Automatic Data Processing (ADP) is a conservatively managed, diversified company that has increased its dividend payout for 35 consecutive years.
-Average revenue growth over the past five years: Less than 3%
-Average earnings growth over the past four years: About 14%
-Cash flow growth has been negative over the past three years.
-Dividend yield: 3.4%
-Boasts an immaculate balance sheet.
-The P/E ratio is currently under 16, which to me appears to be an attractive price.
Automatic Data Processing (ADP) is one of the world’s largest outsourcing companies. ADP handles human resource needs, benefits, payroll, and computing processes for many companies around the world. They prepare employee payroll checks, direct deposits, and tax reports. They capture, calculate, and record employee time and attendance. They perform hiring services. They provide record-keeping and administrative services for retirement plans. Basically, if it’s an uninteresting part of a business, ADP can handle it for a company.
ADP also assists companies in certain industries with computing needs. For client businesses that sell cars, boats, are involved with heavy trucking, or similar fields, ADP can supply important software to help the business operate, from inventory, to networking, to data integration.
Revenue, Earnings, Cash Flow, and Margins
ADP has had mediocre business growth over the past few years, but nonetheless remains strong.
ADP has had irregular revenue growth of less than 3% annually, on average, over the past five years.
ADP has enjoyed normalized net earnings growth of approximately 14% on average over the past four years.
Diluted earnings-per-share have increased from $1.32 in 2005 to $2.63 in 2009, which represents an average of 19% annual growth over this four year period. This larger growth in earnings-per-share than company-wide earnings is due to the company continually repurchasing its shares, thereby reducing the number of shares outstanding. When the number of total shares is decreased, the profit is split among these fewer number of shares, and therefore each share pulls in more profit.
Cash Flow Growth
ADP has had negative cash flow growth over the past three years in this difficult economy.
ADP currently has a profit margin of approximately 14%. This is significantly lower than the profit margin of competitor Paychex, which has a 24% net profit margin.
ADP has had fairly impressive dividend growth over the past several years, but the growth has been slowing lately. The company has managed to raise their dividend for 35 consecutive years. The current dividend yield is around 3.4%.
Over the past 5 years, ADP has grown its dividend by an average of 18% annually, which is quite impressive. The most recent increase, from $0.33 per quarter to $0.34 per quarter, however, is only about a 3% increase.
The dividend payout is about 50%, showing that the dividend is safe and has room to grow.
Over the past 4 years, ADP has repurchased nearly $4.5 billion of its own stock, which is a little over 20% of its current market capitalization of around $20 billion. In fact, ADP typically has spent more money repurchasing its own stock than paying dividends, even though the dividends are moderately sized. This shows that ADP focuses on returning the majority of its earnings to shareholders.
ADP’s balance sheet can only be described as immaculate. The company has a LT Debt/Equity ratio of 0.01, which means that they have very, very little long-term debt. Most companies of this size have a significant amount of debt, but ADP is a very conservatively run business that consists of nearly all-assets and next to nothing in liabilities.
There are currently only four non-financial American companies that still hold the highest possible credit rating from S&P, the AAA rating. These companies are Johnson and Johnson (JNJ), Exxon Mobile (XOM), Microsoft (MSFT) and Automatic Data Processing (ADP). These companies all are large, have diverse income streams, and have very little financial leverage. By investing in ADP, you are investing in what is considered to be an extremely safe company.
Of course, rating agencies like this are taking a lot of criticism lately because they provided good ratings for companies that, during the latest economic crisis, were shown to be extremely leveraged and risky entities. So, don’t take ratings at face value. One can see, however, from looking at the company, that they are indeed a very well-protected business.
A hallmark of a good long-term dividend investment is a company with a strong competitive advantage, or an “economic moat”. ADP has a moat in the form of high switching costs. When a company has high switching costs, it means that it takes a lot of work, frustration, time, or money to switch products or services. Since ADP handles numerous aspects of a given business, that business has to go through a lot of hassle if they want to switch to a competitor.
Taking both of these things into account, ADP is a very reliable business. Because it also pays a moderately sized, growing dividend, and spends a lot of its income buying back its own shares, ADP further defines itself as a serious contender for any dividend portfolio.
Even the companies that are considered the least risky according to rating agencies do, of course, have risk. ADP has a flawless balance sheet giving it an incredible amount of protection in any environment, but ADP is also dependent on the overall economy for growth. ADP handles the needs of other businesses, so it requires a favorable, business-friendly economy in order to flourish. The services that ADP provides for a company are mostly necessary, meaning they are generally not services that can be cut during a time of cut-backs, but ADP is still vulnerable to companies that cease to exist or let go of employees, as that means they have fewer companies and employees to provide services to.
Conclusion and Valuation
In conclusion, I think ADP is a pretty good value at the current price of about $42. The P/E is currently under 16, the company has 35 consecutive years of increased dividends with a 3.4% current yield, and has among the strongest balance sheets possible.
Full Disclosure: I do not own ADP stock at the time of this writing, but it is on my stock watch list for possible purchase.
You can see my full list of individual holdings here.
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