Xero Ltd. (XRO:ASX)

Last update - 9 November 2023 By James Woods

In the latest financial update, cloud-accounting software provider Xero, a current holding within the momentum component of the ASX Growth portfolio, has this morning released its first-half profit results. While there was a turnaround from last year's loss, investors have reacted negatively this morning with results below expectations.

Shares have fallen nearly 10% this morning as the revenue figures fell short of analysts’ projections. While operational revenue surged by 21% year-on-year to NZ$799.5 million, with a notable increase in annualized monthly recurring revenue to NZ$1.77 billion, up 19%. Despite these gains, the growth in average revenue per user and subscriber numbers was more modest at 5.9% and 13%, respectively. While the number of subscribers reached nearly 4 million, the growth in net subscriber change showed a 9.3% dip compared to the previous year. Notably, adjusted earnings were below expectations of NZ$0.427 with an actual of NZ$0.35.

A positive point was the EBITDA, which soared by 90% to NZ$206.1 million, and a swing to a net income of NZ$54.1 million against a loss in the prior year. The company’s effective management of operating expenses, which increased by 15%, contributed to a gross margin improvement, with a notable decline in the operating expense to revenue ratio from 83.9% to 79.1%.

Xero’s strategy remains focused on reinvestment and improving efficiency, with no dividends paid or proposed. They anticipate an operating expense-to-revenue ratio of around 75% in FY24, aiming to enhance the operating income margin further.

For the full fiscal year, projections suggest Xero’s profit could exceed NZ$100 million, bouncing back from a significant loss, driven by subscriber growth in the Australia-New Zealand region and expected increases in average revenue per user. The company’s international segments, particularly the smaller yet fast-growing rest-of-the-world market, could further bolster revenue despite the need for more aggressive cost management.

While Xero’s management is concentrating on strategic growth levers, promising a careful balance between growth and profitability including culling idle subscriptions to enhance user revenue and investing in targeted marketing in the U.S. While there has been a shift from growth at all costs to focus on profitability, the results are undoubtedly disappointing for investors. As a reminder, Xero’s inclusion in the ASX Growth portfolio is based on share price momentum, which following declines today could see the stock removed from the portfolio on the next rebalance date of November 15th, depending on how the stock trades between today and then.

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