Paychex Set to Rally on Rate-Rise Forecasts: EcoPulse
Shares of Paychex Inc. (PAYX:US) are poised to outpace the broader market as the prospect of higher interest rates and more job creation will buoy the payroll-service provider.
The company generates income from the interest earned on money it holds for clients, a so-called float, so rising Treasuries yields are “pure gravy” to its net income, said David Yucius, who oversees $250 million in assets as president of Aurora Investment Counsel Inc. in Atlanta. Paychex stock has lagged behind the Standard & Poor’s 500 Index, amid a backdrop of low rates and slow job growth for small- to medium-sized business in the past five years, he said.
Shares of the Rochester, New York-based company have risen 51 percent since April 3, 2009, trailing the S&P 500’s 119 percent increase. The yield on 10-year U.S. Treasuries — at 2.6 percent as of 5 p.m. in New York yesterday, according to Bloomberg Bond Trader data — is down from as high as 4 percent in April 2010.
By year-end, the yield will be 3.4 percent, according to the median forecast of economists surveyed by Bloomberg. Such an increase, driven in part by the Federal Reserve tapering its bond-buying program, would serve as a tailwind for Paychex, Yucius said, adding that central bank Chair Janet Yellen’s Feb. 11 testimony to the House Financial Services Committee underscored her plans to continue reducing asset purchases.
A boost from higher rates will coincide with an improving economic backdrop marked by more hiring, according to Walter Todd, who oversees about $950 million at Greenwood Capital Associates LLC in Greenwood, South Carolina. These are “positive dynamics” for certain stocks like Paychex, which his firm doesn’t hold, though it does hold Automatic Data Processing Inc. (ADP:US), another payroll-service processor, he said.
February hiring, scheduled to be released March 7, rebounded to 150,000 from 113,000 in January and 75,000 in December, according to the median estimate of economists surveyed by Bloomberg and Labor Department data.
All this is making Paychex’s valuation more compelling for some investors, Yucius said. The stock currently is trading at a multiple of about 14 times on a price-to-earnings basis before interest, taxes, depreciation and amortization, he said. That’s below the 10-year average of about 16.
These new services have lower margins than Paychex’s core business, which is growing at only about the same pace as GDP, so this could “impinge profitability” for the company, said Matthew Beesley, who helps oversee about $125 billion as head of global equities in London at Henderson Global Investors Holdings. This creates a dilemma because Paychex is trying to expand in less-profitable areas while facing increased competition in payroll-service processing, he said.
Analysts’ consensus estimates for Paychex earnings have lagged behind their forecasts for companies in the S&P 500 Index. In fact, the Paychex estimate has been “dead in the water” for the past 12 months — basically unchanged at $1.70 (PAYX:US) a share for the fiscal year ending in May, Beesley said. This will need to change for Paychex stock to outpace the market.