Dividend Review of Automatic Data Processing (ADP)

Introduction

Automatic Data Processing (ADP) is a Dividend Aristocrat which was founded by Henry Taub in 1949.

ADP provides technology based outsourcing solutions to employers and manufacturers. It operates in three segments

1. Employer Services
2. Professional Employer Organisation Services
3. Other

Leadership

Carlos Rodriguez was named President and Chief Executive Officer in 2011, making him ADP’s sixth CEO since its 1949 founding.

During his time at the helm, ADP has transitioned from payroll processor to human capital management services provider leveraging technology to design a more personalized world at work.

Rodriguez also currently serves on the board of Hubbell Incorporated. This is a multinational company that focuses on the design and manufacture of electrical components that it sells for both residential and commercial building products

He is also a member of World 50 which is a private group generally reserved for top-level executives. As a member, Rodriguez is frequently asked to share his ideas and solutions to certain problems plaguing the business world today. It is a forum designed to spread ideas and work collaboratively to bring lasting change.

Business Analysis

The company generates most of its revenue on a recurring basis from payroll services, but has expanded its suite of products over the last decade to cover HCM mobile and cloud solutions.

Overall, ADP provides solutions to more than 800,000 clients in over 140 countries. The company’s clients range from single-employee companies to some of the world’s largest enterprises.

Employer Services

In Q3 2020 Financial Highlights, The ES segment accounted for $2.8B or 70% of revenue. This is up 3% from the same period last year. This revenue growth was in line with expectations however there was a significant 9% drop is new business booking in march due to covid-19.

Professional Employer Organisation Services

In Q3 2020 Financial Highlights, The PEO segment accounted for $1.2B or 30% of revenue. This is up 11% from the same period last year. This is largely due to the Acceleration in Average Worksite Employees growth.

Company Growth

By geography, approximately 85% of ADP’s sales are generated in the U.S.

Over the past 10 years revenue has grown by 5% on average or closer to 7% over the last 5 years.

In January the company expected new business bookings to increase 6%-7% in 2020, in addition to a slightly higher customer retention rate. This has been revised in April 2020 where bookings are expected to drop 20% due to the elevated of out of business losses.

They also expected a strong 6% revenue growth and EBIT margin increase of 100bps to 125bps. This has been revised to losing 30bps to 50bs  and a revenue growth of 3%

Dividends

ADP’s current Dividend yield is 2.40% based on current prices which is higher than the 1.96% S&P 500 Dividend yield.

On November 12, the Board of Directors of the Company approved a 14.90% increase in the quarterly cash dividend. This raised the quarterly dividend to $0.91 per share on the Company’s Common Stock.

ADPs next dividend payment will be on the 1st of july for $0.91.

Dividend Growth

ADP has an impressive 44 year streak for increasing dividends.

Since 1999 they have grown the dividend by 12.69% on average  Some years they have increased the dividend by as high as 27% but they have had a couple of years where they have increased by just under 4%

Comparing the dividend growth rate to the S&P 500 index dividend growth, ADP has constantly outperformed the index over 3, 5, and 10 year time periods.

Payout Ratio

The Payout Ratio is a good indicator of the sustainability of the current dividend. If the payout ratio is too high that there is a real risk that the dividend could be cut at some point in the future.

ADP has a 57% FCF payout ratio which will well below my acceptable threshold of 75%.

Earnings

Earnings have been strong over the last 10 years which have grown over 7.5% on average. At the beginning of 2020 ADP expected to grow EPS by 12 -14% but this has been reduced to 4 – 7% amid the COVID-19.

If management can continue to deliver on its long-term earnings growth, then the company should be able to easily continue its impressive dividend growth streak.

Valuation

Projected Dividend Growth

ADP is predicting a reduced earnings growth however I would expect them to hold their dividend ration constant. This would suggest that the annual dividend growth should drop below the average of 12%.

After the last financial crash we saw the dividend growth reduced to nearly 3% and I would suggest that we will see a similar dividend growth in the future before slowly ramping back up as targets of 14% are reached in fiscal year 2021.

I would forecast that the dividend growth rate will slow down to between 6-8% annually going forward.

Dividend Discount Model valuation

The single-stage dividend discount model takes into account several factors I have discussed thus far.

• Current annual dividend payment $3.64
• Projected annual dividend growth – 6%
• My desired annual rate of return -8%

Using these assumptions, the dividend discount model calculates the fair value of ADP stock to be $182 per share.

CLOSING THOUGHTS

ADP seems to be a high-quality company with an enviable 44 dividend growth record. With the potential to continue delivering double-digit earnings and dividend growth for the foreseeable future, ADP is a company I will be considering as a long-term buy at the current prices.

Thanks for reading and Happy Investing!

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