Payroll and human resources software provider, Paychex (NASDAQ:PAYX) reported strong growth in the Q1 FY2022 earnings announcement, with revenue up 16.1% year on year to $1.08 billion. Paychex made a GAAP profit of $333.6 million, improving on its profit of $211.6 million, in the same quarter last year.
Paychex (NASDAQ:PAYX) Q1 FY2022 Highlights:
- Revenue: $1.08 billion vs analyst estimates of $1.04 billion (3.82% beat)
- EPS (non-GAAP): $0.89 vs analyst estimates of $0.80 (10.8% beat)
- Free cash flow of $355.2 million, roughly flat from previous quarter
- Gross Margin (GAAP): 71.1%, up from 69.3% previous quarter
One of the oldest payroll service providers, Paychex (NASDAQ:PAYX) provides payroll and human resource (HR) solutions.
Managing basic HR functions like payroll and benefits are requirements for all companies, but are particularly time consuming and expensive for small and medium sized businesses, who have historically used a series of patchwork measures involving spreadsheets, accountants and single purpose software from multiple vendors.
Paychex offers a full range of human capital management (HCM) products including payroll processing and HR services to manage employees, from onboarding, managing schedules and benefits, and offering retirement accounts like 401Ks. Paychex also has a large internal staff of professionals who can provide full offers of outsourced HR and compliance functions, while also providing a range of insurance options (e.g. health, cybersecurity, and property) to businesses and their employees.
While considered more of a legacy payroll provider, Paychex’s value proposition is a breadth of offering that many of the newer cloud-native HCM rivals can’t match, such as retirement accounts and serving as an insurance brokerage. It also offers broad flexibility in how customers can choose to purchase any of Paychex’s services as standalone modules or in bundles, delivered either on-premise or through a cloud-based version. In recent years, it has introduced Paychex Flex, a cloud-based integrated HCM platform that addresses the growing demands of SMBs for lower cost, consumer-like user interfaces.
Paychex benefits from the long term trend of business process outsourcing, allowing businesses to focus on core competencies, along with the SaaS-ification of businesses, large and small, who much prefer the flexibility of cloud-based, web-browser delivered software paid for on a subscription basis than the hassle and expense of purchasing and managing on-premise enterprise software.
ADP (NASDAQ:ADP) is Paychex’s primary competitor, but increasingly has come into competition with cloud-native HCM software providers like Asure (NYSE: ASUR), Ceridian (NYSE:CDAY), (Paycom (NYSE:PAYC), Paycor (NASDAQ:PYCR), Paylocity (NASDAQ:PCTY), and Workday (NASDAQ:WDAY).
As you can see below, Paychex's revenue growth has been slow over the last year, growing from quarterly revenue of $932.2 million, to $1.08 billion.
This quarter, Paychex's quarterly revenue was up 16.1% year on year, which is above average for the company. On top of that, revenue increased $53.7 million quarter on quarter, a strong improvement on the $82.5 million decrease in Q4 2021, and a sign of acceleration of growth, which is very nice to see indeed.
Analysts covering the company are expecting the revenues to grow 4.8% over the next twelve months, although we would expect them to review their estimates once they get to read these results.
What makes the software as a service business so attractive is that once the software is developed, it typically shouldn't cost much to provide it as an ongoing service to customers. Paychex's gross profit margin, an important metric measuring how much money there is left after paying for servers, licences, technical support and other necessary running expenses was at 71.1% in Q1.
That means that for every $1 in revenue the company had $0.71 left to spend on developing new products, marketing & sales and the general administrative overhead. Significantly up from the last quarter, this is around the lower average of what we typically see in SaaS businesses. Gross margin has a major impact on a company’s ability to invest in developing new products and sales & marketing, which may ultimately determine the winner in a competitive market so it is important to track.
Key Takeaways from Paychex's Q1 Results
With a market capitalization of $38.8 billion, more than $1.14 billion in cash and with free cash flow over the last twelve months being positive, the company is in a very strong position to invest in growth.
It was good to see Paychex improve their gross margin this quarter. And we were also excited to see that it outperformed analysts' revenue expectations. On the other hand, revenue growth is overall a bit slower these days. Overall, this quarter's results seemed pretty positive and shareholders can feel optimistic. The company is up 2.92% on the results and currently trades at $111.01 per share.
Is Now The Time?
When considering Paychex, investors should take into account its valuation and business qualities, as well as what happened in the latest quarter. We cheer for everyone who is making the lives of others easier through technology, but in case of Paychex we will be cheering from the sidelines. Its revenue growth has been very weak. And while its bountiful generation of free cash flow empowers it to invest in growth initiatives, unfortunately gross margins aren't as good as other tech businesses we look at.
Paychex's price to sales ratio based on the next twelve months is 8.9, suggesting that the market does have lower expectations of the business, relative to the high growth tech stocks. While we have no doubt one can find things to like about the company, we think there might be better opportunities in the market and at the moment don't see many reasons to get involved.
The Wall St analysts covering the company had a one year price target of $107 per share right before these results, implying that they didn't see much short-term potential in the Paychex.
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