Will ADP’s Strong Gains Of Recent Years Continue?

Automatic Data Processing
ADP
is expected to publish its Q1 FY’24 earnings on October 25, reporting on a period that saw the U.S. job market remain strong. We expect ADP’s revenue for the quarter to come in at about $4.52 billion roughly in line with the consensus estimates. We project that earnings will stand at about $2.04 per share, compared to a consensus estimate of $2.02. So, what are some of the trends that are likely to drive the company’s results? See our interactive dashboard analysis on ADP Earnings Preview for more details on how ADP revenues and earnings are likely to trend for the quarter.

Amid the current financial backdrop, ADP stock has seen strong gains of 45% from levels of $175 in early January 2021 to around $250 now, vs. an increase of about 15% for the S&P 500 over this roughly 3-year period. However, the increase in ADP stock has been far from consistent. Returns for the stock were 40% in 2021, -3% in 2022, and 4% in 2023. In comparison, returns for the S&P 500 have been 27% in 2021, -19% in 2022, and 13% in 2023 – indicating that ADP underperformed the S&P in 2023. In fact, consistently beating the S&P 500 – in good times and bad – has been difficult over recent years for individual stocks; for heavyweights in the Industrial sector including CAT, UPS, and UNP, and even for the megacap stars GOOG, TSLA, and MSFT.

In contrast, the Trefis High Quality Portfolio, with a collection of 30 stocks, has outperformed the S&P 500 each year over the same period. Why is that? As a group, HQ Portfolio stocks provided better returns with less risk versus the benchmark index; less of a roller-coaster ride as evident in HQ Portfolio performance metrics. Given the current uncertain macroeconomic environment with high oil prices and elevated interest rates, could ADP face a similar situation as it did in 2023 and underperform the S&P over the next 12 months – or will it see a strong jump?

ADP’s business has held up quite well in recent quarters as the labor market remained strong. ADP posted a stronger-than-expected set of Q4 FY’23 results (ended June), with revenues rising almost 8% to $4.5 billion and adjusted net earnings rising 25% to $781 million. Growth was driven by strong demand for the company’s human capital management and HR outsourcing services, robust retention rates, as well as higher interest income on client funds, amid surging interest rates. Interest on funds held for clients increased 86% to $236 million in Q4. It’s likely that these trends should hold up through Q1 FY’24, as well. For perspective, total nonfarm payroll employment rose by 336,000 in September led by the leisure and hospitality sector, while the unemployment rate stood at about 3.8%. This should result in an expanding base of clients and continued strong demand for ADP’s services. ADP has also done a good job of managing its margins so far and the company has guided for adjusted EBIT margin expansion of 60 to 80 basis points for this fiscal year.

We remain neutral on ADP stock with a $272 price estimate, which is about 9% ahead of the market price. While ADP trades relatively high at 28x projected FY’24 earnings, the company’s consistent growth and stable cashflows justify this to a large extent. See our analysis of ADP valuation for more details on what’s driving our price estimate for ADP stock.

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