Why I think the Xero share price is now too compelling to ignore

The share price of cloud accounting tech stock Xero has fallen from the sky, but I think it’s a buy.

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Key points

  • Xero has lost some market sentiment, but I think it’s now good value after dropping almost 50% this year
  • The ASX tech share is growing rapidly in multiple countries, giving it a large addressable market
  • It has a very high level of customer loyalty, which could mean the announced price increases have minimal overall impact on the business

The Xero Limited (ASX: XRO) share price has fallen heavily in 2022. I think it looks like a good long-term opportunity at these levels.

How much has Xero dropped? It’s down 46% in this calendar year. Considering the business still has a market capitalisation of $11.6 billion (according to the ASX), the drop represents a hefty fall in the valuation.

However, while the Xero share price has almost halved, operationally it’s the biggest it has ever been in terms of revenue and subscribers. That’s one of the main reasons why I think the Xero share price is good value.

Ongoing growth

Every result that Xero reports includes impressive growth statistics.

It seems that investors are now getting better value when comparing the Xero share price to revenue. In FY22, Xero reported that operating revenue increased by 29% to NZ$1.1 billion, while annualised monthly recurring revenue (AMRR) grew by 28% to NZ$1.2 billion.

The business reported solid growth in its subscriber numbers as well. Subscribers increased by 19% to 3.27 million, while the net subscribers added was 16% higher at 530,000 (up from 456,000).

Despite heavily investing for growth, Xero’s FY22 earnings before interest, tax, depreciation and amortisation (EBITDA) managed to increase by 11% to NZ$212.7 million.

As Xero says, it 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”.

While it’s not focused on making big profit in the short term, the gross profit margin of 87.3% signals that Xero can make good profit in the long term when it’s not so heavily focused on growth spending such as marketing.

With its global growth plans, I think the lower Xero share price is even more compelling.

Price increases

In FY22, Xero achieved a 7% increase in average revenue per user (ARPU) to NZ$31.36.

FY23 (and FY24) could see another increase with mid-to-high single-digit price increases planned for most customers in September 2022 in Australia, the UK, and New Zealand. This increase will come roughly halfway through Xero’s 2023 financial year, so it should help growth in both FY23 and FY24.

For example, ‘standard’ UK subscribers will see a 7.7% rise to £28 per month. ‘Premium’ subscribers will experience a 9% rise to £36 per month. Even if Xero weren’t to add many subscribers in the UK in FY23, the price increases could help revenue grow nicely over the subsequent 12 months.

Unless Xero’s costs rise by a similar rate, the price increases could lead to stronger profit margins for the business.

Strong loyalty

There could be a danger of losing subscribers because of the price increases.

However, Xero has displayed a high level of customer loyalty and the ‘churn’ has been decreasing. The FY22 subscriber churn/loss rate was just 0.66%. This was an improvement from 0.73% in FY21 and 0.84% in FY20.

I think the useful time-saving and efficient tools that Xero offers business owners and accountants will mean subscribers want to stick around, even with a higher subscription fee.

The length of time that subscribers are sticking with Xero is helping grow its total lifetime value (LTV) of subscribers. FY22 LTV rose 43% to NZ$10.9 billion.

Foolish takeaway

When combining the above factors, I think the Xero share price looks attractive for the next 12 months and beyond. I’d happily add it to my portfolio today.

Motley Fool contributor Tristan Harrison has no position in any of the stocks mentioned. The Motley Fool Australia's parent company Motley Fool Holdings Inc. has positions in and has recommended Xero. The Motley Fool Australia has positions in and has recommended Xero. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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