Xero Ltd (ASX: XRO) shares have been out of favour in recent months, down about 58% over the past year and well off their highs near $160 per share.
The question now is, are they looking cheap?
The analyst team at UBS certainly seems to think so. They have just issued a new research note on Xero with a buy recommendation, and a bullish share price target, which I'll get to shortly.
Firstly, let's look at why they are so optimistic about the company.
Image source: Getty Images
Fears about AI overblown
Xero was one of many technology stocks which was sold off earlier this year amid fears that AI would destroy their business models.
UBS argues that this "AI overhang" is still weighing down the Xero share price, but they say that looking at the company's expected future revenues, that the share price is way too low.
The broker said:
Current share price appears to be factoring in 7% revenue compound average growth rate over next 4 years, implying no average revenue per user growth from FY27 onwards, which we view harsh, given recent channel checks provide us with comfort on XRO's defensiveness and competitive position in the market. Whilst evidence of AI monetisation bending the revenue growth curve is a critical catalyst for a broader re-rate for our Australian software as a service names, we see continued execution on core business with business as usual pricing growth likely enough to drive a meaningful re-rate in XRO in the short-term.
UBS said their analysis suggests Xero's role as a core accounting software provider gives it a strong defensive position, and they argue the company's pricing power will hold.
The broker said accountants and bookkeepers are risk-averse and therefore likely to stick with what they know.
Xero itself has also started to bundle AI functionality with its plans, UBS says, which could drive average revenue per user higher.
AI a big opportunity
Xero Chief Executive Officer Sukhinder Singh Cassidy told the company's annual general meeting in August that AI was a huge opportunity for the company.
Ms Singh Cassidy said:
Our opportunity in the AI era is both powerful and exciting for both our customers and internally. AI is not just something we are building for our customers, it is reshaping how Xero operates internally so that we can drive greater productivity and enable our people to move faster. Over 83% of Xeros now use AI daily, and our internal AI momentum is just as strong.
UBS has a 12-month price target of $106 on Xero shares, compared to $63.70 now.
If achieved, this would constitute a 66.4% return. Xero is valued at $10.9 billion.
