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Processing Payrolls at Paychex

Paychex (PAYX) is a provider of payroll, human resource services, retirement services, and insurance services to small and medium-size firms, explains David Coleman, an analyst with Argus Research, a leading independent research firm.

Most of Paychex’s operations are domestic, though the company has exposure to Europe. The company has consistently earned high returns on invested capital, maintained a solid balance sheet, and generated healthy free cash flow that can be returned to shareholders.

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We also believe that Paychex has room to grow its core business: serving small companies with fewer than 50 employees. This segment remains under-penetrated and the economics of outsourcing payroll and HR services remain favorable.

Paychex has a growth-by-acquisition strategy. In fiscal 3Q18, the company completed the acquisition of Lessor Group, a provider of payroll and HCM software solutions based in Denmark and serving clients in Northern Europe.

In fiscal 2Q18, the company purchased HR Outsourcing, which was a key driver of top-line growth in fiscal 3Q18. In December 2018, it purchased Oasis Outsourcing, the nation’s largest privately owned professional employer organization.

Given the company’s solid long-term track record, we believe that PAYX shares are a suitable core holding in a diversified portfolio.

Our financial strength rating on Paychex is High, the highest rank on our five-point scale. The company receives high marks on our financial strength criteria of debt levels, fixed-cost coverage, cash flow generation, and profitability.

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On the fundamentals, PAYX shares appear attractive from several angles. In terms of P/E, the shares are trading at 27.5-times our FY19 EPS forecast, compared to a five-year historical range of 23-30.

The current-year P/E is now above the peer average of 21. We feel that PAYX deserves to trade at a premium to peers based on the company’s above-average ROE and the dividend yield.

Our target price of $85 assumes a multiple of 29.7-times our FY19 EPS estimate, near the high end of the five-year historical range of 23-30. In our view, the company’s consistent returns, dividend growth, high margins, and clean balance sheet justify the higher multiple.

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