As Xero beats expectations in FY24, here’s what 3 brokers think

Xero shares rose 9% on Thursday as its FY24 results beat expectations with strong growth across net profit, revenue, and free cash flow.

The software firm reported NPAT of NZ$174.6 million for the year to 31 March, up from the NZ$113.5 million loss last year and ahead of average analyst expectations.

Operating revenue grew 22% (21% in constant currency) to NZ$1.71 million and adjusted EBITDA grew to NZ$527 million from NZ$302 million a year earlier. This resulted in $342 million of free cash flow and a 20% FCF margin.

Delivering her first full-year result, CEO Singh Cassidy said the result demonstrated “we’re doing what we said we’d do”

“We’ve delivered a strong and profitable FY24 result and Rule of 40 outcome, demonstrating our commitment to balancing growth and profitability.”

A rule of thumb for software companies, the “rule of 40” suggests a company’s profit margin plus revenue (in percentage terms) is sustainable if their combined total meets or exceeds this figure. In the case of XRO’s latest result, they tally up to 41%.

Guidance and outlook

Xero management flagged an expectation that total operating expenses (as a percentage of revenue) will be approximately 73% in FY25, compared to FY24. It also anticipates a rise in product design and development costs.

XRO 12-month share price (Source: Market Index)

What the brokers thought

UBS

• Rating: Retain BUY

• Price target: $156, up from $141.90

UBS remains positive on Xero’s ability to grow strong FCF over the medium term, driven by resilience in its mid to high teens top line growth and improving operating leverage.

Hailing the “strong result”, UBS analysts highlighted FCF growth that beat consensus expectations by 133%, “driven by 12% lower than expected spend on total R&D at 32% of sales in 2H24.”

The “rule of 40” achievement was also called out as a surprise; UBS having projected this would be hit by FY27.

“Top line was solid as well, slight 1% beat to us and 2% beat to consensus, primarily driven by better ARPUs,” UBS said.

Macquarie

• Rating: Retain OUTPERFORM

• Price target: $180, up from $141.90

Macquarie was also surprised to see the strong beat across all lines: “We did not expect to see upside to the P&L so quickly.”

Macquarie broke down the result across the following:

The good… Operating expenditure and revenue beat of 73.3% for FY24 versus guidance of 75% Commentary that US subscriber growth was strong Simplifying the ANZ offering. “This improves the go-to-market offering and removes friction from the sales process,” Macquarie said. Exiting of Planday AU and partnering with Deputy in Australia. Not so good…

Rising churn of monthly recurring revenue to 0.99% in FY24, from 0.90% in FY23. While noting this figure is still low, Macquarie notes price increases could lift MRR churn further – though competitors are also following Xero on price.

Interesting

AI use cases, with management highlighting adoption of AI within the sales process. “We think any decision that improves the customer value proposition for the channel partner improves the quality and defensiveness of the revenue base,” Macquarie said.

Jarden

• Rating: Retain OVERWEIGHT

• Price target: $141

Jarden analysts lifted their rating and price target – from Underweight and $110 – ahead of Xero’s result, on 16 May.

On the back of the FY24 result, Jarden analysts said it was strong “but with something for the bulls and bears".

“[The] top line outlook [looks] good, however, a step up in product design and development investment implies no operating leverage in FY25E.”

On the revenue and EBITDA beats versus expectations, they also note the operating cost ratio of 73.3% was well ahead of guidance of “around 75%”.

“This implies a H2 24 operating cost ratio of 68% and annualised H2 EBITDA of $644 million, which compares with FY25 expectations [from Jarden] and consensus of $661 million and $609 million, respectively,” Jarden analysts said.

They highlighted that net subscriber additions were marginally below consensus of approx 4% their own forecast of approx 9%.

The three key questions they ask of XRO management are: where is XRO reinvesting in product design & development, what capitalisation rate is XRO assuming for product design & development in its OPEX ratio guidance?, and when should investors expect to see operating leverage emerge? Key risks to Jarden’s valuation estimate:

• A slowdown or recession resulting in closures of small to medium-size enterprises

• changes to the competitive landscape in XRO’s key markets; and

• inability to increase prices to the extent the market has priced in, due to competitive pressures.

Xero shares opened at $134.43 on Friday 24 May 2024.