Research Team, 27 April 2017

Stock Comment - Xero XRO

Xero (XRO) provides an online accounting solution for small businesses and consumers primarily in New Zealand, the UK, Australia and the US. It offers Xero software for online accounting – including general ledger, bank reconciliation, and invoicing.


One of XRO’s key innovations has been to use accountants as the key sales channel. XRO has enticed accountants with great success in Australia, New Zealand and the UK by enabling them to offer better value services to clients, and providing cloud based software that is fully integrated with the end user software allowing the accounting practice to move fully into the cloud, while also providing the software at no cost.

Although XRO is currently making an operating loss, gross margins continue to improve as revenue growth continues to build. XRO expects to reach a cash flow break even position by FY19, and achieve a gross margin above 80%. This will be achieved via operating leverage; as revenue grows quicker than costs, margins will improve. This leverage has begun to develop in XRO’s more mature markets of New Zealand and Australia, where the costs associated with sales, marketing and product development have stabilised. As some of XRO’s other geographies mature, such as the UK and the US, the business model has the potential to be highly profitable over the long-term.

XRO’s share price has moderated in recent years as the company has found it difficult to penetrate the US market. XRO has performed well in the New Zealand, Australian and UK markets and for a while similar success in the US was priced in. However, Intuit is in a strong position to defend its market share in the US and has shown very strong momentum with its QuickBooks Online, cloud based accounting offering. Nonetheless, XRO continues to penetrate the large US market and we believe this opportunity is now more accurately reflected in the share price.

XRO has created a strong brand presence in the New Zealand, Australia and UK accounting markets, leaving it in a position to build and strengthen its position. XRO’s growth and market share in New Zealand is beginning to mature but the opportunities to grow in Australia, the US and the UK are substantial. We have yet to see the company get a strong foot hold in the US, which will be an important determinant as to whether the company can fulfil lofty expectations. Any investment in XRO should be held as a niche weighting and involves a high risk tolerance.

Risks to XRO include; 1) increased competition, 2) security breach, and 3) loss of key personnel.