ADP: This Ugly Mutt Is Worth Adopting

Most folks have never heard of a little Memphis mutual-fund company named Longleaf Partners (LLPFX ) But when Longleaf speaks, people up on Wall Street listen. In fact, they listened so closely to the firm's conference calls that in February, Longleaf ended them. Too many pros, it seems, were listening for stock tips and then bidding up prices before Longleaf could build full positions at the bargain levels it likes.

Not everything Longleaf buys turns green, naturally. But Longleaf's interest is one reason I find myself focusing lately on Automatic Data Processing (ADP ). The computer-services giant has been one ugly mutt of a stock (chart). Just 3 of 25 Street analysts rate it a buy. But Longleaf's May 1 report shows it bought nearly 4.8 million shares of ADP. A spokeswoman told me Longleaf snapped them up in March, as ADP took a swift dip below $30. It since has bubbled back to $33, yet I wonder if it isn't still a bargain.

If you need your money back inside a year, the answer is probably not. But for investors patient enough to wait a bit longer, ADP looks like a good bet. Without question, the company faces some strong headwinds. As a huge payroll processor, ADP has seen its growth hampered by shrinking employment. As a major handler of Wall Street brokerage transactions, it has been hurt even worse by the flight of individual investors from the market. And as a company that pockets interest on billions in clients' funds, falling interest rates directly hit profits. In fiscal 2003, ending June 30, ADP sees net of no more than $1.73 a share, down from $1.75 the year before, on flat revenues of $7 billion.

Each of these pressures will take time to ease. But few companies are as well-fixed as ADP to withstand bad times. Its balance sheet, with cash and short-term investments of $2.1 billion against total debt of $82 million, is a thing of beauty. ADP also boasts 500,000 clients, and serving them is still producing loads of cash. In the 12 months ended Mar. 31, cash flow after capital spending neared $1.4 billion, or $2.28 a share. Of that, ADP paid 48 cents a share in dividends.

Where else is it directing its cash? For one, ADP expects to keep buying back stock. Its average cost on $817 million in repurchases during the nine months ended Mar. 31 was $34 a share. To spur growth, CEO Arthur Weinbach is aiming in the next year or so to invest more than $150 million to extend ADP's range of services, particularly in what the company has dubbed its "beyond payroll" operations -- managing employee health and retirement benefits, for instance, and screening new hires. ADP says these added service extensions are growing at 15% or more.

ADP does not expect to offer its outlook for fiscal 2004 till July. Yet the Street sees another year of lower profit, with a consensus estimate of $1.66 a share. If that's right, then ADP today trades for 20 times next year's earnings. As net grew steadily over the past decade, its multiple averaged closer to 30. Another way to check ADP's relative valuation is to compare it with First Data, a big handler of credit- and debit-card transactions. First Data's enterprise value -- that is, its market capitalization plus net debt -- comes to $33 billion, or 14 times its earnings before interest, taxes, depreciation, and amortization. ADP's is nine times EBITDA.

All of this tells me ADP is cheap. How long investors will have to wait for it to get expensive again, I don't know. But Longleaf aims to buy stocks for no more than 60% of what it estimates the underlying business is worth. If Longleaf was quick enough to grab its stake in ADP near the March lows, that would indicate it puts ADP's intrinsic value above $45 a share. In my book, that's still a bargain.

By Robert Barker

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