ADP: Financial Analysis through December 2008 (Update)

We previously posted an analysis of ADP's earnings announcement for the three months that ended on 31 December 2008, which was the second quarter of the company's fiscal 2009.  Our evaluation was incomplete because the press release did not include a Cash Flow Statement and the Balance Sheet was condensed.

Using the 10-Q ADP recently filed with the SEC, we updated the analysis to incorporate the data that hadn't previously been disclosed.


Automatic Data Processing, Inc. (NASDAQ: ADP) provides payroll and other personnel-related information technology services to well over 500,000 employers worldwide.  It competes with firms such as Paychex, Inc. (NASDAQ:PAYX).  The company is also known for the monthly ADP National Employment Report on non-farm private employment. 

As a payroll processor, ADP is feeling the effects of decreased employment in the U.S. 

ADP is one of a mere handful of U.S. companies with a AAA bond rating, and it is an S&P 500 Dividend Aristocrat.  ADP has hiked the dividend for 34 consecutive years, including a 14 percent increase last November.

ADP retained its eponymous three-character ticker symbol in October 2008 when it changed its share listing from the New York Stock Exchange (NYSE: NYX) to the NASDAQ Stock Market (NASDAQ: NDAQ).

In 2007, ADP divested its Brokerage Services Group business, which became Broadridge Financial Solutions (NYSE: BR).


With the additional data in the 10-Q, our gauges now display the following scores.

• Cash Management: 13 of 25 (down from 17 in September)
  
• Growth: 18 of 25 (down from 20)
  
• Profitability: 15 of 25 (up from 13)
  
• Value: 12 of 25 (down from 13)
  

• Overall: 55 of 100 (down from 57)
  

 The 10-Q didn't change our evaluation of the latest quarter's Income Statement, including the comparison with our previously communicated expectations.

ADP's decision to reallocate the net increase in Client Fund Obligations from the Investing to the Financing section of the Cash Flow Statement causes us some difficulty.  This arcane but big-dollar change -- $3.5 billion in the last fiscal year -- significantly alters the Net Cash Used in Investing Activities.  We use this figure to compute the Accrual Ratio, which is an indicator of Earnings Quality and Profitability.  For consistency with historical data, we adjusted the newly reported Cash Flow figures to comply the older classification.

Cash Management	December 2008	3 months ago	12 months ago
Current Ratio	1.6	1.4	1.8
LTD/Equity	1.1%	0.8%	0.7%
Debt/CFO	0.0 yrs	0.7 yrs	0.0 yrs
Inventory/CGS	N/A	N/A	N/A
Finished Goods/Inventory	N/A	N/A	N/A
Days of Sales Outstanding (DSO)	45.2 days	39.7 days	51.6 days
Working Capital/Market Capitalization	6.2%	5.7%	5.7%
Cash Conversion Cycle Time (CCCT)	36.6 days	30.9 days	38.2 days
Gauge Score (0 to 25)	13	17	16

The small increase in Long Term Debt/Equity is inconsequential for this AAA company.  Total Debt is effectively zero, relative to cash flow.

A small change in Days of Sales Outstanding was the reason the score dropped 4 points.

Growth	December 2008	3 months ago	12 months ago
Revenue growth	8.5%	11.6%	13.5%
Revenue/Assets	110%	102%	93%
CFO growth	32.8%	34.6%	-0.8%
Net Income growth	11.2%	15.1%	17.7%
Gauge Score (0 to 25)	18	20	18

Growth rates are trailing four quarters compared to four previous quarters.

Given current economic conditions, it isn't surprising that ADP's Revenue growth has slowed.  (The company forecasts Revenue growth between 2 and 3 percent in fiscal 2009.)   However, CFO growth was robust, and Net Income growth, though slipping isn't too bad.

Profitability	December 2008	3 months ago	12 months ago
Operating Expenses/Revenue	80.1%	80.2%	80.3%
ROIC	32.3%	34.1%	27.0%
FCF/Equity	33.6%	34.6%	21.9%
Accrual Ratio	-3.4%	+8.2%	-9.7%
Gauge Score (0 to 25)	15	13	18

Operating Expenses have been extremely stable when assessed on a trailing four quarters basis.  The high and steady ROIC and FCF is comforting.  Good Cash Flow in the most recent quarter brought the Accrual Ratio down, signaling high-quality earnings.  The Accrual Ratio's rise in September appear anomalous.

Value	December 2008	3 months ago	12 months ago
P/E	16.3	18.1	20.1
P/E to S&P 500 average P/E	121%	101%	113%
Price/Revenue	2.2	2.4	2.8
Enterprise Value/Cash Flow (EV/CFO)	10.0	10.8	16.0
Gauge Score (0 to 25)	12	13	7

The price of ADP shares decreased from $42.75 to $39.34 during the December quarter.  The Value gauge score in the table above is based on the price when the quarter ended, which is our standard practice.

The valuation ratios can be compared with other companies in the Business Software and Services industry.

While ADP's P/E has been trimmed, its premium relative to the S&P 500 has increased.  In other words, ADP has retained more of its value than many other companies.  This might indicate that ADP has benefited from some flight-to-safety buying.

Overall	December 2008	3 months ago	12 months ago
Gauge Score (0 to 100)	55	57	54

ADP surprised us with positive (if modest) Revenue and Net Income growth in the quarter, whereas we expected small declines.  The company's Balance Sheet appears AAA.  The current Overall gauge score is good.