Operational efficiency and reduced expenses in the wake of the coronavirus crisis-induced work-from-home wave and increased adoption of cloud computing and other emerging technologies bode well for the Zacks Outsourcing industry. These drive competitive advantage, and increase innovation and speed-to-market.
Automatic Data Processing, Inc.(ADP – Free Report) , Paychex, Inc. (PAYX – Free Report) and Genpact Limited (G – Free Report) are some stocks, which are likely to gain from the abovementioned industry trends. However, rising data security issues, thanks to increased dependency on technology, are concerns for the industry.
Outsourcing is the practice of transferring control of certain operations, services or processes, previously done by the company’s internal staff and resources, to external resources or third-party contractors to improve operating efficiency by focusing on core business competencies. The Zacks Outsourcing industry comprises companies that are engaged in providing human capital management solutions, business management solutions, and information technology solutions for human resource, payroll, benefits, retirement and insurance services to small- and medium-sized businesses. Some industry participants also provide business process services with capabilities in transaction-intensive processing, analytics, and automation in the United States and abroad.
What’s Shaping the Future of the Outsourcing Industry?
A Healthy Demand Environment: Increasing demand for expertise in improving efficiency and reducing costs has benefited the industry over the past several years. The industry has witnessed growth in revenues, income and cash flow over the past few years, enabling most players to pursue acquisitions and other investments, and pay out stable dividends.
Rising Dependency on Technologies: Most of the industry participants are also considering emerging technologies such as cloud computing to drive competitive advantage, increase innovation, improve speed-to-market and drive performance within the industry. The wider application of artificial intelligence (AI) is expected to be the biggest change due to the pandemic. The adoption of AI should lower complications and simplify operations. This should aid the industry.
Notably, industry players are in the process of modernizing their traditional legacy-oriented business processes in order to keep themselves flexible in any kind of operating environment.
Rising Security Issues and Remedies: COVID-led increased dependency on technology has led to growing cases of hacking, identity theft and malicious payload deliveries. With work-from-home models being the new-normal professional scenario, remote infrastructure vulnerabilities and security gaps are being exploited to secure unauthorized access to proprietary systems and data.
As a preventive measure to enhance data security and ensure cyber-resilience, increased implementation of secure access technologies such as VPNs, two-factor authentication and other ID and access-management controls for home workers, as well as increased monitoring and threat-detection tools are being used. Outsourced service providers are also updating organizational policies (including Bring Your Own Device and work from home policies) and data breach protocols in order to reduce security risk. Adequate training of employees about emerging threats and data security issues is also being prioritized by several companies.
Zacks Industry Rank Indicates Encouraging Prospects
The Zacks Outsourcing industry, which is housed within the broader Zacks Business Services sector, currently carries a Zacks Industry Rank #65. This rank places it in the top 26% of more than 250 Zacks industries.
The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates continued outperformance in the near term. Our research shows that the top 50% of the Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1.
The buy-side analysts covering the companies in this industry have been increasing their estimates. Over the past year, the industry’s consensus earnings estimate for the current year has increased 6.1%.
Before we present a few stocks that investors can buy given their growth prospects, let’s take a look at the industry’s recent stock market performance and current valuation.
Industry Outperforms Sector and S&P 500
The Zacks Outsourcing industry has outperformed the broader Zacks Business Services sector as well as the Zacks S&P 500 composite over the past year.
The industry has gained 21.2% over this period against a 42.6% decline of the broader sector. The Zacks S&P 500 composite has risen 15.8% in the said time frame.
One-Year Price Performance
Industry’s Current Valuation
On the basis of forward 12-month price-to-earnings (P/E), which is commonly used for valuing outsourcing stocks, the industry is currently trading at 23.41X compared with the S&P 500’s 20.27X and the sector’s 27.55X.
Over the past five years, the industry has traded as high as 27.76X, as low as 17.59X and at the median of 22.93X, as the charts below show.
Forward 12-month Price-to-Earnings (P/E)
3 Outsourcing Stocks to Buy
We are presenting three stocks that carry a Zacks Rank #2 (Buy) and are well-positioned to grow in the near term.
Automatic Data Processing: This New Jersey-based company provides cloud-based human capital management solutions worldwide.
Amid this challenging scenario, Automatic Data Processing remains strong backed by its momentum in sales, client satisfaction, and client retention. Higher operating revenues and effective cost-containment measures have helped the company improve its margin performance. The company continues to enjoy a dominant position in the human capital management market through strategic buyouts like Celergo, WorkMarket, Global Cash Card and The Marcus Buckingham Company. It has a strong business model, high recurring revenues, good margins, robust client retention and low capital expenditure.
Further, Automatic Data Processing raised its fiscal 2022 outlook. The company now expects revenues to register 8-9% growth compared with the expected prior growth rate of 7-8%. Adjusted EPS is now expected to register 12-14% growth compared with the expected prior growth rate of 11-13%. Employer Services revenues are now expected to grow at a rate of about 6% compared with the prior expected growth rate of 5% to 6%. PEO Services revenue growth rate is expected in the range of 13-15% compared with the expected prior growth rate of 11% to 13%.
The Zacks Consensus Estimate for ADP’s 2022 EPS has moved up 0.9% in the past 90 days. ADP’s shares have rallied 33.5% over the past year.
Price & Consensus: ADP
Paychex: New York-based Paychex provides integrated human capital management solutions for human resources, payroll, benefits, and insurance services for small- to medium-sized businesses in the United States and Europe.
Despite the continuous impact of the COVID-19 pandemic, the company continued to enjoy higher revenues per client resulting from improved price realization, growth in client bases across HCM, and ancillary products resulting from strong sales performance and high levels of retention, improved market conditions on asset-based revenues for retirement services, and increase in funding for temporary staffing clients. An increase in the number of average worksite employees, impact of an increase in average wages per worksite employee, higher revenues on state unemployment insurance and rise in PEO health insurance revenues act as other tailwinds. Additionally, cost-saving initiatives have resulted in sequential improvement of margins. Acquisitions have expanded Paychex’s customer base and generated cost and revenue synergies. Consistency in rewarding shareholders through dividend payments and share repurchases boost investor confidence and positively impact earnings per share.
Paychex has raised its guidance for fiscal 2022. Total revenues are now expected to register 10-11% growth compared with the prior expectation of 8%. Adjusted earnings per share are now expected to register 18-20% growth compared with the prior expectation of 12-14%. Management Solutions revenues are now expected to grow 10-11% compared with the prior expectation of 8%. Adjusted operating margin is expected to be almost 39-40% compared with the prior expectation of 38-39%. The adjusted EBITDA margin is now expected to be nearly 44% compared with the prior expectation of 43%.
The Zacks Consensus Estimate for Paychex’s 2022 EPS has improved 5.2% in the past 60 days. Paychex’s shares have gained 37.2% over the past year.
Genpact Limited: This Bermuda-based company provides business process outsourcing and IT services in North and Latin America, India, the rest of Asia, and Europe.
Genpact enjoys a competitive position in the BPO services market based on domain expertise in business analytics, digital and consulting. Acquisitions have been helping it to expand its product portfolio and gain new domain expertise. Artificial intelligence offers ample growth opportunities amid COVID-induced dependency on technology. The company continues to benefit from its strong clientele across the world. Consistency in rewarding shareholders through dividend payments and share repurchases boost investor confidence and positively impact earnings per share.
The Zacks Consensus Estimate for Genpact’s 2022 EPS has improved 0.8% in the past 90 days. Genpact’s shares have gained 17.7% over the past year.
Price & Consensus: G