ADP Dividend – Slowing Or Growing?
Chad is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
In payroll processing, the giant of the industry is Automatic Data Processing (NASDAQ: ADP). I've seen articles in the past suggest that ADP should be considered as a core holding for any portfolio. The theory is, the economy grows over time and as the economy grows so do jobs. Since ADP is the largest payroll processor, the company makes more money the more jobs are created.
This fact also works in the opposite direction, as ADP shareholders have realized. In the last five years, ADP stock has not done much -- five years ago the stock was at $48, today shares trade for about $53. However, while the stock has been flat, ADP has consistently grown their dividend. For nearly 30 years the company has managed to increase the dividend. The question is, can it continue and if so, are the increases slowing down or speeding up?
It should come as no surprise that as unemployment increased dramatically between 2007 and 2009, ADP stock suffered the worst drop. With unemployment slowly going down in the last few quarters, ADP should benefit. You can see this relationship in the fact that in the past five years, the company has only grown earnings by 5%. In the next five years the company is expected to grow earnings by nearly 10%. This tells us that analysts are assuming job growth will continue.
ADP's current yield is about 2.95%. When it comes to whether the company can pay the dividend, the best way to determine that is by looking at free cash flow. In the last three years, ADP's free cash flow payout ratio of the dividend has varied between 42.65% and 44.8%.
ADP's business is not capital-intensive, as last year capital expenditures only used 10% of operating cash flow. With low capital expenditures and ok free cash flow growth, it looks like ADP's dividend is very safe. The difference between ADP and their closest competitor, Paychex (NASDAQ: PAYX), is somewhat surprising. While ADP's payout ratio has stayed relatively steady at less than 45%, Paychex currently pays out about 71% of their free cash flow in dividends. Of course, part of this has to do with the fact that Paychex's dividend yield is about 4.25%, which is a good bit higher than ADP. However, ADP could increase their dividend nearly 60% and just catch up to Paychex's dividend payout ratio. This shows how much flexibility ADP has to increase dividends in the future.
Speaking of dividend increases, the company's management has directed dividend increases based on what the economy and employment has been doing. Look at the following chart of the company's dividend growth in the last 10 years:
You can see that in the highest times of unemployment -- 2009 and 2010 -- the dividend increases were scaled back dramatically. However, as unemployment has come down in 2011 and into 2012, the dividend increases are on the rise again.
Going forward, ADP investors should watch the economic reports closely. As unemployment drops and more people are added to the workforce, ADP will benefit. When ADP makes more money, they increase the dividend at a higher rate.
In the last three years, ADP's net income has dropped by an average of 2% per year. However, in this same time frame, the company's operating cash flow has actually increased by an average of 3%. If analysts are correct and the company can increase earnings by 10% going forward, I would expect operating cash flow to grow slightly faster.
Given these assumptions, ADP shareholders should expect dividend growth of 10-12%. Dividend growth has sped up, the company's payout ratio is steady, and the nearly $27 billion in cash on the balance sheet doesn't hurt either. As the economy goes, so goes ADP. With the economy on a slow track to recovery, ADP shareholders should do pretty well.
MHenage has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. Motley Fool newsletter services recommend Automatic Data Processing and Paychex. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. If you have questions about this post or the Fool’s blog network, click here for information.
