Paycom Earnings: Firm Posts Mixed Results Amid Module Conversion Headwinds

We lower our fair value estimate for narrow-moat Paycom PAYC to $370 from $388 per share following the release of mixed second-quarter results. While top-line growth and updated fiscal 2023 guidance broadly tracks our forecasts, the near-term profitability outlook disappointed due to slower-than-expected conversion to Paycom’s flagship self-service payroll solution, Beti. We suspect constrained budgets and elongated approval processes at existing clients amid uncertain macroeconomic conditions is hindering Paycom’s conversion efforts despite an attractive value proposition. However, in our view, the market is overacting to these cyclical headwinds, with shares falling sharply post-release, creating an opportunity for investors to purchase Paycom shares at a discount to our updated valuation.

Sales increased an impressive 27% year over year during the second quarter of fiscal 2023, in line with our unchanged full-year forecasts. While Paycom is experiencing a period of sluggish incremental module uptake from existing clients, the firm continues to enjoy market share gains and an ongoing skew to larger clients. Following recent success upmarket, Paycom has lifted the upper end of its target market to firms with over 10,000 employees. However, while recent client wins are encouraging, we remain skeptical that Paycom’s closed architecture that restricts integrations to best of breed solutions will appeal to mega enterprises, limiting enterprise market share potential.

To our surprise, Paycom’s GAAP operating margins fell 100 basis points to 21.8% during the quarter due to greater investment in product development including on-demand pay and international payroll offerings, an uplift in internal hiring to support future growth, and soft module adoption. These headwinds were partly offset by greater contribution from interest income on improving yields, and a pullback on sales and marketing spending.