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Leading broker puts buy rating on Xero (ASX:XRO) share price

broker Buy Shares

The Xero Limited (ASX: XRO) share price has been a strong performer in 2020.

Since the start of the year, the cloud-based business and accounting software provider’s shares have jumped almost 67% higher.

Is it too late to buy Xero shares?

According to a note out of Goldman Sachs, its analysts believe the Xero share price could still go higher from here.

This morning the broker commenced coverage on the company with a buy rating and $157.00 price target.

This implies potential upside of just over 18% for its shares over the next 12 months.

Why is Goldman Sachs bullish on Xero?

Goldman Sachs likes Xero due to the quality of its offering, its large and growing total addressable market (TAM), and its attractive unit economics.

The broker commented: “We estimate Xero has a core TAM of NZ$14bn p.a. across its key markets (4.6% penetrated in FY20). However as it broadens and monetizes its app ecosystem, and expands into new geographies, we estimate this will open a further NZ$62bn in addressable TAM, providing a multi-decade runway for strong revenue growth. Combined with attractive unit economics at maturity (GSe 40% EBIT margins), we believe the long-term earnings opportunity for Xero is material.”

What is it expecting in the coming years?

At the end of the first half of FY 2021, Xero had a total of 2.45 million subscribers and was generating annualised monthly recurring revenue (AMRR) of NZ$877.6 million.

Goldman believes this can grow materially over the 2020s.

It explained: “Based on our penetration assumptions of new market opportunities, which are below current market launch performances, we think Xero can achieve a 2030 subscriber footprint of 7.4mn, generating NZ$3.4bn in annual revenues.”

This, combined with the monetisation of its ecosystem, is expected to underpin strong earnings growth over the decade.

Goldman commented: “A key driver of earnings will be its ability to increasingly monetize the application ecosystem that it has built. This could be done through revenue share agreements (app-by-app, introducing a broader platform fees) or through M&A (example: its purchase of Waddle), which we see as increasingly likely.”

“We estimate that by more aggressively monetizing its ecosystem, Xero can increase its addressable TAM by NZ$44bn in potentially extremely high margin revenues (i.e. app-store fee likely 100% margin). Hence we see material upside to XRO ARPU,” it added.

Overall, while it sees the second half of FY 2021 as challenging due to COVID headwinds, the broker believes Xero’s long term opportunity is considerable.

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James Mickleboro has no position in any of the stocks mentioned. The Motley Fool Australia's parent company Motley Fool Holdings Inc. owns shares of Xero. The Motley Fool Australia has no position in any of the stocks mentioned. 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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