03 December 2010

ADP: Financial Gauge Analysis for the September 2010 Quarter

Automatic Data Processing (NASDAQ: ADP) earned $0.56 per diluted share on a GAAP basis in the September-ending first quarter of fiscal 2011.  Earnings per share were unchanged from the same three months of last year. 

A previous article examined ADP's Income Statement for the September quarter.  Reported earnings were $0.02 more than our $0.54 EPS estimate.

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 latest 10-Q.

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 well over 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's market value is currently about $22.5 billion on a fully diluted basis.

ADP is one of four remaining U.S. companies 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.

In fiscal 2010, which ended 30 June, ADP earned $1.2 billion on Revenue of $8.9 billion. 

ADP has three main businesses:  Employer Services, Professional Employer Organization Services, and Dealer Services.  Employer Services processes payrolls, administers benefits, and performs other services to enable firms "to staff, manage, pay and retain their employees."  PEO Services, by establishing co-employment relationships with customers and their employees, enables businesses to outsource various functions.  In this arrangement, an ADP entity becomes the employer of record for the affected employees.  Dealer Services helps dealers of vehicles and machinery manage their business activities.

In 2007, ADP divested its Brokerage Services Group business, which became Broadridge Financial Solutions (NYSE: BR).  (GCFR articles related to Broadridge can be found here.) 

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: 33 of 100 (down from 34)

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 Sep 201030 Jun 201030 Sep 20095-Yr Avg
Current Ratio (1)
LTD to Equity0.6%0.7%0.7%0.9%
Debt/CFO (years)
Inventory/CGS (days)N/AN/AN/AN/A
Finished Goods/InventoryN/AN/AN/AN/A
Days of Sales Outstanding (days)44.344.143.747.9
Working Capital/Revenue (1)18.0%19.0%16.2%20.6%
Cash Conversion Cycle Time (days)34.834.334.235.0
Gauge Score (0 to 25)991012
1. Excludes Funds held for clients and Client funds obligations.

The metrics that determine the Cash Management gauge score did not change appreciably during the latest quarter.

ADP, one of few remaining of U.S. companies with a AAA bond rating, has $1.2 billion in Cash and only $36 million of Long-term Debt.  Working Capital -- the difference between Current Assets and Current Liabilities, but excluding client funds and obligations  -- is also nearly $1.2 billion. 

The amount of Working Capital relative to Revenue is stable-to-decreasing, which is good.

The Current Ratio, also excluding client funds, is now well under 2.0, which doesn't help the the Cash Management gauge score.

Days of Sales Outstanding, an indicator of cash efficiency, has been relatively static for the last year.

Growth30 Sep 201030 Jun 201030 Sep 20095-Yr Avg
Revenue Growth3.4%0.9%-2.2%5.9%
Revenue/Assets (1)101.5%98.8%96.5%92.8%
Operating Profit Growth7.6%9.6%14.2%11.5%
CFO Growth17.9%7.6%-25.7%6.3%
Net Income Growth-9.7%-9.0%11.1%-3.3%
Gauge Score (0 to 25)154510
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 Growth gauge jumped because Revenue growth, Revenue/Assets, and Cash Flow growth are so much better than they were one year ago.

We exclude Client funds from Assets when making the Revenue/Assets calculation.  This ratio has improved significantly.

The Net Income growth rate appears worse than it might because prior-year income benefited from a tax settlement.

Conversely, one-time events such as tax refunds have made the growth rate for Cash Flow from Operations seem especially robust.  CFO in the September 2010 quarter was almost 9 percent less than in September 2009.

Profitability30 Sep 201030 Jun 201030 Sep 20095-Yr Avg
Operating Expense/Revenue80.6%80.2%79.2%80.3%
Free Cash Flow/Invested Capital35.9%41.3%34.0%37.0%
Accrual Ratio10.5%-1.3%-16.9%-1.5%
Gauge Score (0 to 25)13141716

Although ROIC and FCF/IC slipped in the latest quarter, the returns remained healthy enough to keep the deterioration in the Profitability gauge score to a single point.

There has been a small uptick in the ratio of Operating Expenses to Revenue, when assessed on a trailing four quarters basis. 

One time events, as mentioned above, that have made Cash Flow somewhat erratic are also affecting the Accrual Ratio.

Value30 Sep 201030 Jun 201030 Sep 20095-Yr Avg
P/E vs. S&P 500 P/E
Enterprise Value/Cash Flow (EV/CFO)11.811.012.913.5
Gauge Score (0 to 25)35138
Share Price ($)$42.03$40.26$39.30-

The Price/Earnings multiple increased because Net Income declined at the same time the share price moved up.  This does not help the Value gauge, but ADP's P/E has been much higher at other times (see chart.)

The Price/Sales Ratio has remained static.  It is still less than it's long-term average.

The EV/CFO ratio is less than it was one year ago, which could be considered a positive.  The volatility in Cash Flow  make this suspect.

Overall30 Sep 201030 Jun 201030 Sep 20095-Yr Avg
Gauge Score (0 to 100)33345145

A nice rise in the Growth gauge was balanced by smaller losses in Profitability and the highly weighted Value gauge.

As mentioned above, one-time items have skewed some a few of the financial metrics that determine the gauge scores.

Full disclosure: Long ADP at time of writing.


  1. I notice that you own ADP. Yet 33 seems like an uninspiring total (to say the least). Do you use your totals to identify good purchase candidates? If so, what is your minimum threshold?


  2. Jeff,

    I agree with your characterization of ADP's latest score. It hasn't been a great investment for me, but I have held onto it for other reasons.

    As for interpreting the gauge scores, I tend to consider the following:

    Is the score very high or very low? I consider 60 to be a very good score and 70 exceptional. Scores below 30 are troubling.

    Did the score change substantially over the last few quarters? The degree of change might be more of a signal than the absolute number itself.

    How does the current score fit within the max-min range for the subject company over the last three-to-five years?

    Have one-time events led to unreliable results? has something changed in the company's business model?