Why this top broker just slapped a buy rating on Xero shares

Xero shares could be great value according to Morgans…

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Key points

  • Xero shares are pushing higher on Friday
  • This appears to have been driven by a broker note out of Morgans
  • Its analysts have initiated coverage on Xero with a buy rating and $90.25 price target

The Xero Limited (ASX: XRO) share price has started the month in a positive fashion.

In early afternoon trade, the cloud accounting company’s shares are up 2% to $78.71.

Why is the Xero share price pushing higher?

As well as getting a boost from a rebound in the tech sector, the Xero share price has been given a lift from a bullish broker note.

According to a note out of Morgans, its analysts have initiated coverage on the company with an add rating and $90.25 price target.

Based on the current Xero share price, this implies potential upside of almost 15% for investors over the next 12 months.

What did the broker say?

Morgans notes that Xero has a huge market to grow into and opportunities to boost its earnings from value added services via its app store.

XRO has a significant runway for customer growth with <10% penetration of a 45m+ SMB Total Addressable Market (TAM). We see additional earnings upside from platform / ancillary value-added services and margin expansion.

The broker has, however, warned that it could be a bumpy road ahead for the Xero share price. This is due to the market having difficulty deciding on which valuation method to use for its shares given its propensity to reinvest in its growth.

Execution risk and time value of money are the key operational considerations. What valuation framework investors are prepared to use is the greatest unknown. The subjectivity of this will create share price volatility along the way.

‘A top tech exposure’

Nevertheless, the broker believes Xero is a high quality company, with strong growth potential in an industry with high barriers to entry.

It summarises:

XRO boasts strong customer advocacy, significant barriers to entry, scalability and LTV at ~7x CAC. It should continue to grow earnings/FCF above economic trend and is profitable and liquid. We rate it highly and it appears others do as well. A key risk is XRO trades on large short-term multiples. If we remove FY22F “investing for growth” CAC, XRO trades on a ~2.2% FCF yield. Rising interest rates are a net negative for XRO’s share price and growth companies. However, XRO should be a top tech exposure due its high quality.

Motley Fool contributor James Mickleboro 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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