Australia | 1:53 PM
Xero’s strong FY26 result highlighted accelerating US growth, Melio momentum and expanding AI capabilities, while investor concerns around AI disruption and competition weighed on sentiment.
- Claude Small Business announcement reignites software disruption fears
- US delivers robust results including Melio and the payments strategy
- Accountants remain Xero’s underestimated advantage, and moat
- Analysts argue the AI de-rating has gone too far
By Danielle Ecuyer
Did Claude and AI rain on Xero's earnings parade?
Disruption and change are an inherent part of technological development and evolution.
Arguably, as FNArena has written over recent years, AI is the largest and most transformative mega-trend since the internet (and possibly much more influential too).
As with most predictions and narratives, future outcomes are never set in stone or even straightforward.
Xero’s ((XRO)) full year results, broadly viewed as strong among sector analysts, coincided with the overseas announcement of “Claude for Small Business”, again setting the proverbial ‘cat amongst the pigeons’ when it came to AI-related fears around disruption and displacement inside the software sector.
As highlighted by Citi, Anthropic’s ‘Claude for Small Business’ announcement “overshadowed” Xero’s robust product execution, particularly the Ultra launch, Xeroforce (AI agent), and accelerating momentum in US growth.
More specifically, the inclusion of QuickBooks as one of the partners for Claude’s new small business offered heightened concerns among some observers.
QuickBooks is part of US competitor Intuit’s stable. Citi believes the reference reflects the product’s strong brand awareness and market position in the US, rather than Xero not being available as one of the connectors.
Xero’s ‘model context protocol’ (MCP) integration, which allows AI systems such as Claude to connect to its accounting software, only went live the day before the announcement.
Xero also has commercial arrangements with Anthropic, Claude’s parent company.
Xero's earnings; what's not to like?
Taking a deeper look into the financial results, multiple positive readings were extrapolated for the more studious or investigative investor.
Macquarie et all commended Xero for the achieved growth in US revenue, up 47% y/y in FY26, including growth in net adds to 58,000 compared to 47,000 in the prior period.
Positively, the organic growth trend (ex-Melio) accelerated to around 30% in FY26 from circa 25% in FY25 and circa 13% in FY24. Citi notes US growth gained momentum to 34% y/y over 2H26, including record subs of 42,000, inferring the “product-market fit” is starting to gain traction.
Melio also achieved robust pro forma growth, up 58% y/y, boosted by around 7% growth in Xero BillPay total payment volume and around 20bps of take-rate expansion.
Importantly, as explained by the analyst, every incremental 10bps of take rate equates to around NZ$7.3m of gross profit, which scales over an essentially fixed cost base.
Citi emphasised Melio’s revenue growth of 54% y/y in 2H26 was more robust than expected, with syndicated revenue, around 40% of the total, equally accelerating and direct payments up 46% y/y.
The pick-up has also been achieved before any scheduled brand investment and with minimal go-to-market integration.
The latest Melio results have prompted management to allocate an “incremental US brand spend of up to -NZ$55m”.
While the amount is smaller than anticipated, it does reinforce the upside potential in the US market, which is viewed positively.
The significant valuation and stock de-rating of Xero post the NZ$5bn Melio acquisition and AI disruption concerns has, for now, gone too far according to Morgan Stanley.
The broker sees vindication of that statement in the latest results.
Stripping back the financial metrics to the underlying trends, Morgan Stanley points to the growth potential across all of Xero’s geographies.
Positive underlying growth trends
The core Australian and New Zealand market’s TAM (total addressable market) stands at AU$1.3bn to AU$1.5bn in FY26 and is expected to advance at around 10% p.a. growth to FY30.
Xero holds an estimated 75% market share.
The UK small and medium enterprise (SME) market’s TAM is around 2-3 times larger than Australia’s and worth an estimated AU$3.5bn to AU$5bn in annual revenues, with Xero at a 30% market share.
Bear in mind, the UK’s ‘Making Tax Digital’ program is a significant tailwind, with Xero’s accounting software linked to clients interacting with His Majesty’s Revenue and Customs.
Meanwhile, the total addressable market for US small and medium sized enterprises is estimated at AU$10bn to AU$20bn in annual revenues, with Xero holding an estimated 5% share.
The upside potential for Xero overseas, and specifically in the US market, remains a key factor for analysts. So, at least from the FY26 results, the enthusiastic response to the US performance is hardly surprising.
Citi forecasts Melio to grow 38% y/y in FY27, assuming syndicated growth of 47% y/y and direct growth of around 30% y/y. Citi sees upside potential for the syndicated growth assumptions due to Fiserv (a syndicated partner) acknowledging an inflection point for CashFlow Central usage and implementations.
Morgans sees Melio as on track to becoming earnings (EBITDA) positive in 1H29. Importantly, as revenue growth accelerates, the business becomes more of an earnings growth story than a cost proposition.
Looking at other key geographies, Citi liked the pick-up in product momentum in Australia. The launch of Ultra, a software offering pitched at larger and more complex small and medium sized businesses which are outgrowing standard accounting software packages and do not want ERP software, is viewed positively.
Management noted the early customer feedback has been “very strong”.
Overall, Xero reported subscription growth of 11% y/y to 4.9m, which beat Morgans’ expectations as well as market consensus. UK subs grew 110,000 h/h to 1.3m, above estimates by 83,000.
As noted by RBC Capital, group average revenue per user lifted 31% y/y, a 13% beat to consensus, while churn lifted slightly to 1.14% against consensus expectations of 1%.
Net adds for subscribers rose 454,000 on the prior year and represented the fastest growth in two years.
AI integration
Turning to the question of AI integration, Xedro's new customer AI agent builder, XeroForce, was announced alongside the ongoing expansion of AI capabilities through partnerships like Claude.
Macquarie points out customer usage of AI is growing, with 513,000 using the new GenAI features as at FY26. The number of JAX (Just Ask Xero) messages per customer also lifted by 115% over the financial year.
Internally, AI use is also accelerating, with 83% of employees using AI daily, including 97% of engineers, which Macquarie stresses is resulting in “material productivity gains”, including reducing a timesheet product rebuild to ten weeks from around six months.
For FY27, Ord Minnett noted guidance for revenue and earnings growth (EBITDA) was ahead of, or in line with, consensus forecasts. Broadly speaking, analysts concurred the guidance could well prove to be conservative.
As articulated by the Morgans analyst, the “key question for Xero remains, is AI more an opportunity or threat?”
Morgan Stanley tackles the issue head on. While accepting the de-rating of software stock valuations given the level of uncertainty, as well as adjacent impacts from increased spending on AI enhancements and the debate around longer term earnings and terminal values, this broker argues the market is overlooking one key factor.
Which is Xero’s important, and often underestimated or unacknowledged, relationship with accountants rather than just end users.
Around 90% of Australian and New Zealand small and medium sized businesses have an accounting relationship, and over 50% of Xero’s new subscribers are referrals from accountants, bookkeepers, and advisers.
In the FY26 annual report, the net promoter score with accountant partners was 52, up from 50 in the prior year.
Arguably, for competitors the issue is much more challenging than simply creating a cheaper ledger or user interface, so goes the argument.
If, however, AI disruption lowers the role of the accountant in workflows, then Xero might be more vulnerable.
Equally, the relationship helps support the development of new products for accountants, as well as boosting subscriber growth.
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