15% Downside For Paychex Stock?

Paychex stock (NASDAQ: PAYX) is down 3% since the beginning of this year, but at the current price of around $83 per share, we believe that PAYX stock has around 15% potential downside.

Why is that? Our belief stems from the fact that PAYX stock is still up almost 60% from the low seen in March, compared to the S&P which is up around 55%. Further, after posting weak Q1 2021 numbers, and with demand still not up to pre-Covid levels, we believe Paychex’s stock could drift lower. Our dashboard What Factors Drove 3% Change In Paychex Stock Between 2019 And Now? provides the key numbers behind our thinking, and we explain more below.

PAYX stock’s rise since late 2019 came due to a 7% rise in revenues, which translated into a 6% rise in net income. A roughly unchanged share count meant that earnings per share (EPS) also rose 6%.

Paychex’s P/E (price-to-earnings) ratio dropped from 30x in 2019 to 27x in 2020, due to lower investor expectations as the pandemic especially affected a lot of small and mid-size businesses, Paychex’s primary client pool. Further, given Paychex’s poor Q1 ’21 numbers and the fact that demand is still not back to pre-Covid levels, there is further possible downside risk for Paychex’s multiple, especially when compared with previous years: P/E of 24x at the end of 2016 and 23x as recently as late-2018.

So what’s the likely trigger and timing to this downside?

The global spread of Coronavirus, and the resulting lock downs and quarantine means that a lot of businesses are struggling, and may want to cut costs. Most of Paychex’s clients are small and mid-size businesses, and it is likely that they would want to shift HR and payroll processing activities in-house, instead of outsourcing.  This is evident from Paychex’s Q1 ’21 results where revenue dropped to $932 million from $992 million for the same period last year. A rise in SG&A expenses meant that EPS took a bigger hit, dropping from $0.74 to $0.59 over the same period.

We expect Paychex’s business to struggle to get back to pre-Covid levels in the medium term and if there isn’t clear evidence of containment of the virus anytime soon, we believe the stock will see its P/E multiple decline from the current level of 27x to around 24x, which combined with a slight reduction in revenues and margins could result in the stock price shrinking to as low as $70, a downside of around 15% from the current price of $83.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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