The Xero Limited (ASX: XRO) share price suffered heavily last year. It was one of the worst performers in the S&P/ASX 200 Index (ASX: XJO) in 2022. Xero shares dropped by 52% and the ASX 200 only fell by 7.25%.
With such a significant decline, you'd think the cloud accounting software business saw a big turn in conditions. But, it didn't. The company has continued to report double-digit growth, which I will outline later.
However, the biggest impact on the Xero share price may have been rising interest rates. A wide range of ASX growth shares suffered major sell-offs last year.
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Why do interest rates matter for ASX growth stocks?
Warren Buffett explained how interest rates affect things:
The value of every business, the value of a farm, the value of an apartment house, the value of any economic asset, is 100% sensitive to interest rates because all you are doing in investing is transferring some money to somebody now in exchange for what you expect the stream of money to be, to come in over a period of time, and the higher interest rates are the less that present value is going to be. So every business by its nature…its intrinsic valuation is 100% sensitive to interest rates.
Investors may have an idea of what a business may look like in five or ten years, and potentially the valuation. But, to figure out how much an ASX growth share is worth today, an investor can 'discount' that value back through the years until the investor gets to today's value. The higher the interest rate, the higher the discount rate.
So, with interest rates up so much, it is somewhat justified that the Xero share price is lower than it used to be. But, a decline of 50% may be too harsh.
Xero shares continue to see underlying growth
In the first half of FY23, the company reported that subscribers grew by 16% to around 3.5 million and the average revenue per user (ARPU) grew by 13% to $35.30. Operating revenue went up by 30% to $658.5 million and annualised monthly recurring revenue (AMRR) jumped 31% to $1.48 billion.
All of those statistics are what I'd want to see from a leading business, particularly with a high gross profit margin of 87%.
When a company has that strong of a gross profit margin, it means a vast majority of the new revenue that Xero generates can be turned into gross profit, which can then be spent on categories like software development, marketing, employees, and so on.
The business keeps over 99% of its subscribers each year, showing that loyalty is exceptionally high. Xero is taking advantage by implementing price increases in New Zealand, Australia, and the UK, which can boost its revenue and hopefully the margins.
In the long term, the business expects each of its major expense categories (eg marketing, and general administration) to be a smaller percentage of revenue. In other words, it's expecting its profit margins to rise in the future.
Is the Xero share price a buy?
I think it is. There may be more volatility on the ASX in 2023, but there are few ASX businesses as high-quality as Xero in my opinion. It continues to grow its subscriber numbers globally, subscription prices are increasing and the business is still heavily focused on long-term growth. It's a lot cheaper than it was before.
