The Xero Limited (ASX: XRO) share price has seen a significant decline since the start of the year. It's down by 24%, almost a quarter.
Considering Xero's size, it has seen one of the biggest declines in market capitalisation in the S&P/ASX 200 Index (ASX: XJO) over the last several weeks.
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What's happening to the Xero share price?
There has been a widespread sell-off of many growth-focused names on the ASX (and around the world).
Interest rates play a key role in affecting asset valuations. That effect is felt everywhere – shares, bonds, property and so on. With so much inflation happening in the US, economists are now thinking that the US central bank, the Federal Reserve, is going to need to increase the rate significantly this year to get things under control.
For example, Goldman Sachs economists now reckon there are going to be seven interest rate increases in 2022.
Many other ASX names have also been sold off heavily. The WiseTech Global Ltd (ASX: WTC) share price is down 24.6% this year, Altium Limited (ASX: ALU) is down 22% and the Temple & Webster Group Ltd (ASX: TPW) share price is down 23%. So, Xero is not alone.
The company continues to grow
Xero's management will continue doing what they think is right for Xero, regardless of whether the Xero share price is above $150, or around $100.
The cloud accounting software business is building a global position as a leading player. At the end of September 2021 it had 3 million subscribers, which was an increase of 23% year on year.
Xero recognises that to best support its subscribers and win new ones, it needs to keep investing in supporting customer needs and innovating for the long term. Small businesses around the world are increasingly recognising the critical importance of digital tools to help them adapt and succeed in a changing operating environment, according to Xero. That's why its product design and development costs increased 51% to $166.8 million in the first half of FY22, representing a third of operating revenue.
Xero wants to be the world's most insightful and trusted small business platform to make life better for people in small businesses.
Numerous financial measures improved in the first half for Xero, including average revenue per user (up 5%), annualised monthly recurring revenue (up 29%) and the gross profit margin (up 1.4 percentage point to 87.1%).
Why the Xero share price could be a major buy
Multiple brokers think the Xero share price is a buy including Citi and Credit Suisse. Both of those price targets were $160, though this was before the 2022 decline. It implies 40% upside this year, if those brokers end up being correct. They note the strength of the software as a service (SaaS) offering of the business, with an attractive rise of the average revenue per user.
After seeing the HY22 report, Macquarie rated Xero as a sell/underperform. But the price target was $130 – that's 17% higher than where it is today. The underperform rating was because of the stretched valuation.
However, it must be noted that not every broker's price target is higher. UBS rates Xero as a sell and the price target is $88. That implies a drop of 20% over this year. It thinks the company is growing well, but the Xero share price was too expensive.
