24 February 2008

ADP: Financial Analysis through December 2007 (Update)

We previously posted an analysis of ADP's (ADP) preliminary financial results on the quarter that ended 31 December 2007. The financial statements in this report were limited in that the Balance Sheet was abbreviated and the Cash Flow Statement was missing.

ADP subsequently submitted a more complete quarterly report in a 10-Q filed with the SEC. The 10-Q data changed some of the metrics that determine our gauge scores. The Cash Management gauge score increased by two points, and the Growth gauge score lost one point. However, these two minor differences canceled each other out, and the Overall gauge remained at a pretty good 49 out of 100 points.

For a review of the latest quarterly Income Statement and how it compared with our predictions for the quarter, see our earlier post.

ADP, which is one of a mere handful of U.S. companies with a AAA bond rating, is a top provider of payroll and other personnel-related IT services to corporate customers. It also publishes the monthly ADP National Employment Report(SM) that measures total non-farm private employment.

ADP has been restructuring. It spun off its Brokerage Services Group business on 30 March 2007. The divested company was renamed Broadridge Financial Solutions, and it now trades publicly under the ticker symbol BR -- see our initial analysis of BR here. On 6 July 2007, ADP sold an airline ticket-clearing business based in Spain, which had annual revenues of about $75 million. ADP also acquired three businesses during the second half of 2007, but the acquisitions were not material to the company's finances.

ADP has about $20.7 billion of corporate and client funds (the latter being the lion's share) invested in debt securities. Of this amount, $6.1 billion is in money market securities and other cash equivalents, and the remaining $14.7 billion is in available-for-sale securities. In the latest 10-Q, the company states:

At December 31, 2007 approximately 95% of the available-for-sale securities held a AAA or AA rating, as rated by Moody’s, Standard & Poor’s and, for Canadian securities, Dominion Bond Rating Service.

ADP’s investment portfolio does not include any asset-backed securities with underlying collateral of sub-prime mortgages or home equity loans, nor does it contain any collateralized debt obligations (CDOs) or collateralized loan obligations (CLOs). ADP’s investment portfolio does include senior tranches of AAA-rated, fixed rate credit card, auto loan, and other asset-backed securities.

The Company believes that its available-for-sale securities that have fair values below cost are not other-than-temporarily impaired since it is probable that principal and interest would be collected in accordance with contractual terms, and that the decline in the market value was due to changes in interest rates and not changes in credit risk. The Company currently believes that it has the ability to hold these investments until the earlier of market price recovery and/or maturity and currently intends to do so. The Company’s assessment that an investment is not other-than-temporarily impaired could change in the future due to new developments or changes in the Company’s strategies or assumptions related to any particular investment.

This wording did not change from the 10-Q for the quarter that ended on 30 September 2007.

With full 10-Q set of data for the December 2007 quarter, our gauges display the following scores:

Cash Management. This gauge increased from 14 points in September to 16 points now.

The following measures all helped the gauge:
The following measure was the only drag on this gauge score:

Growth. This gauge increased from 17 points in September to 18 points now.

The following measures all helped the gauge:
  • Revenue growth = 13.8 percent year-over-year, more than making up for last year's -3.4 percent
  • Revenue/Assets = 101.3 percent, up dramatically from 75.7 percent in a year; sales efficiency is improving. The spin off and share repurchases both helped reduce Assets.
  • Net Income growth = 18.1 percent year-over-year, up from -4.9 percent
Net income for the year benefited from a change in the income tax rate from 37.9 to 36.1 percent

The following measure held the score down:
  • CFO growth = -0.8 percent year-over-year, compared to -15.6 percent one year ago.

Profitability. This gauge was unchanged from September at 14 points.

The measures that helped the gauge were:
The measures that hurt the gauge were:

Value. ADP's stock price inched down from $45.93 to $44.53 over the course of the quarter -- it has since fallen under $40. The Value gauge, based on the year-end closing price, moved up from 5 to 8 points.

The measures that helped the gauge were:
  • Enterprise Value/Cash Flow = 16.0, down from 18.4 in December 2006, but just slightly above the 5-year median value of 15.7
  • P/E = 21.7, quite a bit below the 5-year median of 26.4
  • P/E to S&P 500 average P/E = 27 percent premium, nearly half its five-year median value
  • Price/Revenue ratio = 2.8, compared to a five-year median of 3.3
The average P/E for the Business Services industry is currently 18. The average Price/Revenue for the industry is currently 2.14.

An Overall gauge score of 49 out of 100 possible points qualifies as a good score for ADP and the best in four years. Our only real concern is Cash Flow growth. The results need to be treated with some skepticism because the historical financial data we use for comparison might not be representative of the current corporate organization.

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