had more strategic and flexible pricing to optimize its capacity amidst inflation.
Likewise, costs and expenses were in an uptrend due to higher prices. They increased proportionately to revenues as the operating capacity expanded. Even so, they remained well-managed to stabilize margins. Indeed, it practiced what it preached about productivity and efficiency. Also, the increased demand and strategic pricing played a vital role. Revenue growth in Paycom easily offset the increase in costs and expenses. The operating margin reached 28% versus 24% in 2021. Meanwhile, the operating margin in 4Q was 29% versus 24% in 4Q 2021. It also showed a massive rebound from 1Q and 2Q 2022 with 22%. Hence, inflation affected its performance, but Paycom Software, Inc. remained viable.
Why Paycom Software, Inc. May Remain A Solid Company
Paycom Software, Inc. remains a solid HCM solutions company. Its comprehensive cloud-based HR technology and payroll solutions deliver it as a single SaaS application. Aside from its impressive features, the market heavily relies on the industry. Paycom and its peers are also more of a staple today as fintech revolutionizes. We will discuss these aspects one by one.
First, employers and entrepreneurs alike favor hybrid work setups. In my previous coverage, we focused on the employee side. So in this article, we will also look at how employers and business owners respond to the changing labor market landscape. But before that, we must note that 55% of hybrid companies in North America have remote flexibility. The current percentage is lower than in Africa and Australia. Despite this, it allows SaaS apps like HCM solutions to cater to more customers.
Employees prefer a hybrid work setup to either 100% on-site or remote work. In fact, 57% of remote workers plan to shift to hybrid work. More importantly, nearly two-thirds of employees agree that work location and schedule flexibility influences their decision to stay in the company. Almost 80% of employees said hybrid and remote work improved their well-being. Given these statistics, employers must be more aware as the Great Resignation persists. But surprisingly, many employers are eager to shift to hybrid work. The same study shows that the vast majority of companies plan to shift to a hybrid work setup. It is consistent with another study showing that 76% of companies' post-pandemic may shift to hybrid work setups.
Second, software development becomes a booming industry expected to reach $812.97 billion. Meanwhile, the fintech industry reigns over financial transactions across industries. This trend may favor HCM SaaS apps to streamline payroll services. For instance, cash transactions dropped from 2015-2022. Most purchases in 2022 were made using mobile wallets, credit cards, and debit cards. Also, there was a very high negative correlation between cash transactions and income levels. These trends may be more significant for the e-commerce industry and companies doing online transactions. HCM solutions may still be a staple since they help track payroll transactions faster than dealing with piles of payslips.
Also, HCM software served as SaaS becomes more of a staple as recession fears remain intense. Many companies are looking for ways to save more time and cash. Even before the pandemic, over 700,000 Americans approached bankruptcy lawyers to file for bankruptcies and entrepreneurs talked with bankruptcy lawyers. So, HCM software can help companies enhance efficiency and financial capacity. In a study posted, corporate bankruptcies in the first two months of 2023 rose by 76%. HCM solution providers like Paycom are more important today as labor-related expenses rise in line with elevated inflation.
But what makes Paycom a solid company is its stellar Balance Sheet. It has an impeccable liquidity position. It has high and adequate cash reserves of $2.41 billion, about nine times its value in the comparative quarter. Even better, cash comprises 59% of the total assets, making Paycom a very liquid company. Cash reserves are higher than borrowings and common stock value. With that, it has more than enough cash to cover its financial obligations even in a single payment. Borrowings are also low and suitable in a high-interest environment. Also, we can confirm its liquidity using its cash flow from operations, which is more than thrice the CapEx. Hence, its FCF/Sales Ratio of 17% shows that Paycom succeeded in turning revenues into cash to stay liquid.
The stock price of Paycom Software, Inc. has been in a downtrend since the start of the year. The downward pattern became sharper last month, leading to a 22% price decrease. At $274.54, the stock price is 8% lower than last year's value and 13% lower than my previous coverage. Indeed, my hold rating before made sense. The stock price today appears cheap, which is confirmed by the PB Ratio. Currently, it has a BVPS of 18x and a PB Ratio of 15x. It is high, but the current value is reasonable if we compare it to the average ratio of 17x. If we use the current BVPS and the average PB Ratio, the target price will be $306. The EV Model agrees with it, given the target price of ($15.56 B EV - (-$2.34 B) Net Debt) / 57,867,000 shares = $309.33. The two metrics show a potential stock price rebound. The substantial increase is reasonable, given the massive improvement in fundamentals. To assess the stock price better, we will use the DCF Model.
Perpetual Growth Rate 4.8%
Common Shares Outstanding 57,867,000
Stock Price $274.54
Derived Value $288.99
The derived value confirms the potential undervaluation of the stock price. There may be a 5% upside in the next 12-18 months. So, investors may consider the current stock price an ideal entry point.
Paycom Software, Inc. remains a robust company with solid fundamentals. It may become more impressive this year as market prospects remain sunny. Even better, the stock price is undervalued with some upside potential. It is an ideal price for investors to make a position. The recommendation is that Paycom Software, Inc. is a buy.