Payroll and human resource service giant Paychex (Nasdaq:PAYX) posted second-quarter earnings on Monday that beat analyst expectations. Going forward, the company stands to benefit as employment trends improve along with the overall economy; unfortunately for shareholders, a strong share price rally since September means most of this improvement is already discounted into the share price. Let's take a look at Paychex's earnings report and what it could mean for the company going forward.


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PAYX's Second-Quarter Update
The company's Q2 report saw total revenue increase 3% to $512 million. Flagship payroll services, which competes with larger arch rival ADP (Nasdaq:ADP), accounted for the bulk of the total top line at 70%, and experienced a modest 1% increase. Management cited an increase in payroll checks per client and an annual price increase that offset a 2.2% drop in the client base. The other segment is human resource services, which saw sales jump 10% and competes with the likes of Hewitt Associates, which was recently acquired by Aon (NYSE:AON). Accenture (NYSE:ACN) also provides similar outsourcing services, as does Administaff (NYSE:ASF). Management attributed the strong performance to an improving economy, new clients and another price increase.

Operating expenses fell 2% and SG&A costs rose 6% for modest total expense growth of 1%. This allowed for some sales leverage and pushed operating income ahead by 6% to $203.9 million, or a very healthy 39.8% of sales. Net income also rose 6% to $133.9 million, or 37 cents per diluted share. (For related reading, see Analyzing Operating Margins.)

Outlook
For the full year, the company expects revenue growth between 3% and 5% as the core payroll services top line should increase in the low single digits and human resource services should improve in the low double digits. Management is calling for net income growth between 4% and 6%. Analysts currently project full-year earnings of $1.38 and sales just north of $2 billion.

Bottom Line
At the current share price, Paychex trades at a forward P/E of more than 22. The stock has rallied strongly since September and is currently bumping up against its highs over the past year. As such, the valuation now discounts much of the recovery the payroll and human resource services are likely to see as the economy improves. A new CEO has proclaimed a commitment to better sales execution, while higher interest rates will allow the company to earn more on the float it receives from the lag between when it receives payroll funds and when they are disbursed to clients. A current dividend yield of 4% is another investment positive for the stock; unfortunately these shares could be dead money for awhile given the recent rally.

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Tickers in this Article: PAYX, ADP, AON, ACN, ASF

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