ADP – An Overvalued Dividend Aristocrat

I encourage you to review NOTE 4. CORPORATE INVESTMENTS AND FUNDS HELD FOR CLIENTS which commences on page 75 of 153 in ADP’s 2020 10-K. The information in this note indicates how ADP invests BILLIONS of dollars to generate significant investment income even in this low-interest-rate environment.

Page 13 of 18 in the Q3 8-K shows the degree to which ADP has been successful in generating income from this strategy in Q3 and YTD.

Additional supplemental financial data that includes information about the Client Funds Investment Strategy is found here.

ADP – Financial Review

Q3 2021 and YTD 2021 Results and FY2021 Guidance

The Q3 10-QApril 28, 2021 8-K, and accompanying investor presentation provide investors with a high-level overview of the company’s Q3 and YTD performance. The 8-K and investor presentation include management’s guidance for the remainder of the current fiscal year.

ADP – Free Cash Flow

FCF provides management with the ability to:

  • repay debt;
  • increase dividends;
  • repurchase shares.

I closely monitor this metric and compare current and historical levels. I do this to determine if the variance is the result of a major change in CAPEX. Variances from historical FCF levels are possible but I want to know why. ADP has generated ~$2.3B of FCF in the first 3 quarters of FY2021 (deduct CAPEX from Net cash flows provided by operating activities found on page 11 of 18 in the Q3 8-K). Looking at FCF for 2011 – 2020 we see $1.428B, $1.661B, $1.342B, $1.518B, $1.639B, $1.511B, $1.655B, $2.044B, $2.122B, and $2.41B.

ADP – Credit Rating

It is prudent for investors to look at the credit risk aspect of a company and not just the potential return. Regrettably, many investors completely overlook the degree of risk assumed. This often leads to a permanent impairment of the investment. ADP’s local currency unsecured long-term debt ratings are:

  • Moody’s: Aa3 since August 28, 2015.
  • S&P Global: AA since April 10, 2014.
  • Fitch: AA-: Fitch initiated coverage on December 23, 2020

Moody’s and Fitch’s ratings are the lowest tier of the high-grade investment-grade category. S&P Global’s rating is one notch higher. These ratings define an obligor a having a VERY STRONG capacity to meet its financial commitments. It differs from the highest-rated obligors only to a small degree. ADP’s ratings satisfy my prudent investor profile.

Peer Group Credit Ratings

Let’s quickly look at the credit ratings of a few ADP peers.

Intuit Inc. (INTU) – Moody’s: A3 and S&P Global: A-. Fitch does not rate the company. Both ratings are the lowest tier of the upper-medium grade investment-grade category. This is three notches below those of ADP. These ratings define an obligor as having a STRONG capacity to meet its financial commitments. It is, however, somewhat more susceptible to the adverse effects of changes in circumstances and economic conditions than obligors in higher-rated categories.

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Disclosure: I am long ADP, PAYX, BR, CDK, and CSCO.

Disclaimer: Dividend Power is not a licensed or registered investment adviser or broker/dealer. We are not providing you with ...

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