“Automatic” Total Return on a Conservative Play - ADP
One issue that meets my criteria right now is:
Automatic Data Processing [NYSE:ADP] Feb. 18, 2009 close: $36.84
52-week-range: $30.83 (Oct. 16, 2008) - $45.97 (Sep. 9, 2008)
Dividend = $0.33 quarterly = 3.58% current yield
ADP is America’s largest payroll and employee tax filing processor with over 585,000 accounts. Domestic revenues account for about 82% of their approximately $9 billion in expected sales for FY 2009 (ends June 30, 2009). They also provide Human Resource solutions and various accounting, inventory and leasing services to smaller companies.
EPS have risen in 13 of the past 16 fiscal years and the current year is almost certain to add to that total with consensus estimates running about $2.40 versus FY 2008’s $2.20 figure. As payroll processors they are being restrained by the nation’s worsening unemployment numbers [less workers = less payroll to process]. Even so, analysts now are looking for $2.56 for FY 2010.
These are low volatility shares [Beta = 0.75] and the balance sheet is fabulous with treasury cash of over $1.37 billion versus total debt of just $51.2 million as of December 31, 2008. Only $16.9 million of that comes due in the next five years.
The dividend has been raised in each of the past 34 years. The current yield of 3.58% is better than that on a 10-year Treasury and almost all bank CDs. It’s also higher than ever before on ADP shares (excepting at last October’s nadir).
Value Line gives ADP its highest safety rating, an ‘A++’ for financial strength. They show them in the 100th percentile for ‘stock price stability’ and in the 95th percentile for ‘earnings predictability’ [with 100th being best].
Historically, ADP shares have commanded premium P/Es. Their 10-year median multiple has been 27x and the past five-year average was 24x.
At today’s close of $36.84 ADP is offered at about 15 times calendar year 2009 estimates.
I expect ADP shares to climb by year end but in the current equity environment here’s my conservative combination play with great total return potential even if the stock does nothing through next January.
………………………………………….…….………. Cash Outlay …………..…… Cash Inflow
Buy 1000 ADP @ $36.84 ………………..………$36,840
Sell 10 Jan. 2010 $35 calls @ $5.50 ………………………………………..…….$5,500
Sell 10 Jan. 2010 $35 puts @ $4.70 ……………………..………………..….….$4,700
Net Cash Out-of-Pocket …………………………………………..$26,640
On expiration date (Jan. 15, 2010):
If ADP shares are $35 or above (as they already are today):
Your $35 calls will be exercised.
You will sell your shares for $35,000.
Your $35 puts will expire worthless (a good thing for you as a seller).
You will have collected $1,322 in dividends (at the current rate).
You will have no further option obligations.
You will have $36,322 from the stock sale and yield for your $26,640
net cash outlay. That’s a $9,682 profit or 36.3% cash-on-cash if this ‘best case scenario’ plays out.
Not too bad considering that ADP shares do not have to advance to achieve this return. In fact, they could go up, stay unchanged or even decline by up to 4.99% (to $35) and you’ll still get that best case profit.
What’s the risk?
If ADP shares end up below $35 you’d have to buy an additional 1000 shares and lay out $35,000 more cash.
You’d then have put out the original $26,640 plus $35,000 = $61,640.
You’d own 2000 shares.
You’d still have collected that $1,322 in dividend payments.
Your net out-of-pocket cash would be $61,640 - $1,322 = $60,318.
$60,318 for 2000 shares = $30.16 /share as your net break-even price.
While I can’t guarantee you that ADP won’t be below that price by next January I can tell you that ADP shares have not changed hands that cheaply since early 2003. Sales, cash flow, earnings, dividends and book value are all way higher now than they were then making today’s valuation way better. I’d be ok with owning those extra shares at that multi-year low price if it comes to that.
Astute buyers of ADP at the lows in March 2003 (at about 16.3x that year’s earnings) saw their shares climb from $27.20 to $47.30 in under 14 months.
Disclosure: Author owns shares and is short options on ADP.
ADP shares went up from $36.84 to $42.27 from the trade incetption date through the Jan. 15, 2010 expiration date of the suggested buy/write.
Including the generous dividend outright buyers made a total return of 18.4%.
Those who put on the buy/write combo did substantially better with a cash-on-cash total return of 36.3% for the 11 month holding period.
WEEKDAY TRADER | THURSDAY, MARCH 4, 2010
ADP Could Pay Off for Investors
By TERESA RIVAS | MORE ARTICLES BY AUTHOR
Shares of the nation’s leading payroll-processing company have gotten cheap.
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ONE WOULD THINK THAT TWO years of high unemployment would be awful for Automatic Data Processing (ticker: ADP), the nation’s leading payroll processor.
But the company, which counts many of the Fortune 500 companies as its clients, seems to be weathering tough times well.
