49 Years and Counting: A Closer Look at the Dividend Power of ADP (NASDAQ:ADP)

introduction

It’s time to talk about it automatic data processing (Nasdaq: ADP)An arrow I called “One of the most impressive dividend growth stocks on my radarIn the title of my last article, which was… Written on February 5.

What makes ADP so special is not just its double-A credit rating, its massive portfolio, or the fact that it is one year away from becoming the dividend king with 50 consecutive years of dividend growth, but also that it tells us a lot about an economy.

Since my February article, the stock has fallen 1%, including dividends, lagging the S&P 500 by about eight points.

In this article, I’ll revisit the bull case, take a closer look under the hood, and weigh the risk/reward in light of the increasing pressure on the labor market.

So, since we have a lot to discuss, let’s talk Get it right!

Huge addressable market

Automated data processing is about streamlining processes.

The company has become a leader in human capital management software and solutions. It currently has more than one million customers in 140 countries, served by more than 60,000 employees.

The company’s services help deliver salaries to more than 41 million workers. This includes more than 25 million employees in the United States (one in six!).

Moreover, while it is fair to emphasize that recruiting services are cyclical, the automation of HR tasks benefits from secular tailwinds.

According to the company, we are addressing a $150 billion addressable market that is growing at 5-6% annually.

This is a big deal and opportunity for company innovation, which includes next-generation HR platforms to run operations efficiently.

The company, which turned 75 years old this year, believes it has unparalleled service and expertise, allowing it to continually increase its market share in an addressable and ever-growing market.

This includes adopting new technologies to further improve the “new user experiences” listed in the overview above.

During JPMorgan’s recent annual global technology, media and telecommunications conference, the company noted that it has invested heavily in generative artificial intelligence and other advanced technologies to enhance its product offerings and operational efficiency.

The best thing is that these investments are already paying off.

According to the company, AI-based tools have improved service agent productivity by reducing call processing times, while advanced analytics have improved sales processes.

Additionally, the company is expanding its services beyond traditional payroll services in areas such as benefits administration, talent acquisition, and compensation planning.

These services are enhanced by the growing demand for 401(k) retirement planning and workers’ compensation insurance.

Currently, the company administers 401(k) plans for approximately 150,000 clients out of a client base of more than 850,000.

It does this with great success, with the company achieving a record retention rate of 92.2% last year.

Not only is this a record, it’s also a great number overall.

The numbers below show average retention rates for each industry, with 35% to 84% considered a “good” retention rate.

• Media and professional services have the highest average retention rate at 84%
• Healthcare companies have a retention rate of up to 77%.
• IT and software retains 77% of its customers
• Retail companies have an average CRR of 63%
• Hospitality, restaurant and travel companies had the lowest average score at 55%.

But wait there’s more!

In 2023, the company generated 89% of its revenue in the United States, with Europe being its largest international market, accounting for nearly 7% of total revenue.

The company wants to capture a larger market share in international markets, as its business model has proven to be very successful in the United States.

This growth strategy includes organic growth as well as merger and acquisition opportunities.

Continuous growth and shareholder returns

With all that said, cyclical growth right now is not a company’s best friend.

While overall economic conditions remain stable, we are seeing a deterioration in key factors such as consumer confidence, loan quality and hiring plans.

As we can see in the latest NFIB report, small business hiring plans have taken a turn for the worse, with net hiring plans reaching 10%.

However, the company continues to perform well.

In the third quarter of fiscal 2024, the company achieved revenue growth of 7%, resulting in adjusted EPS rising by 14%.

Furthermore, the Employer Services segment, which is a significant portion of the company’s business (67% in 2023), posted revenue growth of 8% on a reported basis and 7% on an organic constant currency basis.

The sector saw record bookings for the third quarter, keeping the sector on track with its full-year guidance.

The EPS outperformance was supported by higher margins, with adjusted EBITDA margins up 140 basis points.

Over the past 10 years, the company has continually grown its portability, increasing its operating margin from approximately 17.5% to approximately 26.0% – despite higher inflation since the pandemic.

Looking ahead, the company provided a positive outlook for the fiscal year, expecting consolidated revenue growth of 6% to 7% and EBIT margin improvement of at least 60 basis points.

Please note that the overall company guidance trends below show that despite weak employment fundamentals, the company maintained its revenue and earnings guidance.

This bodes well for shareholders.

On November 8, 2023, the company raised its dividend 12% to $1.40 per share per quarter. This was the 49th consecutive dividend increase, meaning the company is one year away from earning the official Dividend King title.

This has a dividend payout ratio of 2.3%, a payout ratio of 59%, and a five-year CAGR of 12.4%, which means it will become a mature dividend farmer with high dividend growth.

On top of a good payout ratio, the dividend is protected by a healthy balance sheet.

This year, analysts expect the company to end up with more than $100 million in net cash, which translates to more cash than total debt.

It also has a credit rating of AA-, one of the best in the world.

Furthermore, if it were up to analysts, we could expect consistently high earnings growth to continue.

Using the FactSet data in the chart below, the company is expected to grow earnings per share by 11% this year, the midpoint of the company’s guidance.

In 2025 and 2026, EPS growth is expected to reach 9% and 8%, respectively.

Since ADP currently trades at a blended P/E ratio of 27.0x, with a long-term normalized P/E ratio of 24.9x, we get a fair target price of around $270, which is 10% higher than the current price.

Including its dividend, we can look forward to annual returns of between 7 and 10%, which would be lower than the company’s 11.9% annual return since 2003.

Please note that this performance includes a sideways trend since 2021.

Do you know what happened in 2021?

Employment expectations have peaked.

On top of the NFIB Employment Index that I’ve already briefly featured, we see that other leading indicators, such as the Philadelphia Fed’s Manufacturing Employment Index, have trended south since 2021.

While ADP is performing well thanks to long-term growth, I don’t expect a meaningful upside in ADP stock until we get a rebound in employment indicators.

Please keep this in mind, as further deterioration may put pressure on ADP’s stock price and guidance.

Since I believe the Fed will have to keep inflation “higher for longer” to combat inflation, I am a bit more cautious on cyclical stocks and hope to buy a slightly lower ADP – despite my bullish hypothesis.

Away

ADP remains a standout in the dividend growth space thanks to its imminent Dividend King status, supported by strong business fundamentals and continued innovation that is helping the company penetrate a huge global market.

Moreover, ADP’s broad market reach, strategic investment in AI, and high customer retention highlight its resilience and growth potential.

However, with economic indicators pointing to a tougher hiring environment, caution is warranted.

However, I maintain an optimistic outlook on ADP, as I believe ADP has the potential to deliver significant capital gains and dividend growth over the long term.

Pros and Cons

Positives:

• Strong earnings growth: ADP is about to become the dividend king with 49 years of consecutive dividend increases.
• Market leadership: With more than 1 million customers and innovative HR solutions, ADP is a leader in human capital management.
• Strong financial health: ADP has an AA- credit rating and a strong balance sheet, which provides stability.
• Technological innovation: Investments in artificial intelligence and advanced technologies support productivity and operational efficiencies.
• Expanding services: In addition to payroll, ADP is growing its offerings in benefits administration, talent acquisition, and compensation planning.

cons:

• Cyclic pressures: Economic uncertainties and weak employment indicators could put pressure on ADP’s stock price and guidance.
• High rating: With a current P/E ratio of 27.0x, ADP is trading above its long-term average, which could limit capital gains in the short term.