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Why the XERO FPO share price shot the lights out

The XERO FPO NZX (ASX: XRO) share price is likely to rise over the long run if it can keep posting results like it did this morning.

Indeed, the Kiwi company, which prides itself on “beautiful, easy-to-use accounting software”, reported a 43% rise in revenue and a narrowing loss of NZ$69 million for its 2016 financial year.

Here are some of the key takeaways from Xero’s financial year to 31 March 2017:

  • Total number of subscribers was 1.035 million, up 318,000 in the last year
  • Xero is now the largest cloud accounting business outside the US
  • Subscription revenue increased 52% in constant currency
  • In New Zealand, 33% of small businesses use Xero
  • In the UK, subscriber numbers grew 59% to 212,000
  • The gross profit margin came in at 77%, up from 76%

“It has been a milestone year for Xero, achieving operating cash flow break-even in the second half of the financial year, and doubling subscriber numbers in less than two years to pass the one million subscriber mark, while completing our major re-platform to Amazon Web Services,” CEO Rod Drury said.

Pleasingly, the company had $114 million of cash on its balance sheet at March 31, and plans to reach cash flow breakeven within the current balance.

Cash flow breakeven includes all cash flows, not just operating flows. In the analyst community, cash flow is perceived a more reliable measure of a company’s value than reported profits.

Xero expects improvements in the company’s systems and processes will improve its already impressive margins.

“We believe the application of machine learning and AI to accounting will unlock significant productivity for our accountants, bookkeepers and small business customers,” Mr Drury added. “We are making progress in rewiring how businesses work together with more bank feeds, large enterprises connecting to their customers with Xero, and more than 20 million unique connections doing business on our platform.”

Foolish Takeaway

In my opinion, Xero is one of the most impressive companies in Australia and New Zealand. However, it’s a special type of company that requires a special type of investor. It does not make a profit, so don’t expect a dividend. And it does not measure success in regulatory profit, so don’t expect its valuation to make a lot of sense if you are using standard measures like P/E ratios.

Notwithstanding the risks — there are plenty — Xero is a well-run growing business with an incredibly high-margin and sticky product.

Therefore, while I couldn’t call its shares a bargain in a conventional sense, I would be a happy shareholder over the ultra-long-term.

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Motley Fool Contributor Owen Raszkiewicz does not have a financial interest in any company mentioned. Owen welcomes and encourages your feedback. You can follow him on Twitter @OwenRask.

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.

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