Dividend Aristocrat in Focus: Automatic Data Processing (ADP)

The Dividend Aristocrats are a select group of currently 57 S&P 500 stocks with 25+ years of consecutive dividend increases. These 57 are large, US companies that have historically provided (slightly) better performance and (slightly) lower volatility than the S&P 500 as a whole.

S&P 500 applies the following criteria to construct the Dividend Aristocrats list:

• must be members of the S&P 500
• must have increased dividends every year for at least 25 consecutive years
• Market Cap at least USD 3 billion
• Liquidity at least USD 5 million (average daily value traded)
• Diversification, at least 40 constituents and no sector allocation above 30%

Read more about the dividend aristocrats’ performance or check-out the European dividend aristocrats.

There are currently 66 Dividend Aristocrats. You can download an Excel spreadsheet of all 66 (with metrics) for FREE by joining our newsletter:

 

This “in focus article” will discuss several aspects of the dividend aristocrat Automatic Data Processing (ADP) and why the stock could be attractive for income investors based on our Dividend Score. Our Dividend Score System takes into account several fundamental and technical metrics that affect a company’s ability to continue paying dividends and its overall return.

 

Automatic Data Processing (ADP) overview

 

	Dividend Score
	74
Dividend	Dividend Yield	DGR 3 years
3.16	1.86%	11.87%

Data: December 9th, 2019

Business model and growth perspective

Automatic Data Processing (ADP) was founded in 1949 and has grown into the leading payroll and human resource outsourcing company. ADP is well-know since economists use the payroll figures from ADP, often as an indicator for the U.S. Labor Department employment report. This is the report on “how many new jobs are created in a month”.

ADP has a global reach with approximately 800,000 clients, delivering payroll for 26 million US workers and 15 million international workers, in more than 140 countries worldwide. ADP is in a “trust” business, ADP handles some of the most sensitive information like payrolls and tax-data. ADP showed that they are able to keep clients in, its overall client retention rate has remained above 90% every year for the last 9 years.

ADP’s main competitive advantages are due to its scale and long-standing customer relationships. ADP has a leading position across its three strategic pillars (see the above investor day presentation), as well as a highly diversified client list. By geography, ~86% of ADP’s sales are generated in the U.S., 9% in Europe, 2% in Canada, and 2% in other countries. The client footprint is not only “unrivaled” but also making ADP’s business model more flexible and less risky. No single customer represents more than 2% of annual revenue.

 

ADP has delivered about 11% annual earnings growth over the past 12 years, and its management has a 7-9% revenue growth ambition which should be realistic. Since earnings grew by 19.8% over the past year and analysts forecasts of 11.35% per year, it is even somewhat conservative.

 

Dividend history and dividend growth

It is important that companies that can maintain or even increase their dividend payments in bad times. This is an indication that the company has a strong market position in a stable business that performs well throughout the economic cycle.

ADP does have a strong market position (wide-moat) and this makes ADP one of the fastest-growing dividend aristocrats, given the dividend growth rate of approximately 12% per year. As dividend aristocrat, Automatic Data has raised its dividend already for 44 consecutive years.

In November, Automatic Data Processing declared a quarterly dividend of $0.91/share, which is a 15.2% increase from the previous dividend of $0.79. The payout for the full fiscal 2019 is $3.64 per share after this November 2019 increase.

Dividend Yield

Automatic Data Processing current dividend yield of 1.86% is -13% below its 5-year average. The 5-year average dividend yield is 2.14% (see red-line in the chart). This indicates the stock could be a bit overvalued today.

The dividend payments are reasonably covered by its earnings, given the payout ratio of 58%. Looking forward, its dividends in 3 years are forecast to be well covered by earnings (51% payout ratio). This future payout ratio is decent for this sector, we prefer a payout ratio of around 60%.

Stable cash flow

Without stable cash flow, it is almost impossible to maintain the dividend in times of a downturn. Operating free cash flow and free cash flow are 2 important metrics for a dividend stock. ADP has generated positive free cash flow in each of the last 10 years, which is a sign that ADP’s business has consistently earned enough cash to cover its spending needs, giving ADP more flexibility to maintain its dividend over time.

Low debt ratio

Companies with a low debt ratio have the option of maintaining or even increasing the dividend even during recessions. The (net) debt-to-EBITDA ratio is a great metric to include. ADP’s net debt-to-EBITDA ratio, is at a very healthy level of 0.36 (the lower, the better). This is below the 1.5 net debt/EBITDA ratio, we prefer for dividend stocks in this sector. net debt/EBITDA ratio values below 3.0 are even still acceptable. Overall ADP’s debt level appears to be in good shape and not putting the dividend’s safety at risk.

Valuation

ADP’s forward P/E ratio of 26.7 is currently exactly the same as its 5-year average of 26.7. Indeed, the market appears to be valuing the stock similarly to how it has in the past, suggesting that ADP could be fairly priced.  ADP’s forward P/E ratio is well above the Information Technology sector average of 20.5 and is a noticeable difference. Since we see fair value for ADP at 22 times earnings, the current valuation is at the high end.

Recession performance

Price-performance

Year-to-date ADP is trading up 28%, which is in line with the S&P 500 performance. The 10-year geometric annual performance is 16.4% annually. Looking at the win-ratio of 44% and a loss ratio of 2.3, those two ratios are average for this stock. After 2008 the price-performance of ADP is very impressive and combined with the dividend, the total return is 401.9% over the last 10 years.

ADP’s performance triangle.

 

Final Thoughts

ADP is a high-quality company with a global revenue stream and has a strong market position (wide-moat). This enables ADP to be one of the fastest-growing dividend aristocrats, given the dividend growth rate of approximately 12% per year.

As dividend aristocrat, Automatic Data has raised its dividend already for 44 consecutive years. Going forward, there should be plenty of room for growth, both in terms of earnings and dividends. The business-model and highly diversified client list combined with above-average growth rates make ADP an attractive dividend stock. Key for ADP is to keep client’s trust and prove to be reilable year after year.

Since the stock is a bit overvalued at the moment based on current PE-ratio’s and dividend yield, our recommendation for long-term dividend growth investors would be “Buy the Dips” or buy on regular intervals (Dollar-cost averaging strategy).