Company Overview: Xero Limited (ASX: XRO) is engaged in providing software solutions across various geographies, offering cloud-based accounting software that connects small businesses to their advisors. Xero offers an ecosystem of more than 1,000 third-party apps and over 300 connections to banks and other financial partners. The company was listed on ASX in November 2012.

XRO Details

XRO Rides on Acquisition Synergies & Geographical Diversification: The company’s 1HFY22 performance highlights its robust position within the small business economy. XRO remains on track with ongoing product and technology investment, thus adapting to the changing operating environment.

Spotlight on 1HFY22 Results:

• Robust Operational Performance: The company reported operating revenues of NZ$505.7 million, up 23% on the pcp. On a constant currency basis, operating revenue went up by 26% on pcp. Core accounting revenue went up by 18% on pcp, whereas Platform revenue more than doubled on a year over year basis, indicating higher contributions from payments, payroll and recently acquired businesses.
• Rise in Subscribers: In 1HFY22, the total subscriber base increased by 23% on pcp, and AMRR, exceeded $1 billion for the first time. Total subscriber lifetime value (LTV) during the period came in at NZ$9.9 billion, up 61% on pcp. The strength of XRO’s performance in a number of its Software as a Service (SaaS) metrics, including average revenue per user (ARPU), positively impacted subscriber LTV.
• Margin Details: During the period, EBITDA, and free cash declined on a year over year basis, due to higher investments across both sales and marketing and product development. Nevertheless, the gross margin stood at 87.1% in 1HFY22, up from 85.7% reported in 1HFY21.
• Product and Technology Investment: Product and technology investment in 1HFY22 were in line with XRO’s long-term goals, which included platform enhancements. Product design and development costs amounted to 33% of total operating revenues and went up more than 50% year over year.
• Liquidity Position: The company’s net cash amounted to around NZ$125.05 million at the end of 1HFY22. Total available liquid resources came in at NZ$1.2 billion as at 30 September 2021, which included NZ$150 million of undrawn committed debt facilities.

Geographical Highlight; Analysis by Kalkine Group

Acquisition Synergies: 

• The company’s three recent purchases, Planday, Tickstar and Waddle, made good progress in 1HFY22. Jointly, these businesses improved product and talent capabilities, added new sources of revenue, and contributed NZ$19 million of operating revenue during the period.
• Recently, the company announced that it is acquiring TaxCycle, a Canadian tax preparation software company. The move will aid XRO with direct access to an established Canadian income tax solution and customer base, thus extending its product offering in that market.
• In another update, the company announced that it is acquiring LOCATE, a US cloud-based inventory management provider. With this acquisition, the company is looking forward to leveraging market expertise, better supporting the inventory needs of small businesses, and improving its e-commerce capability.

Key Metrics: For 1HFY22, the company reported an EBITDA margin of 20%, higher than the 2HFY21 figure of 16.1%. In 1HFY22, the company recorded a current ratio of 6.72x, higher than the industry median figure of 2.50x.

Profitability Profile; Analysis by Kalkine Group  

Top 10 Shareholders: The top 10 shareholders together form around 34.17% of the total shareholdings, while the top 4 constitute the maximum holding. Drury (Rodney Kenneth) held the maximum number of shares with a percentage holding of 6.65%, followed by Hyperion Asset Management Limited holding 5.19%, as also highlighted in the chart below: 

Top 10 Shareholders; Analysis by Kalkine Group 

Risk Analysis:

• Losses in 1HFY22: Net loss in 1HFY22 stood at NZ$5.9 million, against a profit of $34.5 million reported in the year-ago period, owing to higher operating expenditure and investment in new markets and acquisition-related costs. Hence, these mounting losses may throw tough challenges at the company’s overall functioning and may dampen margins in the future.

• Other Possible Headwinds: Any adverse movement in foreign exchange price may impact the company's financial performance. The company is also exposed to general global economic and market conditions risks. The company is susceptible to certain risks such as risks associated with cyber security, information technology, international expansion, and stiff competition.

Outlook: In order to drive long-term shareholder value, the company aims to grow its global small business platform and maintain a preference for reinvesting cash generated. Further, it continues to operate with a disciplined cost-management approach, which aids XRO to spend on new products and customer growth. As a percentage of operating revenue, total operating revenues are expected to be in a range of 80-85% for FY22. Further, the acquisition of Planday is anticipated to contribute around three percentage points of further operating revenue growth in FY22. XRO continues to invest in research and development to provide differentiated products and services, which adds value to its software solutions.

Valuation Methodology: EV/Sales Multiple Based Relative Valuation (Illustrative) 

Source: Analysis by Kalkine Group 

*% Premium/(Discount) is based on our assessment of the company’s NTM trading multiple after considering its key growth drivers, economic moat, stock's historical trading multiples versus peer average/median, and investment risks. 

Stock Recommendation: The stock of the company has been corrected by ~31.84% in the past three-months. Currently, the stock is trading below the average of its 52-week high and low levels of $156.65 and $91.81, respectively. The stock has been valued using an EV/Sales-based illustrative relative valuation method and arrived at a target price of low double-digit upside (in % terms). The company might trade at some discount compared to its peers, considering the losses in 1HFY22, decrease in free cash flows, integration risk, shifts in consumer preferences, etc. For the purpose of valuation, peers such as Seek Ltd (ASX: SEK), REA Group Ltd (ASX: REA), NEXTDC Ltd (ASX: NXT), and others have been considered. Considering the higher revenue base, robust customer base, product launches, positive long-term outlook, acquisition synergies, current trading levels, upside in valuation, and key risks associated with the business we recommend a ‘Buy’ rating on the stock at the current market price of $94.20 as on 25 February 2022, 12:30 PM (GMT+10), Sydney, Eastern Australia. Markets are trading in a highly volatile zone currently due to certain macro-economic issues and geopolitical tensions prevailing. Therefore, it is prudent to follow a cautious approach while investing.

XRO Daily Technical Chart, Data Source: REFINITIV 

Note 1: The reference data in this report has been partly sourced from REFINITIV.  

Note 2: Investment decision should be made depending on the investors’ appetite on upside potential, risks, holding duration, and any previous holdings. Investors can consider exiting from the stock if the Target Price mentioned as per the Valuation has been achieved and subject to the factors discussed above. 

Technical Indicators Defined:-

Support: A level where-in the stock prices tend to find support if they are falling, and downtrend may take a pause backed by demand or buying interest.

Resistance: A level where-in the stock prices tend to find resistance when they are rising, and uptrend may take a pause due to profit booking or selling interest.

Stop-loss: It is a level to protect further losses in case of unfavourable movement in the stock prices.

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