High PE global tech stocks are currently vulnerable to sentiment shifts if earnings metrics are even mildly astray. Xero’s FY22 result was castigated by the market for missing optimistic consensus net profit and subscriber forecasts.
XRO’s FY22 EBITDA of $212.7 million was modestly above the consensus forecast. It was driven by lower than expected operating expenditure while revenue was broadly in line. The result was high quality, in our view, given the high rate of cash conversion (92% of gross cashflow converted to EBITDA) in 2H22.
Annualised monthly recurring revenue (AMRR) increased 28% yearon- year from subscriber growth of 26% and average revenue per user (ARPU) growth of 7%. Gross margin reached a new all-time high of 87.5% in 2H22 and customer churn remained low at just 0.9%.
Sales and marketing costs grew 32% to $405.7 million representing 37% of revenue. Product design and development expenses also increased 49% to $372 million, representing 34% of revenue. XRO also has a long tail of acquisitions that require investment and integration with the company’s platform, and this also suppresses operating earnings during the early phase.
Marketing and operating costs will slim down for FY23f. XRO has set FY23f guidance for opex to be at the lower end of its 80-85% range, including acquisition integration costs. This will be below the 84% reported in FY22 and will steer operating margins higher.
Investment view
XRO’s modus operandi for most of its existence so far has been to build its subscriber base and invest in its products and marketing to deliver such growth. Revenue growth has been impressive under this approach, but the heavy investment strategy has always made the earnings appear skinny.
The prospect of sustained subscriber growth is undiminished with government initiatives to modernise (digitalise) small business accounting systems pushing customers towards XRO. SME’s spend a minuscule amount on their accounting software as indicated by the ARPU of $30 per month, or typically less than 1% of turnover. Most SME’s probably spend more on coffee!
XRO has strong market positions in its geographies and generates very good cash flow due to low working capital from monthly billing cycles.
We see no fundamental change to XRO’s long term outlook despite the savage reaction in the share price following the result.
Risks to investment view
Subscriber and revenue growth may not pan out as expected, or competition could erode XROs’ market share.
Recommendation
We have retained our Buy recommendation.
