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Get Four
|  | NOVEMBER 7, 2003
 TECH KNOWLEDGE By Jonathan Rudy, CFA Better Days for Payroll Services Given the brightening employment picture, S&P has upgraded its recommendations on top names ADP and Ceridian We at Standard & Poor's upgraded our outlook for the payroll provider subindustry to positive from neutral on Oct. 7, following the government's report showing corporations added 57,000 jobs in September, which has now been revised to an increase of 125,000. Upward revisions for August showed that monthly payrolls increased for the first time since January, 2003. While we don't believe the September report was the absolute bottom in unemployment, and we realize that this can be a volatile number from month to month and is a lagging indicator, we do believe that as the economy continues to strengthen, employment will gradually improve as well. Indeed, the employment picture should be notably better a year from now, in our opinion. Further confirmation of this forecast came in Nov. 6's report on initial claims for jobless benefits, which fell by 43,000, to 348,000 in the week ending Nov. 1. Economists had been expecting a number in the range of 380,000 to 386,000. Even better, the Labor Dept.'s monthly payroll report on Friday, Nov. 7 was much stronger than expected, with an increase of 126,000 nonfarm jobs, handily beating the 58,000 estimate (see BW Online, 11/7/03, "There's Hope for Hiring, After All"). A SOLID CREDIT. As a result of our improved outlook for the payroll market, we raised our recommendation on Automatic Data Processing (ADP ; Nov. 6 price: $37) from hold to buy. We believe that this market leader will benefit notably from a strengthening job market (see BW, 11/17/03, "New Hiring Means More Work For ADP"). We also believe that ADP's valuation remains attractive at these levels, and based on our discounted cash-flow analysis (DCF), our 12-month target price is $48 a share, using our assumptions of an 11.5% discount rate and a terminal value growth rate of 3%. With $2.3 billion in cash and securities and little debt, ADP has a strong balance sheet, in our view. The Roseland (N.J.)-based company is one of a handful of U.S. nonfinancial companies to have a high triple-A credit rating. Approximately 62% of ADP's fiscal 2003 (ended June) revenues (which totaled $7.15 billion) came from its core employer-services business, which provides payroll, human-resources, benefits administration, and tax-filing and -reporting services to more than 460,000 clients. Brokerage services, which made up approximately 22% of ADP's revenue, has been the hardest-hit segment over the last couple of years due to the significant slowdown in the financial-services industry. ADP provides securities processing, desktop productivity applications, and investor communications services to the industry. ADP's two other significant segments are Dealer Services, which provided about 11% of revenues, and Claims Services, which contributed about 5% of revenues. RISING EPS. In June, ADP acquired ProBusiness Services, another employee-administration outsourcer, for about $500 million in cash. We believe that this deal will help boost ADP's revenue growth. We anticipate revenues rising roughly 5% in fiscal 2004 and 3% fiscal 2005. Due to some strategic investments in its core businesses in fiscal 2004, we estimate a slight decline in earnings per share, to $1.60 from $1.68 in fiscal 2003. However, we do expect noticeable operating leverage as a result of this investment, and we expect EPS to rise to $1.77 in fiscal 2005. We recommend that investors buy the shares of this industry leader, given its strong balance sheet, cash flow, and a high quality of earnings. Plus, ADP trades at a discount to its peers on an enterprise-value-to-sales basis, at 2.8 vs. the peer average of 5.2. We upgraded Ceridian (CEN ; Nov. 6 price $21.54) to accumulate from a hold recommendation. We believe Ceridian's relative valuation is attractive as well, at a 2.6 enterprise-value-to-sales ratio, a discount to its peers. Based on our DCF analysis, our 12-month target price for Ceridian is $24, with our assumptions of an 11% discount rate and a terminal value growth rate of 3%. WIDER MARGIN. Approximately 74% of Ceridian's 2002 revenues (which totaled $1.19 billion) came from its Human Resources Solutions division, which offers services and software to help employers more effectively manage their workforces and information that's important to human-resource processes. The rest of its revenue was generated by the Comdata unit, which provides transaction processing and information services to the transportation and retail industries. We anticipate Ceridian's revenues rising approximately 7%, to $1.35 billion, in 2004. And thanks to a wider operating margin, we expect operating EPS to increase about 10%, to 92 cents. Based on Ceridian's attractive valuation, and that it's trading at a discount to our target price, we would recommend accumulating the shares at these levels. With the job tide rising, all of the payroll provider boats should rise as well. However, we believe at this point, ADP has more upside potential than Ceridian.  Analyst Rudy follows software stocks for Standard & Poor's Edited by Karyn McCormack All of the views expressed in this research report accurately reflect the research analyst's personal views regarding any and all of the subject securities or issuers. No part of analyst compensation was, is or will be, directly or indirectly related to the specific recommendations or views expressed in this research report. Standard & Poor's Regulatory Disclosure Any advice, analysis, or recommendations contained in articles labeled "Insight from Standard & Poor's" reflect the views of Standard & Poor's, which operates separately from and independently of BusinessWeek Online. It is possible that BWOL may from time to time publish information that is not consistent with advice, analysis, or recommendations that are published by Standard & Poor's. Standard & Poor's and BusinessWeek Online are each units of The McGraw-Hill Companies, Inc.
BW MALL
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