ADP Delivers Robust FY 2022 Result as Labor Markets Prove Resilient Despite Economic Headwinds

Business Strategy & Outlook

ADP has invested heavily over the past decade to develop public cloud native solutions and consolidate its portfolio of disparate platforms. As of fiscal 2021, ADP has successfully migrated most of its small and midsize clients to its strategic platforms and will be migrating enterprise clients to its new HCM platform over the coming decade, as well as rolling out its new underlying payroll and tax engines. While the platform migrations ultimately result in higher retention and profitability, the forced migrations will likely create a catalyst for enterprise clients to reassess providers, temporarily hindering both metrics. ADP faces fierce competitive pressure from nimble upstarts, legacy peers, accounting software, and ERP providers. The new solutions will allow ADP to compete more aggressively on functionality, reduce software maintenance costs, and provide scope for greater operating leverage, supporting margin uplift. However, the increasing competitive pressure will result in greater pricing pressure and force ADP to maintain high levels of investment to ensure the functionality of its product offering remains competitive.

This investment is in addition to the continued investment in sales and implementation required to roll out new solutions and migrate clients. As such, the ADP’s price increases will be limited to about 0.5% a year on average, in line with recent growth but below long-term averages, limiting margin expansion potential. The increased regulatory complexity, tight labor markets, and growing adoption of hybrid work will underpin strong demand for ADP’s solutions, supporting greater share of wallet and market share gains in the small and midsize market. This includes greater penetration of the outsourced payroll and HR model. However, the expected forced platform migrations to hamper ADP’s enterprise market share growth over the next decade before gradually recovering as the new platform is adopted in the market. In aggregate, the ADP’s overall market share to grow modestly for the five years to fiscal 2027, followed by higher growth as platform migrations complete.

Financial Strengths

ADP is in a strong financial position. At the end of fiscal 2022, ADP’s balance sheet was modestly geared with net debt/EBITDA of 0.3. During fiscal 2021, ADP almost tripled long-term debt to $3 billion to fund share repurchases and optimize its capital structure with low cost debt. The expected ADP’s annual operating income can comfortably cover annual interest expense on its debt at least 60 times over the forecasted period. ADP also has access to short-term funding facilities to meet client’s obligations rather than liquidating available for sale securities. ADP has returned over $20 billion of capital to shareholders during the eight years to fiscal 2022 through dividends and share repurchases. The expected ADP’s strong free cash flow generation will support a dividend payout ratio of about 60% over the period. The balance sheet is robust, and ADP has ample scope to increase leverage to execute on bolt-on acquisitions.

Bulls Say

ADP benefits from high client switching costs, a scale based cost advantage, intangible brand assets, and a powerful referral network.
Despite facing fierce competitive pressures and undergoing forced platform migrations, ADP has retained high revenue retention and improved operating margins over the past decade.
ADP has a strong record of returning capital to shareholders through dividends and share repurchases.

Company Description

ADP is a provider of payroll and human capital management solutions servicing the full scope of businesses from micro to global enterprises. ADP was established in 1949 and serves over 990,000 clients primarily in the United States. ADP’s employer services segment offers payroll, HCM solutions, HR outsourcing, insurance and retirement services. The smaller but faster-growing PEO segment provides HR outsourcing solutions to small and midsize businesses through a co-employment model.

(Source: Morningstar)

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