Paychex Inc: $PAYX Cash Flow Valuation Update

Current Price: ~ $33/share
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.           

Estimated WACC for the firm today is 10.11% using the Capital Asset Pricing Model and the company's recent SEC filings.

Recent free cash flows and noted growth rates:

Year	FCF $Millions
2003	313
2004	340
2005	397
2006	488
2007	552
2008	642
2009	624
2010	538
2011	615
2012	617

Average Annual Growth FCF: ~ 8%

CAGR FCF: ~ 8%

Consensus Forecast Industry 5-Year Growth: ~ 15% per year

Consensus Forecast Company 5-Year Growth: ~ 10% per year

Internal Growth Rate: ~ 1.5%

Sustainable Growth Rate: ~ 6%

Scenario 1
Average FCF (2012, 2011, 2010) is $590 million

• Start at $590 million FCF
• Assume a 5-year growth rate in FCF of 10% per year, then no growth or 0% growth in FCF per year forever:

Discounted Cash Flow Valuation

Year	FCF $Millions
0	590
1	649
2	714
3	785
4	864
5	950
Terminal Value	10338

The firm's future free cash flows, discounted at a WACC of 10.11%, give a present value for the entire firm (Debt + Equity) of $9329 million. The firm has no debt and $9329 million / 363 million outstanding shares is approximately $26 per share.  A 20% margin of safety is $21/share.

Scenario 2
All else being equal,

• Assume a 5-year growth rate in FCF of 8% per year, then 4% growth in FCF per year forever:

Discounted Cash Flow Valuation

Year	FCF $Millions
0	590
1	637
2	688
3	743
4	803
5	867
Terminal Value	15323

• Present Value of the entire firm (Debt + Equity): $12252 million
• Value of Equity: $12252 million or $34/share
• 20% margin of safety is $27/share

Sources

Morningstar.com

Yahoo! Finance

Paychex.com

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