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Summary
Readers may find my previous coverage via this link. My previous rating was a buy, as I believed Paycor (NASDAQ:PYCR) stock continues to be undervalued as the business fundamentals continue to perform better than I had expected. I am reiterating my buy rating as PYCR fundamentals remain strong, with management sounding very confident during the call.
Financials/Valuation
With a total increase of 26.2% to $140 million, PYCR saw a 17.6% increase in recurring and other revenue. Interest income, thanks to rising interest rates, increased by 7.5x, contributing significantly to the rapid growth. As a result, the increase in gross margin from the previous year was 210bps, bringing the total to 68.2%. Non-GAAP EBIT came in at $15.4 million, up 68% from 4Q22, as a result of the company’s strong performance across the board in terms of revenue and gross profit. Exiting 4Q23, PYCR had $95.2 million in cash and only $16.1 million in operating leases, indicating a very healthy balance sheet.
Based on my view of the business, PCYR should be able to grow as management guides in FY24 given the increase in sales reps, demand strength, and win rates vs. legacy providers. Following FY24, the business should recover back to 20% growth, as I expected previously, as the economy recovers and the sales cycle shortens. Another revision is my revenue multiple assumption. I previously modeled 8x forward revenue but now expect 6x (the current multiple) as I expect the near-term challenges to pressure the stock as investors take on a wait-and-see approach for 1H24.
Based on author’s own math
Comments
Overall, I have the impression that the fundamentals of PYCR are still very strong and that there are no major signs of a slowdown in demand. The underlying metrics paint the same picture that management is painting (demand is still high). For instance, the average number of employees per customer has increased to 82, from 77 in the same period last year and from 79 in 3Q23, showing continued success in the transition upmarket. Notably, PEPM rose from last quarter’s $44 to this quarter’s $48; this is significantly higher than the FY19 levels of $27. Just shy of $2, I expect PYCR to meet its target of $50 PEPM by CY2024, which will drive additional revenue upside. Management also reported that bookings were at an all-time high with a consistent mix, growing 23% year over year, indicating continued strength in the metric.
In particular, management has noticed an increase in this year’s win rates when compared to the largest legacy provider. There is also an increase from 28% to 36% in the number of cities where sales are being made in Tier 1. This information strongly suggests that demand for new logos and the market as a whole are both stable for the time being.
“Demand remains strong for our modern, innovative HCM solution that empowers leaders to unlock the potential of their people and business performance.”
“In summary, we’re as optimistic about our opportunity in HCM as we’ve ever been. Demand remains strong. Our innovative HCM solution that empowers leaders to build winning teams continues to win in the market.”
“Yes. Actually, our win rate against the largest legacy provider increased this year versus last year. So we saw a slight increase against them. I would say, some of the cloud competitors, we continue to compete with them very infrequently from a displacement perspective. We see new business generation, we see some PEO takeaways that kind of spiked up a little bit in the quarter. But I would say, by and large, our top three sources of wins are, and literally they interchange month to month are regional service bureaus in-house in ADP. And those three are comprising over 60% of the legacy wins with paychecks being a distant fourth because we don’t really compete with them as they’re primarily an under 50 solution — really an under 15 solution” Source: 4Q23 earnings
Adding to what has I had said about coverage, the increase in sales representatives is a promising sign that the company will continue to grow at a healthy clip; management hopes to keep this expansion rate of around 20% going in the foreseeable future. With 560 sellers now, an increase of around 100 during the fiscal year represents a 22% increase in the sales force, exceeding management’s 20% target. The sales force, according to management, can expand by another 20% annually and can easily be increased by a factor of three. PYCR’s Tier 1 markets are currently 36% covered, up from 28% in FY22, and I anticipate further penetration and coverage with the addition of sales reps. It’s important to remember that it takes time for productivity to ramp up (i.e., for sales reps to become mature), so growth will lag behind sales staffing levels. The good news is that even though there was an increase in the number of sales representatives, PCYR was able to maintain or improve its sales efficiency.
One factor that could weigh on the stock is management’s comment that an emphasis on the enterprise market, combined with longer implementation times, is delaying revenue recognition until 2H24. As a result, investors may adopt a wait-and-see attitude toward 1H24, especially in light of the challenges posed by form filling revenue. On the other hand, I see that billings grew rapidly in FY23, especially in the fourth quarter, which could help sustain a quickening in recurring revenue growth in FY24.
Overall, Despite the increasing volatility of the labor market and the continued unpredictability of the macro, I believe PYCR has shown a consistent ability to get the job done.
Risk & Conclusion
While PYCR is seeing success in upselling, I believe SMBs pose a significant risk because they often have a weak financial position and could fail in a downturn. Therefore, many of PYCR’s customers would likely leave during a major recession.
In conclusion, my reaffirmed buy rating for PYCR is grounded in the company’s resilient business fundamentals. PYCR’s impressive financial performance, evident in its 26.2% revenue increase and strong gross margin growth, reaffirms its robust position. The expansion of the sales force by 22% and increased market coverage bolster its growth potential. While near-term challenges might pressure the stock, management’s optimistic outlook, high win rates, and sustained demand signal continued strength.
