Wednesday, April 6, 2011

Paychex Inc: $PAYX cash flow valuation

Current Price: ~ $32/share
Projected Yield: ~ 3.85%

Paychex competes in the payroll outsourcing industry. It is the second-largest player in terms of revenue and focuses on providing this service to small and medium-size business (50-100 employees). Paychex was created from the consolidation of 17 payroll processors in 1979 and services about 550,000 clients. The firm has 12,500 employees and is based in Rochester, N.Y.

I estimated the firm's WACC today at 11.38% using the Capital Asset Pricing Model and the company's recent SEC filings.


Recent free cash flows and noted growth rates:
Year
FCF $Millions
2001
260
2002
249
2003
313
2004
340
2005
397
2006
488
2007
552
2008
642
2009
624
2010
538

Average Annual Growth FCF: approx. 9%

CAGR FCF: approx. 8%
Consensus Forecast Industry 5-Year Growth: approx. 17% per year
Consensus Forecast Company 5-Year Growth: approx. 12% per year

Scenario 1
Assuming the company achieves a 5-year growth rate in FCF of 12% per year, and assuming that after the next five years, the company achieves no growth in FCF or 0% growth per year forever:

Discounted Cash Flow Valuation

Year
FCF $Millions
0
538
1
616
2
690
3
773
4
865
5
969
Terminal Value
9540

The firm's future cash flows, discounted at a WACC of 11.38%, give a present value for the entire firm (Debt + Equity) of $8362 million.  The firm has no debt so the fair value of the firm's equity could be $8362 million.  $8362 million / 362 million outstanding shares is approximately $23 per share and a 20% margin of safety is $18/share.


Scenario 2
Assuming the company achieves a 5-year growth rate in FCF of 12% per year, and assuming that after the next five years, the company achieves growth in FCF of 3% per year forever:

Discounted Cash Flow Valuation
Year
FCF $Millions
0
538
1
616
2
690
3
773
4
865
5
969
Terminal Value
12955

The firm's future cash flows, discounted at a WACC of 11.38%, give a present value for the entire firm (Debt + Equity) of $10,354 million. The firm has no debt so the fair value of the firm's equity could be $10,354 million.  $10,354 million / 362 million outstanding shares is approximately $29 per share and a 20% margin of safety is $23/share.


Sources
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

2 comments:

  1. Both scenario is so different than each other. This seems a big change in industry.
    -IT outsourcing Los Angeles

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  2. Hi John:

    Thanks for the comment. I like the business, the FCF and the yield.

    Morningstar's take: Paychex was formed through the consolidation of 17 payroll processing companies in 1979. It has been one of the most successful human resources outsourcing firms in the United States. The minimal amount of capital required for operations and the firm's significant competitive advantages have allowed it to produce returns on invested capital that have averaged 70% over the past 10 years. High customer switching costs, inherent scalability, and a respected brand image are the main drivers of the firm's wide economic moat, and we believe they form a potent combination that will last for some time to come.

    I wonder if the firm might be just a little bit overpriced here given the state of the U.S. economy and tough conditions for small businesses.

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