How Paychex Can Face ADP's and Intuit's Threat

Dan Caplinger for the MotleyFool writes: Paychex (NASDAQ: PAYX  ) will release its quarterly report on Wednesday, and investors have continued to like the payroll-processing company's prospects, bidding the stock to multiyear highs. But in order to keep its earnings growing strongly, Paychex has to navigate a tough competitive environment, dealing with Automatic Data Processing(NASDAQ: ADP  ) and its targeting of high-end large business clients as well as Intuit (NASDAQ: INTU  ) and its pursuit of small-business customers.

Paychex has positioned itself as the go-to solution for small and medium-sized businesses to meet various payroll processing and human resources needs. ADP and Paychex traditionally carved up the overall market by company size, with ADP taking large companies. But now that Intuit is leveraging its exposure to small businesses from its Quickbooks accounting software and its TurboTax tax software, Paychex has to defend its market share from competitors on both sides. How will Paychex's efforts fare? Let's take an early look at what's been happening with Paychex over the past quarter and what we're likely to see in its report.

Stats on Paychex

Analyst EPS Estimate	$0.42
Change From Year-Ago EPS	2.4%
Revenue Estimate	$598.89 million
Change From Year-Ago Revenue	5.2%
Earnings Beats in Past 4 Quarters	2

Source: Yahoo! Finance.

Can Paychex earnings keep growing this quarter?Analysts haven't budged on their views about Paychex earnings recently, keeping their expectations for 5% to 6% growth in fiscal 2014 and roughly 7% growth in fiscal 2015 unchanged. The stock has done reasonably well, though, rising 8% since mid-September.

Paychex's results for its August quarter showed the extent of the challenges the company faces. The payroll processor successfully increased total service revenue by 5%, with HR services outpacing payroll and leading to net-income growth of 6%. Yet expenses also increased 4%, and some of the company's revenue from retirement services has benefit greatly from the bull market in stocks and are thus vulnerable to a pullback when it occurs.

But Paychex is working hard to improve efficiency and gain competitive advantages against ADP and Intuit. Its new software-as-a-service platform attempts to give HR administrators a cloud-based environment on which to manage their corporate HR operations, and its Paychex Accounting Online application will go up directly against QuickBooks in providing integrated accounting services to Paychex customers. ADP has given its clients a solid online experience with its Vantage cloud-based package of integrated payroll, benefits, and HR management functions, while Intuit has had great success with QuickBooks and other software-based services like TurboTax. That makes Paychex smart to fight back with user-friendly technology as well.

Interestingly, Paychex might serve a useful function for investors looking to protect themselves against a potential rise in interest rates. Paychex benefits from acting as a temporary depository for businesses' cash before it goes out to employees, and when interest rates are higher, Paychex can earn more income on the money it holds on behalf of its clients.

In the Paychex earnings report, look to see what the company has to say about its ongoing efforts to expand internationally. In its previous report, Paychex noted efforts to expand into South America through a joint venture in Brazil, as well as the acquisition of a payroll provider in Germany. By diversifying its exposure, Paychex might be able to avoid the same downdraft it suffered during the U.S. market meltdown in 2008 if the next bear market turns out not to be a worldwide phenomenon.