Paychex is my top pick for 2022, this investor says

Heading into the new year, it might be about time to take rising interest rates as an investment theme, and on that front portfolio manager David Driscoll thinks investors looking for good ideas should try Paychex (Paychex Inc Stock Quote, Charts, News, Analysts, Financials NASDAQ:PAYX), a stock that’s had a great year but could go even higher in 2022, according to Driscoll.

“Paychex, if you think about it, for every quarter per cent interest rate increase that happens in the United States Paychex makes $3 million in free money and that’s on the the amount of money that they have to remit to the IRS every payroll tax every two weeks,” said Driscoll, President and CEO of Liberty International Investment Management, who named Paychex one of his three Top Picks in a BNN Bloomberg segment on Friday. 

Paychex is a payroll, human resource and benefits outsourcing company with its software solutions running the breadth of business from self-employed through small, medium and enterprise-level, with the bulk of its business in the SMB bracket. The Rochester, NY-headquartered company has over 100 offices around the US and Europe and has over 710,000 payroll clients worldwide, with revenue topping $4 billion for its latest fiscal year.

The stock has done very well this year, even as its business was a little stagnant over the pandemic-influenced environment. The $48-billion market cap PAYX had been rising steadily over the years preceding 2020, but after the initial market drop in February and March of that year, the stock started to take off, climbing from about $60 per share to $125 by this past November. A well-received quarterly report on December 22 has pushed PAYX up to $134 as of early trading on Monday, December 27. That makes for a year-to-date return of almost 44 per cent. 

“The company is finally getting some due respect,” said Driscoll. “It’s now trading at a new all-time high and that’s because it’s not just the payroll processing. It’s been the HR business, the 401k, the insurance and all of their side businesses have made things a lot stickier for their small and medium sized businesses, and even COVID rules have helped them to be able to attract more more business.”

“Their earnings were up [last] week and performance numbers exceeded expectations. Roughly, instead of six per cent they came out with 12 per cent growth in revenues and profits. And as a result the stock shot higher,” he said.

Paychex beat analysts’ estimates for top and bottom numbers in its fiscal 2022 second quarter financials delivered on December 22. The company saw revenue up 13 per cent year-over-year to $1.11 billion and EPS up 21 per cent to $0.91 per share. The consensus forecast was for $1.06 billion and $0.80 per share. (All figures in US dollars.)

Paychex said the growth came from rising employee numbers within its client base and further sales growth and client retention.

“The environment is more complicated than ever for small- and medium-sized businesses,” said CEO Martin Mucci in a press release. “Trends that emerged during the pandemic continue unabated, particularly the demand for human resource advice and the need for benefits packages that address talent needs.”

“We continue to support our clients in a proactive manner, as we have done throughout the pandemic. We have assisted businesses in securing $6.0 billion in employee retention and paid leave tax credits to date. Most recently, we introduced an automated tool that businesses can leverage to capture and store employee vaccination status and communicate with their employees on an ongoing basis,” he said.

Drilling down, Paychex saw its Management Solutions business grow by 14 per cent to $832.0 million while Professional Employer Organization and Insurance Solutions revenue grew by 11 per cent to $262.4 million.

Earlier in December, the US Federal Reserve said it expects to raise interest rates three times in 202 as part of a planned attack on inflation which has been at its highest level of rising prices seen in decades. The Fed has indicated it will raise its key interest rate which has been kept at zero in effort to spur economic recovery while also projecting three more increases in 2023 and two in 2024.

“We are prepared to use our tools to make sure high inflation doesn’t get entrenched,” Fed Chair Jerome Powell said in a video news conference. “This is a strong economy, one in which it’s appropriate for interest rate hikes.”

Driscoll says Paychex has shown its ability to grow and retain its client base, which makes for more dependable earnings down the line.

“This is a company with very little debt, very strong free cash flows and the stickiness: once [clients] become customers they tend not to leave, so it’s just building and building upon one after the other,” Driscoll said.
“And two thirds of all businesses in the United States have employees at less than 50 which is Paychex’s bailiwick,” he said.