Treasure Chest: Xero

This story features XERO LIMITED. For more info SHARE ANALYSIS: XRO

FNArena's Treasure Chest reports on money making ideas from stockbrokers and other experts.

Whose Idea Is It?

Jarden

The subject:

Xero ((XRO))

More info:

Xero is a global cloud accounting software-as-a-service company with exposure in Australia/New Zealand, UK. North America and (some) South-East Asian markets.

Following a change in analyst coverage, Jarden has re-modeled the outlook for Xero with a specific focus on longer term strategic growth opportunities and projected trends for the company over the decade ahead.

The new analyst in charge highlights Xero is undergoing a major corporate transition from being a start-up to a self-funding business model which has the potential to unlock substantial shareholder returns via improved capital management while balancing growth and profitability.

Future success hinges on the company's ability to produce "meaningful" cash flow as operating leverage improves.

At the outset of today's research report, Jarden emphasises the remodelling has a longer term focus and acknowledges short term forecasts could be subject to volatility in terms of both earnings beats and misses.

Breaking down the divisions by geography, Australia and New Zealand represent the more mature markets with Xero commanding a 53% market share in Australia and around 74% in New Zealand.

The forecast compound average growth rate (CAGR) for revenues between FY24 and FY34 is 9.5% in Australia and 8.4% in New Zealand.

Internationally, future growth opportunities could offer considerable more upside with market shares of around 35% in the UK and only 5% in North America.

Due to the less developed nature of these markets, a base case CAGR  of 13.2% and 15.3% for the UK and North America, respectively, are assumed for the ten years ahead, with the Rest of the World given a 14.5% CAGR forecast.

Jarden's new analyst in charge has upgraded Xero to Overweight from Neutral with a $141 target price.

Cashflow Translates Into Dividends?

The new analyst is upbeat that Xero will be able to pay off the NZ$1.18bn convertible notes (maturing December 2025) with existing cash reserves. Future mergers and acquisitions will be paid for via debt with the capacity to make acquisitions up to NZ$3.4bn in cash under a new debt/equity structure of new debt to 3.0x FY26 EBITDA (forecast).

Updated cash flow assumptions suggest there is scope for the company to start paying out dividends to loyal shareholders. Jarden thinks dividend payments are possible from as early as FY25 (next financial year).

FY24 Earnings Expectations

Xero is due to report FY24 earnings on May 23 and Jarden is looking for 21% revenue growth and net profit of NZ$162m versus NZ$155m consensus.

Key issues the broker will be looking out for is commentary around the US market regarding partnerships and subscriber growth; the change in ARPU depending on the removal of inactive subscribers, and the FX/geographic mix, as well as any guidance on costs.

Macquarie recently reiterated an Outperform rating on Xero with a more bullish target price of $154.60 on the back of flagged price increases to both the Partner and Business edition for Australian subscribers commencing July 1.

Earnings forecasts were revised by 3% for FY24 and -5% for FY25 and FY24. Macquarie is keeping an eye out for more insights on product and partnership announcements at the FY24 results.

Goldman Sachs has also adopted an upbeat view on the latest Xero pricing plans in Australia and views the streamlining of the company's product ladder as positive. The changes should also drive revenue benefits from improved ARPU growth. Similar pricing plans are forecast to be rolled out in the UK/New Zealand and the US markets, although the extent of the price rises remains unclear.

Goldman Sachs is expecting FY24 revenue growth of 22% and net profit of NZ$158m with this broker's focus firmly on operating expenses in the 2H24 and the FY25 outlook, as well as subscriber growth in the UK and North America, and ARPU trends.

The broker has a Buy rating and a target price of $156m, and notes risks include increased competition, and possibly weaker UK momentum on the back of macro headwinds for SME businesses. Looking beyond the short term, Goldman Sachs considers Xero is well positioned to take advantage of global digitalisation of SMEs, with an estimated total addressable market of over 100m worldwide.

Citi calculates a 2% increase to FY25 forecast ARPU for Xero on the back of the recent pricing and packaging changes. Pricing in Australia rose 9% for a starter plan, 8% for a standard plan, and 6% for Premium 5.

Citi's currently has a Buy rating and $159 target price.

Of the six brokers monitored daily by FNArena, four rate the stock positively, despite a firm share price performance over the past twelve months. The two remaining -Morgans and Ord Minnett- sit on Hold and Sell respectively. Ord Minnett whitelabels research from Morningstar where the analyst in charge is not a fan of Xero's business model, resulting in a value assessment that is consistently miles below the share price.

FNArena's consensus price target effectively combines all six to sit on $127.25, below today's share price (which is running hard on the day). Excluding Morningstar/Ord Minnett the average of the five brokers rises above $137.

Jarden and Goldman Sachs are not included in FNArena's daily monitoring, and neither is RBC Capital which rates the shares Sector Perform with a $130 price target.

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" – Warning this story contains unashamedly positive feedback on the service provided.

FNArena is proud about its track record and past achievements: Ten Years On

Click to view our Glossary of Financial Terms