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Paycom Finds Big Profits By Sticking To Smaller Firms, Simpler Plans

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Paycom Software ( PAYC ) is a rare bird these days - a fast-growing vendor of cloud-based applications that's also quite profitable.

In this case, Oklahoma City-based Paycom has managed to make its mark providing payroll processing and human capital management software in an integrated offering to U.S. companies.

Paycom stock has been a big winner this year, with shares up 30% so far in 2016. Its stock ended trading Thursday down fractionally to 48.75. It went public at 15 in April 2014.

"The company has consistently outperformed expectations, is expected to grow well over 40% in 2016, and is nicely profitable - a rare combination in the cloud software space," Canaccord Genuity analyst David Hynes said in a recent note to clients. He rates Paycom stock as a buy with a price target of 55.

[ibdchart symbol="PAYC" type="daily" size="threequarter" position="rightchart" ]Paycom focuses mostly on small and midsize companies with 50 to 2,000 workers for its software-as-a-service. That keeps it under the radar of larger firms such as payroll-processing leader ADP ( ADP ) and cloud-based human resources software provider Workday ( WDAY ).

Still, ADP is considered to be among its main rivals, along with Paychex ( PAYX ), Paylocity ( PCTY ) and Ultimate Software (ULTI), RBC Capital Markets analyst Ross MacMillan said in a note to clients. He rates Paycom stock as sector perform with a price target of 54.

While most providers of payroll and HR software tick off all the necessary boxes for functionality, Paycom excels in several ways, MacMillan said.

Keeping It Simple

For starters, its software is based off a core system of records maintained in a single database. Since the Paycom software is essentially a single application, it is easier for administrators to manage, MacMillan points out.

"We believe our success is due to the growing recognition of the benefits that can be gained from Paycom's single database architecture," Paycom Chief Executive Chad Richison said on a conference call with analysts on Aug. 2.

Paycom's software also is sold directly to customers through agents in regional sales offices.

"Paycom has a very clear playbook for driving growth by adding customers and by increasing the average recurring revenue per customer," MacMillan's report says.

Its customer growth strategy is based on expanding its sales organization through new regional offices across the U.S. Paycom has 42 sales offices now with line of sight to about 124 possible offices, MacMillan said.

"We are still in the early stages of a multiyear mission to gain market share and grow into one of the largest providers of cloud-based payroll and human capital management software," Richison said.

25% Growth

MacMillan believes Paycom can grow its sales by 25% or more for the next three years by adding new customers and increasing revenue per customer.

HR management today is all about regulatory compliance and benefits, so Paycom and the industry benefit when the government imposes new employee rules on companies.

For instance, Paycom has gotten a boost from selling software to help companies comply with the Affordable Care Act, aka ObamaCare.

The company also recently released a tool kit to comply with changes to the Fair Labor Standards Act, allowing customers to make strategic decisions related to new overtime pay regulations.

IBD'S TAKE:Paycom stock sports a best-possible IBD Composite Rating of 99 and is ranked No. 1 in IBD's Computer Software-Enterprise industry group. Paycom also is on the IBD 50 list of superior stocks.

Another area for compliance involves meeting diversity requirements.

Paycom says it helps companies effectively navigate a rapidly changing business environment. Its software is designed to manage employees from recruitment through retirement.

The market for cloud and outsourced payroll processing and related human capital management services is worth about $25 billion to $30 billion a year in the U.S. and is growing in the high single digits, MacMillan said.

"We think Paycom can address up to $14 billion of the payroll/HCM market," MacMillan said. "Paycom's calendar 2016 revenue forecast of $326 million suggests the company has single digit share.

Taking Away Share

Paycom likely gets about half its new customers by winning business away from ADP and, to a lesser extent, Paychex, he said. The rest it pulls from small regional players running payroll-centric licensing software and from in-house and on-premises services like Microsoft (MSFT) Dynamics GP and Sage.

Paycom is scheduled to report third-quarter results after the market close on Nov. 1.

In the second quarter, Paycom reported earnings per share of 21 cents excluding items, up 110% year over year, on sales of $73.9 million, up 51%. Analysts polled by Thomson Reuters were expecting 13 cents EPS minus items on sales of $70.6 million.

For the September quarter, analysts are looking for Paycom to earn 11 cents a share excluding items, up 38%, on sales of $76.7 million, up 39%.

Paycom is starting to face difficult comparisons to big year-ago quarters, so its growth rate is likely to decelerate, MacMillan said.

There's a lot to like about Paycom, MacMillan said. He just thinks the stock is fairly valued at current levels.

Shares have been in a base of late, but neared a breakout point in Monday trades, climbing nearly 5% to close at 52.44.


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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.

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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