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Paycom Earnings Review - COVID Impacts Slow Growth

Proverbs Chapter 12 verse 1 states, "Whoever loves discipline loves knowledge,

but whoever hates correction is foolish."

Discipline is hard, whether it relates to the physical discipline of working out to achieve a goal, or the uncomfortable position of being disciplined by someone else. I have been on both ends of those examples at the same time during my past college basketball days. I find it much easier to be the one disciplining than the one taking constructive criticism. It's always important to recognize the foolishness of discounting others words of advice and wisdom.


For investing, sometimes it feels like I am being disciplined for my actions as the market decides the SP path each and every day. But just as it is foolish to despise correction, it is equally foolish to not take the market's gyrations seriously, especially during earnings season. For Paycom Software, Inc. (PAYC), I agree with the market's reaction.

Paycom

Paycom is a leading provider of comprehensive, cloud-based human capital management (“HCM”) solution delivered as Software-as- a-Service (“SaaS”). The company provides functionality and data analytics that businesses need to manage the complete employment lifecycle, from recruitment to retirement. Paycom's solution requires virtually no customization and is based on a core system of record maintained in a single database for all HCM functions, including talent acquisition, time and labor management, payroll, talent management and human resources (“HR”) management applications. This user-friendly software allows for easy adoption of the solution by employees, enabling self-management of their HCM activities in the cloud, which reduces the administrative burden on employers and increases employee productivity.


Paycom's key financial metrics as of today's filing and on a Last Twelve-Month, LTM, period are as follows:

  • Net Cash Position: $121 million

  • Revenues: $841 million

  • Gross Margin, GM: 85%

  • Operating Cash Flow, OCF / Margin: $227 million / 27%

  • Free Cash Flow, FCF / Margin: $70 million / 8%

  • Shares Outstanding: 58 million

  • Recurring Rev: $799 million

  • Implementation & Other Rev: $15 million

Paycom's fiscal year ends every December 31st of each calendar year. For the full 2020 year, Paycom witnessed Revenue growth at 14%, reflecting a strong drop from the annualized 35% return over the past four years. This was largely related to COVID impacts over the past year. Despite this, GM improved by 20 basis points, but OCF/FCF margins declined by 300/350 basis points, while nominal values were flat and down by over 20%.


The core driver for Paycom's Revenue is Recurring Revenue which includes fees for talent acquisition, time and labor management, payroll, talent management and HR management applications as well as fees charged for form filings and delivery of client payroll checks and reports.


Additionally as part of Recurring Revenue, the company collects funds from clients in advance of either the applicable due date for payroll tax submissions or the applicable disbursement date for employee payment services. These collections from clients are typically disbursed from one to 30 days after receipt, with some funds being held for up to 120 days, and Paycom earns interest as funds for clients are invested.

Paycom is an example of a company that witnessed a slow-down directly from COVID impacts. This provided a ripple effect across the company's entire financial performance. I think that Paycom is a great example of a company that will likely have a strong uptick in Revenue performance, but the immediate short-term remains murky and Paycom's valuation is stretched.


Key updated valuation metrics for Paycom include:

  • Enterprise Value, EV: $24 billion

  • EV/Revenues: 28 times

  • Net Debt/OCF: N/A

  • Stock Price, SP/OCF per Share: 106 times

In late December leading up to the earnings report and soon after, five analysts upgraded Paycom's SP to a PT average at $475 per share. Paycom's SP dropped towards $400 after the results. Today, Paycom is trading with a strong premium at 28 times EV/Revenue, and an OCF/share at over 106 times. Over Paycom's history since 2013, these levels reflect a significant premium.


Looking out over the next five years, I believe that Paycom will get its Revenue growth accelerated and back on track. However, even with an annualized return towards 25%, I don't see compelling investment value at today's SP. I have an 18-month PT set at just below $530 per share. This considers a return towards a 30% OCF margin, and a OCF/share multiple back towards 50 times.

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