15 May 2010

ADP: Financial Gauge Analysis for the March 2010 Quarter

Automatic Data Processing (NASDAQ: ADP) earned $0.80 per share in the fiscal 2010's third quarter, which ended 31 March 2010.  ADP made the same amount in the third quarter of 2009.

In our earlier review of ADP's Income Statement, we compared the actual results to our "look-ahead" estimates.

We have now updated the various financial metrics we use to analyze Cash Management, Growth, Profitability and Value.  This post reports on the metrics for ADP and the associated financial gauge scores.  The metrics were calculated using data from ADP's current and historical financial statements, including the latest 10-Q report.

Automatic Data Processing performs payroll, tax, and other personnel-related Business Services for over 500,000 clients, large and small.  ADP pays one of every six private sector employees in the United States.  Additional background information about ADP and the business environment in which it is currently operating can be found in the look-ahead.

In summary, ADP's latest quarterly results produced the following changes to the gauge scores:

The current and historical values for the financial metrics that determine the gauge scores are listed below, with some brief commentary.

Cash Management31 Mar 201031 Dec 200931 Mar 20095-Yr Avg
Current Ratio (1)
Debt/CFO (years)
Inventory/CGS (days)N/AN/AN/AN/A
Finished Goods/InventoryN/AN/AN/AN/A
Days of Sales Outstanding (days)43.844.544.148.7
Working Capital/Revenue (1)18.8%17.2%15.2%20.8%
Cash Conversion Cycle Time (days)34.735.234.735.1
Gauge Score (0 to 25)10101012
1. Excludes Funds held for clients and Client funds obligations.
ADP, one of few remaining of U.S. companies with a AAA bond rating, has a Balance Sheet that features $2.0 billion in Cash  and Long-term Debt of only $41 million. The Current Ratio is over the 2.0-threshold for good liquidity, and the closely related Working Capital -- the difference between Current Assets and Current Liabilities, but excluding client funds and obligations  -- is about $2.0 billion. 

The amount of Working Capital relative to Revenue is stable, as is the Cash Conversion Cycle Time

Days of Sales Outstanding seems to be trending lower, which is one indication of better cash efficiency. 

Growth31 Mar 201031 Dec 200931 Mar 20095-Yr Avg
Revenue growth-1.1%-2.6%4.6%5.6%
Revenue/Assets (1)103.0%103.5%105.5%91.9%
Operating Profit growth15.1%15.7%9.2%9.6%
CFO growth6.6%-16.3%8.4%7.3%
Net Income growth11.8%11.7%6.8%14.3%
Gauge Score (0 to 25)751410
Revenue, CFO, and Net Income growth rates compare the last four quarters to the four previous quarters.  The Operating Profit rate is the annualized rate of growth in Operating Profit after Taxes over the last 16 quarters.
1. Assets excludes Funds held for clients.

Trailing-year Revenue growth has been negative after each of the last three quarters, but the rate of contraction has been slight: -1 to -3 percent.   High unemployment negatively affects sales of payroll and related services.  Downward pressure on Revenue has also come, for obvious reasons, from ADP's unit servicing auto dealers and from changes in foreign exchange rates.

Given the sales weakness, ADP has done a good job keeping Revenue-to-Assets as high as they have.  For this ratio, we exclude Client funds from Assets.

Under these circumstances, the Net Income and Operating Profit growth rates look quite healthy.  However, some digging below the surface indicates that much of the Net Income growth can be attributed to settlements that reduced income taxes by $120 million in the June 2009 quarter.  (This period will soon become part of the prior year in the trailing-year calculations.)

Similarly, the Cash Flow from Operations growth rate has fluctuated more than it would normally because of one-time events.  These events include the tax settlement mentioned above and a $158.7 million tax refund received by a Canadian subsidiary of ADP.

Profitability31 Mar 201031 Dec 200931 Mar 20095-Yr Avg
Operating Expenses/Revenue79.6%79.1%79.8%80.0%
Free Cash Flow/Invested Capital41.8%37.9%38.4%37.2%
Accrual Ratio6.0%-4.7%-0.3%-1.9%
Gauge Score (0 to 25)15171515

Operating Expenses have been stable when assessed on a trailing four quarters basis. 

The high returns on Invested Capital are impressive, but they did benefit from the one-time events mentioned above.  The fluctuations have made the Accrual Ratio less useful as a measure of earnings quality.

Value31 Mar 201031 Dec 200931 Mar 20095-Yr Avg
P/E vs. S&P 500 P/E
Enterprise Value/Cash Flow (EV/CFO)12.012.810.113.2
Gauge Score (0 to 25)47178
Share Price ($)$44.47$42.82$35.16-

Most of the Value gauge's decline can be attributed to ADP's share price being so inexpensive in March 2009 (when investors were down on all equities, but especially those with financial market exposure).  The value case wasn't as compelling on 31 March 2010 quarter as it was one year earlier.  However, all of the metrics above are less than (i.e., more attractive) than their long-term averages.

Instead of using ADP's quarter-end share price -- our standard practice -- to calculate the Value gauge score, plugging in the $41.80 closing price on 14 May 2010 would lift the Value gauge back up to 8 points.

Overall31 Mar 201031 Dec 200931 Mar 20095-Yr Avg
Gauge Score (0 to 100)36435945

In summary, the Cash Management and Profitability scores have remained stable during a period with economic headwinds for a company such as ADP.  The Growth and Value scores weakened, although the Value gauge is already recovering.

Extra caution is warranted when assessing ADP.  As mentioned above, one-time items over the last several quarters have temporarily boosted some of the financial metrics that determine the gauge scores.

Full disclosure: Long ADP at time of writing.

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