Xero Limited (XRO) offers an online accounting system which sits between accountants and small to medium business as an accounting ledger with real-time reconciliation.
Xero (ASX: XRO) is a recent inclusion within Rivkin’s ASX Growth portfolio, and in this article, we’ll provide a more detailed summary of the company, as well as the potential outlook, which is designed to be informative rather than a standalone recommendation outside of the portfolios.
New Zealand’s Xero is a trailblazing tech firm renowned for providing innovative, cloud-based accounting solutions to small and medium enterprises globally. As a SaaS pioneer, Xero offers clients secure, real-time financial information access, serving primarily four geographical zones: New Zealand, Australia, the United Kingdom, and various other international markets, including North America. As of 2023, Xero’s expanding global footprint includes a robust subscription base of 3.7 million users.
At its core, Xero offers cloud accounting services, equipping subscribers with comprehensive financial management tools such as invoicing, bank reconciliation, bookkeeping, and payroll services. The firm has further integrated AI and machine learning to optimize and automate accounting processes, promising a streamlined user experience.
It is worth noting that XRO’s operational performance has been strong throughout a difficult 2022 for the share price, but that was far more related to the aggressive moves in interest/discount rates than any company-specific issues. XRO’s recent share price outperformance coincides with a new CEO, Sukhinder Singh Cassidy, who has made an early mark on the company with significant cost-cutting initiatives and a focus on profits/cash generation. XRO’s profitable tech peers on the ASX, such as WiseTech (WTC) and TechnologyOne (TNE), are both trading at all-time highs, so it’s not overly surprising to see investors play catch-up with the recent buying in XRO with shares up 66.8% year-to-date.
This performance is attributed to robust revenues and a strategic focus on expanding market share outside the US, a region with a potential 10.5 million customer base, instrumental to the 20% customer growth achieved between 2019-2023. Xero’s growth prospects remain promising, with an estimated total addressable market of NZ$19 billion, of which its core cloud-based software accounts for NZ$1.4 billion in 2023. Amid a focus on balancing growth and profitability, XRO announced an increase in prices for Australian and New Zealand subscribers ranging between 6.4-11.9% depending on the user’s subscription. Plans to reduce staffing by 700-800, roughly 17% of employees will help in 2023, lowering the cost ratio to around 75%, compared to prior guidance of 80-85%.
In FY23, Xero reported a 28% increase in operating revenue to NZ$1.4 billion, driven by a 14% increase in subscribers to 3.74 million and a 10% lift in average revenue per user (ARPU) to NZ$34.61. The growth was underpinned by robust performances in both the ANZ and international markets. The company reported a 26% increase in ANZ revenue to NZ$798 million and a 30% increase in international segment revenue to NZ$602 million. Its operating expense to operating revenue ratio for FY23 was 80.7% excluding restructuring costs, which is in line with its guidance. The result was a 45% increase in adjusted EBITDA to NZ$301.7 million, driving a significant increase in free cash flow to NZ$102.3 million.
Earnings will next be announced in November 2023, and a key focus will be average revenue per user or ARPU which Citi analysts expect to rise as much as 5% following price increases, which should offset any weakness from the macroeconomic outlook. A shift to focusing on profitability going forward seeing analysts expecting 21% revenue growth in FY2024 to NZ$1.697 billion followed by a further 18% growth in FY 2025 to NZ$2.006 billion. With revenue expected to exceed costs that should translate to NZ$1.05 in EPS in FY2024 and NZ$1.64 EPS in FY2025.
No specific guidance was provided for FY24, but the management aims to reduce its operating expense to operating revenue ratio to around 75%, improving operating income margin compared to FY23. Xero’s long-term goal is to continue improving its operating expense ratio and operating income margin, although a specific timeline has not been set.
Despite commanding a premium to peers with forward P/E multiples of 122 and 78.5 for FY24 and FY25, respectively, the company’s resilient revenue streams, customer retention, and improving profit expectations justify the valuation. Analyst consensus remains bullish, with 70% recommending a buy, despite a predicted -4.8% decrease from the current twelve-month price target of $111.25.
Xero’s prospects appear bright, bolstered by robust revenue growth, positive management guidance, and its strong positioning within the growing SaaS industry. The firm’s ability to adapt its product offerings and business model will be pivotal in its future performance amidst potential challenges such as market volatility and increased competition. Xero’s annual meeting is set for August 17, 2023, with the FY24 Half Year Results expected on November 9, 2023.
It’s important to note that XRO’s presence in the ASX Growth portfolio hinges on its share price momentum. This portfolio often encompasses high-performing stocks from the preceding 6-12 months, echoing a ‘momentum effect’ that stems from investors’ predisposition towards stocks exhibiting recent superior performance. As a result, it’s not uncommon to see stocks rotating in and out of the portfolio in tandem with their share price volatility.
