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Stock Strategist

Payroll Processing Pays Off

Growth in the core payroll business has slowed, but Paychex's wide moat is intact.

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While  Paychex's (PAYX) core payroll business is still highly profitable, it has struggled to find growth in recent years. This business is exposed to macroeconomic conditions, and its focus on serving small businesses magnifies the effect. A pullback was understandable during the recession, but payroll client growth has been fairly meager even as this headwind has abated. In our view, the company has reached a point of maturity in payroll processing that will limit payroll processing growth.

Paychex has other factors working in its favor, however. Its growth in recent years has come mainly through cross-selling ancillary services centered on human resources, employee retirement plans, and insurance. Further, we think the company's professional employer organization services, a model that helps small businesses better negotiate employee benefit plans, is positioned to expand as health-care costs rise. We expect the company's growth to continue to shift in this direction and believe that its small-business focus is a benefit as the limited resources available to small businesses should make them more likely to look for bundled solutions like those offered by Paychex, as opposed to searching for best-of-breed applications. Paychex, with its broad product portfolio and dominant position in the small-business space, is best positioned to exploit this trend. As such, we think the company can maintain healthy earnings growth even as the addition of new payroll clients diminishes.

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Brett Horn does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.