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Paychex, Inc. (PAYX): The Most Profitable Payroll Service Company

Since the end of 2012, Paychex, Inc. (NASDAQ:PAYX) has witnessed a nice rally, climbing from around $31 per share to more than $35 per share, a gain of 12.9%. Recently, it announced impressive Q3 results, which beat analysts’ estimates. Is Paychex a decent investment opportunity at its current price? Let’s find out.

Paychex, Inc. (NASDAQ:PAYX)

Business snapshot

Paychex, Inc. (NASDAQ:PAYX) is one of the leading providers of payroll, human resource, and benefits outsourcing solutions for around 567,000 small and medium business clients, operating in more than 100 offices in the U.S. The company has two streams of revenue: the service revenue and the interest on funds held for clients.

The majority of its revenue, $2.19 billion or 98% of total revenue, was service revenue, while the interest on funds held for clients generated only $43.6 million in 2012. Based on Dun & Bradstreet’s data, most of Paychex, Inc. (NASDAQ:PAYX)’s clients have a size of 1-4 employees, accounting for 42% of the company’s client base. Businesses, which have 5-19 employees, represented around 40% of the total client base of Paychex.

A cash cow

In the past ten years, Paychex has experienced consistent growth in its top line and bottom line. Revenue increased from $1 billion in 2003 to $2.23 billion in 2012, while profit rose from $293 million, or $0.78 per share, to $548 million, or $1.51 per share, during the same period.

In addition, Paychex is known for consistently increasing its dividend, with its dividend growing from $0.44 per share to $1.27 per share since 2003. What makes me interested is the increasing cash flow. While the operating cash flow climbed from $374 million in 2003 to $707 million in 2012, its free cash flow also rose from $313 million to $617 million in the same period.

In the third quarter, Paychex, Inc. (NASDAQ:PAYX) reported revenue of $593.3 million, higher than analysts’ estimate of $592.6 million. EPS came in at $0.40 per share in the third quarter, beating analysts’ estimate of $0.39 per share.

At the first glance, Paychex seems to have an over-leveraged balance sheet. As of February 2013, it had $1.6 billion in total stockholders’ equity, $571 million in cash and short-term investments, and no bank debt. The biggest item in the company’s liabilities is the client funds obligations of around $5.5 billion.

The most profitable with the highest dividend yield

At around $35 per share, Paychex, Inc. (NASDAQ:PAYX) is worth around $12.7 billion on the market. The market seems to value Paychex quite expensively at 12.5 times EV/EBITDA. Compared to its peers, including Automatic Data Processing (NASDAQ:ADP) and Insperity Inc (NYSE:NSP), Paychex’s valuation stays in between.

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