3 reasons why the Xero (ASX:XRO) share price selloff could be an opportunity

There are a number of reasons why the Xero Limited (ASX:XRO) share price could actually be an opportunity for brave investors.

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The Xero Limited (ASX: XRO) share price is down 11% at the time of writing. The sell-off could prove to be an opportunity for investors over the long-term.

Why is the Xero share price falling?

Not only is there a wide selldown of ASX growth share names, but Xero just released its FY21 result which wasn’t quite as strong as some investors were expecting.

Operating revenue grew by 18% to NZ$848.8 million, with total subscriber growth of 20% to 2.74 million. Annualised monthly recurring revenue (AMRR) grew 17% to NZ$963.6 million. Earnings before interest, tax, depreciation and amortisation (EBITDA) went up 39% to NZ$191.2 million and free cashflow rose 110% to NZ$56.95 million. Net profit after tax (NPAT) grew from NZ$3.3 million to NZ$19.77 million.

The total lifetime value of subscribers went up 38% to NZ$7.65 billion.  

Here’s why the Xero share price could be an opportunity

A lower share price can present a better time to buy shares. But there still have to be compelling reasons to believe there can be long-term growth of the business.

Continuing growth of the profit margin

One of Xero’s best selling points is how profitable it is. Not necessarily at the net profit line – it only made NZ$20 million of profit – but at the gross profit line. Xero has one of the highest gross profit margins on the ASX. This shows how low cost it is to deliver its exceptional cloud accounting software product to clients.

How high is the gross profit margin? A year ago in FY20 it was 85.2% and in FY21 it grew by another 0.8 percentage points to 86%. This means that most of the new revenue can fall to the next profit line without losing much to unavoidable variable costs.

But Xero can use a lot of that new revenue to re-invest for better products and win over even more customers.

Large international growth

Australia and New Zealand are great countries. However, they have relatively small populations and that means the addressable markets are quite small. But when a high-quality ASX share can expand significantly overseas, then it means that company has a very long growth runway.

The local markets are still seeing very strong growth for. New Zealand subscribers rose by 14% – this was the best year for net subscriber growth in three years. Australian subscribers went up 22% to 1.11 million – this was the best ever year of growth.

Internationally, Xero is also doing very well. UK subscribers grew 17% to 720,000 – there was a good recovery in the second half of the year, leading to the second strongest half period. North American subscribers went up by 18% in the year to 285,000.

There was particularly strong growth in the rest of the world with a 40% increase of subscribers. The largest contributors to subscriber growth here was South Africa and Singapore.

Long-term focus

Xero is focused on the long-term for shareholders. During the year it made acquisitions (called Planday, Tickstar and Waddle) to improve the overall offering for subscribers.

The company said:

Xero will continue to focus on growing its global small business platform and maintain a preference for reinvesting cash generated, subject to investment criteria and market conditions, to drive long-term shareholder value.

Xero plans that its total operating expenses (excluding acquisition integration costs) as a percentage of operating revenue in FY22 will be in the range of 80% to 85%, which is consistent with levels seen in the second half of FY21 and the pre-pandemic period.

As the business invests to win higher market share, it aims to increase the underlying value of the entity to shareholders.

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Tristan Harrison 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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