Last week cloud-accounting business Xero Limited (ASX: XRO) held its AGM in Auckland where its management team provided a few updates on the business and its growth strategy.
Perhaps most importantly its CEO stuck to guidance for FY 2020's free cash flow as a percentage of revenue to be around the 1.2% hit in FY 2019. The lack of growth is slightly disappointing, but if we consider that Xero grew revenue at 36% over FY 2019 then it's reasonable if it can come close to that sort of growth rate over FY 2020.
For example if it added 36% to FY 2019's operating revenue of NZ$552.8 million it would come in at around NZ$772 million to produce free cash flow of NZ$12.4 million or around double the NZ$6.5 million achieved in FY 2019.
So while it won't be shooting the lights out we can see that if Xero can produce consistently strong revenue growth via reinvestment in marketing and lift gross profit margins it should produce strong profit growth over the long term.
As an aside for FY 2020 the revenue growth assumptions may be a little bullish, but on the other hand it might beat the 1.6% as a percentage of free cash flow to revenue.
One factor supporting it over the six-months to March 31 2019 was the UK tax office's push to get all small business accounting online or digital, rather than desktop, Excel spreadsheet, or even paper based.
"We also see continued opportunity in the UK from HMRC's Making Tax Digital initiative. We added 151,000 subscribers in FY19, with 108,000 subscribers added in the second half," commented CEO, Steve Vamos.
It's worth noting that the UK tax office is actually ahead of peers in Australia or the U.S. for example in forcing small businesses to go online or digital in what has created a huge tailwind for Xero and other cloud accounting players like Myob, Sage or Intuit.
For investors then this is an attractive point to consider as the ATO could move to do similar one day, while zooming out further stats show that markets like the US, Canada, or South Africa are still under-penetrated in cloud accounting generally.
Thanks to its attractive economics, market-leading nature and strong outlook I'd continue to rate Xero shares as a buy.
Other SaaS type businesses to watch include Altium Limited (ASX: ALU) and Infomedia Limited (ASX: IFM). The latter reporting some strong profit growth today.