It has a robust cash flow, virtually no debt, and a continually rising dividend. Given its strong position, the company, which controls just under 20% of the payroll-processing business in the U.S., is poised to benefit extremely well from a rebound in the economy.
At a Glance
Automatic Data Processing (ADP)
Stock Price: $41.71
52-Wk High: $44.50
52-Wk Low: $32.03
Market Cap: $21 billion
Est. FY 2010 EPS*: $2.40
FY 2010 P/E: 15.5 times
Est. Long-Term EPS Growth**: 10
Est. (FY’11/FY’10) EPS Growth: 5.4%
Revenue (trailing 12 months): $8.8 billion
Dividend Yield: 3.3%
CEO: Gary Butler
Headquarters: Roseland, N.J.
*ADP’s 2010 fiscal year ends June 30, 2010.
** Based on analyst estimates looking ahead three to five years.
Sources: Morningstar, Barron’s, Yahoo Finance, Thomson Reuters
The shares trade around 15.5 times trailing 12 months, quite cheap for a stock that historically commanded a premium of as much as 35% to the market multiple.
“It’s not often you get the opportunity to buy such a high quality company at a discount,” says Intrepid Capital Management president Mark Travis.
Credit Agricole analyst Craig Maurer notes that by contrast, main competitor Paychex (PAYX) “trades at a significant premium [22 times] despite its concentration in a less stable segment [smaller employers].” He also expects ADP to continue to gain market share from Paychex and other smaller competitors.
In the last year, ADP’s stock has returned a respectable 26.7%, but has trailed the Dow Jones U.S. Financial Administration Index’s 42.4% gain, and the overall market’s 62.6% rise.
That should change, as a recovery and ADP’s own strength will combine to return the company to its historically high growth.
Even through the hard times, ADP’s earnings per share have been surprising on the upside — and not just from cost cutting. Revenue, income, and profit are all growing year over year.
ADP also raised its quarterly dividend last fiscal year to 34 cents — the 35th consecutive year it has done so — and is projected by analysts to raise it again by 7% this fiscal year (ending June 30) and the next.
The stock’s current dividend yield is 3. 3%
Henry Sanders, portfolio manager of River Road’s Dividend All-Cap Value Portfolio, says that the company’s continually increasing dividend shows its confidence in its position and future growth prospects. “It’s one of only three companies left with a triple-A credit rating, and despite job losses, it has been able to benefit during the recession as business cut costs by outsourcing,” he tells Barrons.com.
Of course continued high unemployment isn’t great news for the company. Data out last week saw initial jobless claims jump by 22,000. Still, ADP has weathered the worst of the layoffs and has come out with $1.8 billion in cash on its balance sheet. Likewise, the increasing number of involuntary part-time workers may not have the full-time work that they want, but they are still drawing paychecks that ADP likely processes.
As an industry leader, ADP, which counts Amtrak and the District of Columbia as its clients, also has built in safeguards and advantages. The high cost of switching payroll providers means that companies are loath to change, and ADP can lock its clients into multiyear contracts. (Full disclosure: ADP handles payroll processing for Dow Jones, the publisher of Barrons.com.)
As Morningstar analyst Vishnu Lekraj notes, “This stickiness allows ADP to raise prices with very little resistance. ADP’s scale also keeps it price-competitive without much margin pressure, because it can leverage its large client base and minimal capital requirements to spread costs.”
Additionally, given its brand reputation and strong relationship with many large, stable companies, it can also sell other nonpayroll-related services, like human resources, outsourcing, and tax and benefits administration.
Another contrarian silver lining may be the company’s smaller dealer-service segment, which services auto retailers. The company expects that this segment can grow faster than employee services: Despite depressed auto sales, dealers seek third-party services to give them an edge in a hypercompetitive market. The company already has made market-share gains in this area.
Elsewhere, Thomas Weisel Partners analyst David Grossman notes that improving sales growth, retention and pricing are also contributing to a brighter outlook.
“ADP is a late-cycle stock and a combination of improving economic fundamentals and new growth initiatives will drive revenue growth,” Grossman wrote in a research note. “Accompanied by margin expansion and share repurchases [ADP] should yield single to low double-digit EPS growth and multiple expansion more commensurate with historical levels.”
ADP Could Go Hire
1:39
The world’s largest payroll processor should return to its former strength, given its clean balance sheet and diverse revenue streams. Barrons.com’s Teresa Rivas reports.
Of course, a prolonged period without any improvement in unemployment would make it more difficult for ADP to begin returning to its former high level of profit.
Yet, the company has come through the recession so far without a scratch to its balance sheet, and has been able to promote its other businesses to compensate for high unemployment. And management is confident in its return to its former growth, as evidenced by their comments and their chain of dividend raises.
Which means ADP’s investors should be getting a check of their own soon.