Time to Cash in Paychex?
Just before the Fourth of July holiday, Paychex (PAYX) - Get Report reported fourth-quarter revenue of $753.9 million, up 8.9%, and earnings of 49 cents a share. Its stock rose 6% to a 52-week high.
But should you sell it now?
In its earnings report, Paychex said its total service revenue rose 9% to $741.6 million, up 8%. The company ended fiscal 2016 with $2.9 billion in revenue. Payroll services increased 5% for the quarter and 4% for the year. The Paychex human resources business continued to perform well and was up 14% for the quarter and 13% for the year. Paychex ended the year with 605,000 payroll clients, up 2.5%.
Fiscal 2016 marks the fifth year that net income and earnings per share have grown at an 8.4% and 8.5% consolidated annualized growth rate, respectively. Operating cash flow ended the year at just over $1 billion and return on equity was up 4 points over last year to 40%.
The company spent $290 million and bought back 6.1 million shares of stock during the year, and it has an authorization to repurchase another $350 million worth of stock.
On the conference call after the earnings report was released, management gave guidance for 2017 payroll service growth of 4% and a rise in human resource revenue of between 12% and 14%. Net income is expected to tack on another 8% next year.
Here's my problem with the stock.
Assuming the economy stays steady, Paychex will probably earn $2.23 per share in 2017 and about $2.42 the year after. While the company is well run, it's hard to see how margins can expand much over the next year or two.
Paychex is spending heavily on technology and headcount, while U.S. payroll growth is clearly slowing. The company is seeing less revenue growth per client and operating margins have most likely peaked for this cycle. Just before the recession, operating margin peaked at 36.4%.
With the stock at $60, its already trading at 27 times forward estimates, a cycle high.
While U.S. nonfarm payroll is still growing, the growth has been slowing since October, when the U.S. added 295,000 jobs. In May, the U.S. only added 38,000 jobs.
Year to date, Paychex stock is up almost 16% and is at its 52-week high. With a high valuation and slowing business trends, I think the good news is already built in to the shares.
I think it's time to cash in.
This article is commentary by an independent contributor. At the time of publication, the author held no positions in the stocks mentioned.