Summary
- Consistent Revenue Growth: ADP projects a 6-7% revenue increase for 2024, primarily driven by its Employer Services, which make up 67% of total revenue.
- Strategic PEO and Client Fund Interests: Offers comprehensive PEO services and gains significant revenue from interest on client funds, which is sensitive to interest rate changes.
- Market Expansion Potential: Holds 10-15% of a $150 billion total addressable global market, providing substantial room for growth.
- High Client Retention and Stickiness: Due to the essential nature of its services, ADP benefits from high customer retention and predictable, subscription-based revenue streams.
Investment Thesis
#1: ADM is a mature company with stable and consistent growth that allows for a more accurate price forecast
- ADP has been growing it’s revenue between 4-6% annual since 2016. The outlook for 2024 remains the same story with a projected growth between 6-7% with majority of the growth from it’s Employer Services (67% of total Revenue) and slower growth it is PEO services (33% of total revenue)
- Employer Services: This line offers a range of human capital management (HCM) solutions to businesses of various sizes. Services include payroll processing, human resources management systems (HRMS), time and attendance solutions, benefits administration, talent management, and compliance resources. These solutions are designed to help employers manage their workforce more efficiently through technology-driven services and software
- PEO Services: ADP’s Professional Employer Organization (PEO) service, known as ADP TotalSource, allows small and mid-sized businesses to outsource their employee management tasks, including employment administration, HR management, benefits administration, and compliance. In a PEO arrangement, ADP co-employs a client’s employees and takes on primary responsibility for most aspects of employee administration, which provides businesses with more resources to focus on their core operations.
- Client Funds Interest: ADP earns interest on funds held temporarily during the processing of payroll and other transactions for its clients. These funds are client money that ADP holds to make payments for payroll, taxes, and other deductions during payroll processing cycles. The interest earned on these funds can contribute a substantial revenue stream, depending on interest rate conditions and the volume of funds processed.
- Our forecast suggests that ADP is currently at an attractive level with ~10% upside in the next 12 months plus another 2.1% in dividend yields
- The breakdown of this valuation: $19.7bn revenue (assumes 6% growth from Dec 2023) x 5.7 P/S ratio / 410k diluted shares outstanding = $274 price target
- The caveat here is that the forecast implies projects a continual decline in it’s price to sales ratio between -3% to -5% and that ADP continues it’s shares buyback at an rate of 1% per year
#2: ADP has a built a moat around mission critical processes within HCM and achieved safety in diversification of customer around the world
- HCM systems integrate deeply with internal processes, including payroll, benefits, and compliance. Switching systems requires a significant overhaul of these critical processes, which can be disruptive and costly.
- HCM solutions handle sensitive employee data, making data security a priority. Migrating this data to a new system poses risks and potential data integrity issues, deterring frequent switches.
- Over time, companies heavily customize their HCM solutions to fit their unique workflows and processes. This customization adds to the difficulty of switching platforms
- There’s still room to grow as ADP reported a $150Bn total addressable market in which ADP only accounts for 10-15% of the global market share.
- In addition, much of ADP’s revenue comes from subscription-based services, which provide a steady and predictable income stream. This model is bolstered by high client retention rates due to the sticky nature of payroll and HR services
Risk Assessment
- Med Risk: Economic downturns can lead to job cuts and lower business formation rates, directly reducing the demand for payroll and HR services provided by ADP. During recessions, businesses often freeze hiring and cut costs, which can decrease ADP’s revenue
- In addition, ADP earns interest on funds (~5% of total revenue) held temporarily while processing payroll. Fluctuations in interest rates, particularly declines, can reduce the income generated from these funds. For example, a decrease in the Federal Reserve’s interest rate could lower ADP’s interest revenue from these client funds
- Med Risk: The U.S. payroll services market is highly saturated, making it difficult for ADP to achieve high growth rates domestically. This saturation pushes ADP to seek growth through international expansion, which comes with its own set of challenges and risks
- High Risk: Many developed countries, including Japan, Italy, Germany, and even the U.S., are experiencing aging populations due to low birth rates and higher life expectancy. This demographic shift is leading to a shrinking working-age population. For example, the United Nations projects that by 2050, one in six people worldwide will be over age 65, up from one in 11 in 2019.
- The labor force participation rate in the U.S. has been declining, particularly among men aged 25-54. This rate has fallen from nearly 98% in the 1950s to about 89% today.
- Studies, including those from McKinsey, suggest that automation could displace a significant number of jobs by 2030, depending on the speed of adoption across industries
- Low Risk: The rise of freelance and contract work challenges traditional payroll models typically offered by ADP. Adapting to these changes requires flexible and often more complex service offerings, potentially increasing operational costs