Financial Services

Xero hitches growth upside to strong SME uptake

Tue 15 Mar 22, 3:34pm (AEST)
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Key Points

  • Accounting and bookkeeping sector is poised for growth in 2022
  • Macquarie urges longer-term investors to start reviewing the stock at current valuations
  • Xero share price has increased over 400% in the last five years

Having concluded that Xero (ASX: XRO) has been unfairly thrown into the same bus as technology stocks that chase growth at the expense of profit or margin, Ord Minnett has upgraded the cloud-based accounting software platform to Accumulate from Hold.

But in the light of the general sector de-rating, the broker’s target price has reduced to $107 from $130.

Despite precious little news coming out of Xero in recent times, the share price appears to have been dragged into the tough love dished out the tech sector at large, with the share price down around 35% since the start of the 2022.

Fundamentals haven’t changed

Unsurprisingly, this morning Xero announce that the company was axing services in Russia. Prior to today’s news, the last notable update from Xero was the  largely positive set of half-year results in November.

Key takeaways at the half year included:

  • Annual recurring revenue is up 29%.

  • Subscribers increased 23%.

  • Total lifetime value of subscribers up 61%.

However, having invested more back into the business, earnings growth reversed, with earnings down -19%.

At face value, it looks as if the market either didn't like or understand the value of reinvesting virtually all of its cash flow to help deliver bigger future profits.

To expand its offering, Xero has continued to acquire businesses, with recent acquisitions including Planday, Tickstar and Waddle.

Focussing on the growth

Recent share price weakness defies the 'share market darling' status the company has enjoyed, evident in the more than four-fold share price increase in the last five years.

Having parked negative market sentiment to one side, Ord Minnett has, after refocussing on fundamentals, concluded that Xero is in a strong market position in Australia, NZ and the UK, plus early positioning in North America to capture the growth and adoption of cloud accounting software by SMEs.

Despite persistent challenges over the past two years Joseph Lyons, managing director for Australia recently noted that the accounting and bookkeeping sector is poised for growth in 2022.

“Heightened demand for industries like construction and professional services are leading to a boom in small business creation, generating even more demand for skilled advice."

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Xero share price: A five year view.

What brokers think

Based on the brokers covering Xero (as reported on by FN Arena) the stock is trading with 28.9% upside to the current price.

Given that Xero has traditionally traded at a growth-adjusted premium to peers, Macquarie concludes the downside risk from here looks limited, and in the anticipation of emerging value recently upgraded Xero to Neutral from Underperform.

The broker urges longer-term investors to start reviewing the stock at current valuations but has reduced the target price to $100 from $130.

While higher interest rates may present some ongoing headwinds to valuation multiples, Goldman Sachs notes that valuation has been re-based to pre-covid levels, while underlying growth remains robust.

As a result, the broker reiterates a Buy on Xero, but cuts the target price to $135 (from $158) to reflect lower multiples.

Consensus on Xero is Moderate buy.

Based on Morningstar's fair value of $86.47, the stock looks to be overvalued.

Xero will report its FY22 results on May 12.

 

Written By

Mark Story

Editor

Mark is an investigative financial journalist and editor who started his career working for Marathon Oil in London. He has a degree in politics/economics and a diploma in journalism. Mark has worked on 70-plus newspapers and financial publications across Australia, NZ, the US, and Asia including: The Australian Financial Review, Money Magazine, Australian Property Investor and Finance Asia. Mark is passionate about improving the financial literacy of all Australians through the highest quality content. Email Mark at [email protected].

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