Paychex: Trading At A High Valuation (NASDAQ:PAYX)

Investment Thesis

In this thesis, I will analyze the Paychex, Inc. (NASDAQ:PAYX) Q2 FY23 results and discuss their future growth potential. I think we might see stagnant revenue growth in PAYX in 2023 due to inflation and other macroeconomic headwinds. In my opinion, they are overvalued and might not be able to provide significant returns to their shareholders in 2023. So I assign a hold rating on PAYX.

About PAYX

Paychex offers integrated human capital management solutions for human resources and insurance services for small to medium-sized businesses. They also provide HR solutions, employer compliance, risk management outsourcing, and retirement services administration, including electronic funds transfer and other administrative services. They also offer property and casualty coverage insurance services like cyber security protection, workers’ compensation, and commercial auto. They run their business in the U.S., India, and Europe. PAYX was founded in 1971 and is headquartered in Rochester, New York.

Financial Analysis

PAYX recently announced its Q2 FY23 results. They beat the market EPS estimate by 3% and the market revenue estimate by 1.2%. The reported revenue for Q2 FY23 was $1.1 billion, an increase of 7.4% compared to Q2 FY22. I believe the primary reason behind this rise was an increase in the number of worksite employees, which led to the revenue growth of professional employer organization and Insurance solutions. The other reason was expanding revenue per client. The net income for Q2 FY23 was $360.3 million, a rise of 8.5% compared to Q2 FY22. In my opinion, the main reason behind the surge was the rising demand for HCM ancillary services. The diluted EPS for Q2 FY23 was $0.99, an increase of 8.8% compared to the Q2 FY22.

The total expenses for Q2 FY23 were $718 million, an increase of 7% compared to Q2 FY22. I think the primary reason behind the increased expenses was a rise in wage rates and an increased workforce. Overall, the financial performance of PAYX was decent. Inflation impacted their growth, and I believe macroeconomic headwinds might hinder their growth in upcoming quarters.

Technical Analysis

PAYX is currently trading at the level of $115.13, below its 200 ema, which is at the level of $120. When a stock is trading below its 200 ema, it is considered a downtrend. The stock has been stuck in the range of $140-$110 for the last 1.5 years. The stock is facing strong resistance from the $140 level; it tried to break it three times but failed. Now the stock is trading near its support zone, and it has touched the support zone seven times in the last 1.5 years. When a stock continuously trades near the support zone, the support zone becomes weak, and there is a high chance we can see a breakdown in the stock. If the stock gives a closing below $110 in a daily time frame, we can see a down move of up to the level of $85. One can only enter the stock when it gives a strong closing above $140 in a daily time frame, but for now, I believe it is better to avoid this stock.

Should One Invest In PAYX?

The revenue estimate of PAYX for FY23 is $4.98 billion, which is 8% higher than the FY22 revenue. They expect the revenue growth of the management solutions to be in the range of 7%-8% and the revenue growth of PEO and insurance solutions to be in the range of 5%-7% for FY23. The management expects slow revenue growth in FY23, and I believe the company might face a hard time in the upcoming quarters with the macroeconomic headwinds.

PAYX has a quant valuation grade of d-, which shows that the company has a poor valuation. They have a P/E (FWD) ratio of 27.08x compared to the sector ratio of 18.29x. A PEG ratio of 0.5-1 is considered suitable for a company. A company having a PEG ratio above one is considered overvalued, and PAYX has a PEG ratio (FWD) of 3.59x compared to the sector ratio of 1.48x. They have a Price / Sales ratio (FWD) of 8.33x compared to the sector ratio of 2.37x. After looking at the company’s valuation metrics, I believe they are overvalued. They have a revenue growth rate (YOY) of 11.18% and a revenue 3-year (CAGR) of 6%; with the current growth rate, I think they are not a suitable investment opportunity.

The shareholding pattern of PAYX looks decent. Institutions hold 73% of the shares in the company, which is a positive sign. It is considered safe if institutions own more than 60% of the shares in a company.

Risk

Volatility In Political And Economic Environment

Trade, economic, and political conditions may substantially change, and credit markets could experience periods of constriction. These conditions might impact their business due to inflation, lower transaction volumes, and rising costs may reduce their profitability. They invest their corporate and clients’ funds into money markets and (AFS) securities. The funds are subject to general market and liquidity risks. Any unfavorable change in the market might severely affect their balance sheet.

Bottom Line

Paychex, Inc. posted decent quarterly results, but I believe with inflationary pressure and other macroeconomic headwinds, the company might find it difficult to maintain the revenue growth rate. I think they may even see a drop in its revenue in upcoming quarters. PAYX is overvalued and has a poor growth rate compared to its peers. So after analyzing all the aspects and growth potential, I assign a hold rating on Paychex, Inc.