Shares of Paycom Software (NYSE:PAYC) took a hit in Wednesday’s trading session following the release of the company’s earnings report. Despite reporting solid Q3 results, including over 20% revenue growth and strong profit margins, investors were spooked by management’s guidance for the next quarter and the upcoming year. While the company’s growth outlook may have deteriorated due to the cannibalization of its automated Beti product, the stock’s crash seems overdone considering its strong fundamentals: a net cash balance sheet, GAAP profitability, and a promising secular growth profile. As such, I am upgrading the stock to a “strong buy” based on its attractive valuation.
Paycom Software Stock Price Woes
PAYC has been among the worst-performing stocks in the tech sector over the past year, and the recent stock tumble has only added to the pain.
Back in August, I rated PAYC as a buy, but little did I anticipate such a significant decline. The deceleration in growth without any significant macro changes has given me cause to take another look at the stock.
Paycom Stock Key Metrics
In the latest quarter, PAYC demonstrated a year-over-year revenue growth of 21.6%, amounting to $406.3 million, which was slightly below the guidance of $411 million. Despite this, PAYC maintains its profitability, with $165.6 million in adjusted EBITDA (31% YoY growth) and $102.4 million in non-GAAP net income (39.5% YoY growth). The company also reported $75.2 million in GAAP net income.
The strong financial performance allowed PAYC to return value to its shareholders, distributing $21.6 million in dividends and repurchasing $76.5 million of its own stock during the quarter. With $484 million in cash and just $29 million in debt, PAYC boasts a robust net cash balance sheet. It is important to note that this cash balance does not consider the $2.1 billion held on behalf of clients.
Looking ahead, management has issued guidance of approximately $425 million in revenue for Q4, representing a growth of around 14% YoY. However, full-year guidance has been revised downward to $1.684 billion in revenues and $717 million in adjusted EBITDA, reflecting concerns over the growth deceleration.
During the conference call, management delivered further negative news, highlighting that revenue growth is expected to decline to the 10-12% range in 2024. The main cause for this decline is the success of the company’s Beti automated software, which has eliminated the need for additional software to correct payrolls. Despite the negative guidance, management emphasized its focus on the value provided to clients, suggesting potential pricing power in the future. However, given the poor guidance for the upcoming year, this offers little solace.
Is PAYC Stock Worth Buying?
PAYC operates as a payroll and Human Capital Management (HCM) solution, making recurring revenues a crucial aspect of its business, similar to other well-known enterprise tech companies like Salesforce (CRM). However, the recent guidance downgrade has negatively impacted the company’s valuation. Currently, PAYC is trading at approximately 20 times this year’s earnings and around 5.2 times sales (excluding the revised guidance).
Considering the company’s growth outlook and strong profit margins, a valuation reset was to be expected. However, at the current price levels, PAYC is trading on par with CRM based on price-to-sales ratio, despite offering a stronger growth profile and higher profit margins. Based on a projected 12% revenue growth, 35% long-term net margins, and a 1.5x price-to-earnings growth (PEG) ratio, I believe the stock has the potential for multiple expansion, offering an upside to its current valuation. Together with the earnings yield, PAYC has the potential to deliver approximately 15% annual returns, which is a satisfactory value proposition considering its strong financials and reasonable assumptions. Consistently executed share buybacks are expected to be the catalyst for further stock appreciation.
However, it is important to consider the key risks. Further deterioration in the macro environment could negatively impact PAYC’s growth outlook. Additionally, given the recent guidance revision, there may be doubts regarding management’s ability to accurately forecast future performance. While the risk related to interest income from funds held on behalf of clients is relatively low, as it constitutes a smaller portion of GAAP net income, any changes in interest rates could impact the company’s profitability. Finally, competition in the payroll and HCM space remains a risk, especially as the market becomes increasingly saturated.
In conclusion, the cannibalization caused by Beti may have improved the quality of PAYC’s earnings and potentially offers future pricing power. With an attractive valuation, I am upgrading my rating of PAYC stock to a “strong buy.”