Topic: How To Invest

Paychex makes big move into cloud computing to expand its payroll services

Stock InvestingPat McKeough responds to many requests from members of his Inner Circle for specific stock market advice, as well as questions on investment strategy and the economy. Every week, his comments and recommendations on the most intriguing questions of the past week go out to all Inner Circle members. And each week we offer you a report on one of the stocks profiled in these Q&A sessions. We give you Pat’s buy-hold-sell recommendation as well as his analysis of the stock. This is part of the specific buy, hold and sell advice we offer you in our daily posts. Every week you get “A Stock to Sell” on Monday, “Best Canadian Stocks” on Tuesday, and “Our Top U.S. Stocks” on Thursday.

This week we had a question from an Inner Circle member about a company that helps Americans get paid. Paychex derives the greater part of its revenue from payroll services, but it also helps clients with health insurance programs and pension plans. Pat looks at the company’s business, including the escalation of its cloud computing and online services, and considers its prospects as it works to maintain and build on a strong customer base.

Q: Hi Pat: What do you think of Paychex? Thanks for your help.

A: Paychex Inc. (symbol PAYX on Nasdaq; provides a range of human resources and payroll services, including accounting, salary deposits and automatic tax payment and filing.

The company’s 580,000 clients are mostly small- to medium-sized businesses (10 to 200 employees). It operates about 100 offices in 41 states, as well as Germany and Brazil.

Paychex gets 65% of its revenue from payroll services. The remaining 35% comes from human resources, including managing health insurance programs and pension plans. As well, Paychex recently started offering accounting and payment-processing services.

In its 2014 fiscal year, which ended May 31, 2014, the company’s revenue rose 8.3% to $2.5 billion from $2.3 billion in fiscal 2013. Earnings gained 10.3%, to $627.5 million or $1.71 a share, from $569.0 million or $1.56.

Paychex is debt-free and holds cash of $936.8 million, or $2.58 a share. It recently raised its quarterly dividend by 8.6%, to $0.38 a share from $0.35. The new annual rate of $1.52 yields 3.6%. The company also plans to buy back $350 million worth of its shares by May 31, 2017.

New product sends wages directly to MasterCard debit card

In response to growing demand, Paychex continues to move to a cloud computing model and offer more services online. As a result, it plans to spend $110 million to $120 million on new equipment and system upgrades in fiscal 2015. That’s up roughly 37% from the $84.1 million it spent in fiscal 2014.

At the same time, Paychex continues to develop innovative products. For example, it recently launched a program that lets businesses deposit their employees’ wages directly onto a MasterCard debit card. About 30% of U.S. residents do not have a bank account, so demand for this service could be strong. These cards are also cheaper to process and manage than cheques.

Paychex expects its revenue to rise around 10% in fiscal 2015, because the improving economy should spur more hiring. The company is also doing a good job of hanging on to its customers, retaining a record 82% in fiscal 2014. Recurring revenue from these contracts cuts its risk.

In the longer term, Paychex should continue to benefit as it lets small companies cut costs and focus on their main businesses. For example, the company helps small clients comply with increasingly complex tax laws and the new Obamacare health care rules.

The stock trades at 22.9 times the $1.85 a share that Paychex will likely earn in fiscal 2015.

We view Paychex as a hold.

Coming up Next On Monday we take a critical view of the growing interest in marijuana investments.


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