30 August 2010

ADP: Financial Gauge Analysis for the June 2010 Quarter

Automatic Data Processing (NASDAQ: ADP) earned $0.42 per share in fiscal 2010's fourth quarter, which ended 30 June 2010.  Earnings per share were 41 percent less than the $0.70 ADP made in the same quarter of 2009. 

The prior-year result was boosted by a tax benefit of $0.24 per share.  Excluding this one-time benefit, diluted quarterly earnings from continuing operations declined from $0.45 in June 2009 to $0.42 per share in June 2010.

A previous article examined ADP's Income Statement for the June quarter.  Reported earnings fell $0.01 short of the $0.43 per share we had forecast.

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 those in the 10-K for fiscal 2010.

Before getting into the details, we will take a step back to introduce the subject of today's analysis.

Automatic Data Processing performs payroll, human resource, data processing, and outsourcing Business Services for more than 500,000 clients, large and small, in the United States and other countries.  ADP pays one of every six private sector employees in the U.S.  The company is one of four remaining of U.S. firms with a AAA bond rating.  It is also an S&P 500 Dividend Aristocrat, having hiked its dividend for 35 consecutive years.

Fortune Magazine deemed ADP to be Most Admired in the Financial Data Services industry. 

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:
  • Overall: 34 of 100 (down from 36)

The current and historical values for the financial metrics that determine the gauge scores are listed below, with some brief commentary.  Readers are encouraged to verify these figures and calculate others as they see fit using the filings available at the SEC's web site and elsewhere.

Cash Management30 Jun 201031 Mar 201030 Jun 20095-Yr Avg
Current Ratio (1)
LTD to Equity0.7%0.7%0.8%1.0%
Debt/CFO (years)
Inventory/CGS (days)N/AN/AN/AN/A
Finished Goods/InventoryN/AN/AN/AN/A
Days of Sales Outstanding (days)44.043.843.648.3
Working Capital/Revenue (1)19.0%18.8%15.4%20.8%
Cash Conversion Cycle Time (days)34.334.733.735.0
Gauge Score (0 to 25)910912
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 $1.6 billion in Cash  and Long-term Debt of only $40 million.  Working Capital -- the difference between Current Assets and Current Liabilities, but excluding client funds and obligations  -- is also nearly $1.6 billion. 

The amount of Working Capital relative to Revenue is stable.

The Current Ratio, also excluding client funds, slipped under 2.0, which took a point from the Cash Management gauge score.  However, the ratio is at its five-year average value.

Days of Sales Outstanding, an indicator of cash efficiency, has flattened.

Growth30 Jun 201031 Mar 201030 Jun 20095-Yr Avg
Revenue Growth1.0%-1.2%0.9%7.0%
Revenue/Assets (1)98.9%102.9%99.5%92.9%
Operating Profit Growth9.8%15.1%14.5%11.5%
CFO Growth7.6%6.6%-11.8%8.1%
Net Income Growth-8.9%11.8%14.3%1.0%
Gauge Score (0 to 25)57610
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.

The results of the June quarter enabled trailing-year Revenue growth to get back over zero, albeit slightly.  Nevertheless, it may be encouraging that payroll-processor ADP was able to achieve positive Revenue growth given the high level of unemployment in the U.S.

Revenue-to-Assets declined, but the ratio remains well above its five-year average.  We exclude Client funds from Assets when making this calculation.

The negative growth rate for Net Income was made worse by a fiscal 2009 tax settlement that reduced taxes and boosted prior-year income.  Conversely, the growth rate for Cash Flow from Operations benefited from a $158.7 million tax refund received by a Canadian subsidiary of ADP.

Profitability30 Jun 201031 Mar 201030 Jun 20095-Yr Avg
Operating Expense/Revenue80.2%79.5%79.3%80.3%
Free Cash Flow/Invested Capital41.3%41.8%38.1%38.8%
Accrual Ratio-1.3%0.6%-5.0%-3.4%
Gauge Score (0 to 25)14151716

The Profitability gauge score reflects the laudable rates of return on Invested Capital.  The returns are above their five-year averages.

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

Greater Cash Flow helps the Accrual Ratio's positive assessment of earnings quality.

Value30 Jun 201031 Mar 201030 Jun 20095-Yr Avg
P/E vs. S&P 500 P/E
Enterprise Value/Cash Flow (EV/CFO)
Gauge Score (0 to 25)54198
Share Price ($)$40.26$44.47$35.44-

The Price/Earnings multiple stayed constant because Net Income and the company's share price declined proportionately in the June quarter.   Since Revenue increased in this period, the Price/Sales Ratio came down a tad.

In general, the current value metrics are attractive when compared to their five-year averages, but they are not quite as appealing when compared to their value one year earlier.  This explains why the Value score was so much higher in June 2009 than June 2010.

Overall30 Jun 201031 Mar 201030 Jun 20095-Yr Avg
Gauge Score (0 to 100)34366145

None of the gauge scores changed by more than 2 points in the second quarter.  Small decreases in the Cash Management, Growth, and Profitability gauges were just slightly more significant that the small rise in the double-weighted Value gauge. 

As mentioned above, one-time items have skewed some a few of the financial metrics that determine the gauge scores.   The overall weakness that is, nevertheless, evident can be attributed to the negative marginal effects high unemployment has on a payroll-processing company.

Full disclosure: Long ADP at time of writing.

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