Why you need some XERO FPO NZ in your portfolio

The story of XERO FPO NZX (ASX:XRO) may be only just beginning.

| More on:
a woman

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

I have previously written about my reasons for investing in XERO FPO NZX (ASX: XRO); how to understand its key software as a service (SaaS) company metrics; and why I think it has a good chance of hitting its $1 billion revenue target within 5 years.

After attending a Xero roadshow event recently, and being impressed with the latest developments, I decided to revisit the current outlook for investors.

Making great progress

Xero has been developing a complete cloud-based operating system for small businesses which connects them to a global network integrating all parts of the financial ecosystem. Obviously, this requires lots of innovation and investment and comes with substantial execution risk. However, the potential payoff is massive.

Xero has made good progress, most recently reporting 862,000 customers as at 30 September last year. Results for the year ending 31 March 2017 are due out in May, and I will be surprised if it has not reached the milestone of 1 million customers, with a total lifetime value of somewhere in the vicinity of $2 billion.

If Xero does reach these targets for 31 March, it will represent several years of impressive growth, with over $1 billion in total customer lifetime value created in the last two years alone.

Xero SaaS Metric March 2015 March 2016
Number of subscribers 475,000 717,000
Average revenue per user (ARPU) per month $28 $30
Customer acquisition cost (CAC) months 13.5 14.5
Customer churn % (monthly revenue) 1.23% 1.19%
Gross margin % 70% 76%
Lifetime value per subscriber (LTV) $1,733 $2,103
Lifetime value (LTV)/CAC 4.6 4.8
Total lifetime value of subscribers $823 million $1.5 billion

A huge market – but plenty of competition

Xero is competing against Sage in the UK, Intuit in the US, and Myob Group Ltd (ASX: MYO) and Reckon Limited (ASX: RKN) in Australia. However, product ratings suggest that Xero has one of, if not the best solution, meaning it should continue to win market share as accounting moves from the desktop to the cloud.

The potential global cloud accounting market is also much larger than the desktop software market it is replacing. This is because the power, simplicity, and low cost of cloud software make it a compelling solution for the many small businesses that previously shied away from using accounting software products.

This is reflected in Xero's customer data – many of its current customers were not won from competitors, but are new to accounting software.

Demand for Xero will only grow as its capabilities continue to improve and its network becomes more integrated. In my view, any small business not using cloud accounting software is already at a competitive disadvantage – research suggests those that do are more profitable.

Much more innovation to come

Xero CEO, Rod Drury, expects that there will be more innovation in the next two years than the last 10, as machine learning and artificial intelligence transform the industry.

This technology has the power to automate most of the accounting process, from coding transactions straight from the bank statement, right through to preparing financial reports. This will help to unlock the tremendous value that comes from having current and accurate data, such as real-time insights into business performance that were previously impossible.

Granted, the future value of these technologies is hard to quantify for Xero investors today.

An income stock of the future?

Shares are currently trading around $17.30; a level they first reached back in 2013, not long after Xero listed on the ASX. In my view, this represents good value given there is a reasonable chance of Xero surprising on the upside in relation to its customer growth in the next few years. However, weaker than expected progress out of key markets such as the US has the potential to weigh on the share price in the short term.

Xero is yet to make a profit as it has been investing heavily to win market share. The next challenge will be to transition to profitability while continuing to manage growth.

Xero's growth rate, attractive margins, and recurring revenue model could mean that it becomes an attractive dividend paying stock in the future.

Motley Fool contributor Matthew Bugden has shares in Xero. The Motley Fool Australia owns shares of Xero. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

More on ⏸️ Investing

A white and black robot in the form of a human being stands in front of a green graphic holding a laptop and discussing robotics and automation ASX shares
Technology Shares

Joining the revolution: How I'd invest in ASX AI shares right now

Advances in artificial intelligence (AI) could usher in a new industrial revolution. Here’s how you can invest in it.

Read more »

Close up of baby looking puzzled
Retail Shares

What has happened to the Baby Bunting (ASX:BBN) share price this year?

It's been a volatile year so far for the Aussie nursery retailer. We take a closer look

Read more »

woman holds sign saying 'we need change' at climate change protest

3 ASX ETFs that invest in companies fighting climate change

If you want to shift some of your investments into more ethical companies, exchange-traded funds can offer a good option

Read more »

a jewellery store attendant stands at a cabinet displaying opulent necklaces and earrings featuring diamonds and precious stones.
⏸️ Investing

The Michael Hill (ASX: MHJ) share price poised for growth

Investors will be keeping an eye on the Michael Hill International Limited (ASX: MHJ) share price today. The keen interest…

Read more »

ASX shares buy unstoppable asx share price represented by man in superman cape pointing skyward
⏸️ Investing

The Atomos (ASX:AMS) share price is up 15% in a week

The Atomos (ASX: AMS) share price has surged 15% this week. Let's look at what's ahead as the company build…

Read more »

Two people in suits arm wrestle on a black and white chess board.
Retail Shares

How does the Temple & Webster (ASX:TPW) share price stack up against Nick Scali (ASX:NCK)?

How does the Temple & Webster (ASX: TPW) share price stack up against rival furniture retailer Nick Scali Limited (ASX:…

Read more »

A medical researcher works on a bichip, indicating share price movement in ASX tech companies
Healthcare Shares

The Aroa (ASX:ARX) share price has surged 60% since its IPO

The Aroa (ASX:ARX) share price has surged 60% since the Polynovo (ASX: PNV) competitor listed on the ASX in July.…

Read more »

asx investor daydreaming about US shares
⏸️ How to Invest

How to buy US shares from Australia right now

If you have been wondering how to buy US shares from Australia to gain exposure from the highly topical market,…

Read more »