Expect Paychex to Reinvest More

Wide-moat Paychex (PAYX) completed its second fiscal quarter with results comparable to our near-term expectations. During the quarter, the company generated year-over-year service revenue growth of 6.9% with HRS revenue growth offsetting weak payroll services growth of only 88 basis points. Management attributed this to a smaller average client size. Though smaller average client size was a headwind to growth this quarter, we suspect smaller clients generate a higher margin as they are less expensive to service. For the quarter, pretax margins declined 210 basis points sequentially. Normally, we wouldn’t pay too close attention to quarter-to-quarter fluctuations in margins, but we do suspect that Paychex will need to reinvest more in its business in the coming years. During the quarter, the company spent nearly $77 million on capital expenditures, a more than 300% increase from the previous quarter. The company grew its earnings per share to $0.60, an increase of four cents from the previous year. After this quarter’s results, we’ll be tweaking some near-term forecasts and increasing our fair value estimate to $52 per share from $50, as a result of these changes and an increase from the time value of money. We continue to believe shares are significantly overvalued and do not reflect the modest rise in competition.

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