The Xero Limited (ASX: XRO) share price still looks like a solid buy to me because it’s achieving pleasing growth.
Xero is one of the biggest account software providers in the world. I think it’s going to become a lot bigger.
There are three reasons why I’d say Xero still has a great future.
Strong gross profit
The ASX doesn’t have many businesses that have a stronger gross profit margin than Xero’s 87%.
With such a high margin, Xero’s revenue growth is more valuable than a company with a low gross profit margin.
While Xero isn’t making strong profit yet, it has a strong start to its profit ‘waterfall’ which will benefit a lot as the company becomes bigger.
Great revenue growth statistics
There are various measures that are showing why Xero’s revenue is rising so quickly.
In FY23, operating revenue rose by 28% to NZ$1.4 billion. The number of subscribers increased by 14% to 3.74 million, while the average revenue per user (ARPU) increased 10% to NZ$34.61.
Its customer retention rate remains over 99%, which means a high level of its revenue is locked in each year, and the loyalty enables the company to pass on subscription price increases while not losing many subscribers.
If it keeps growing subscribers and ARPU, then its revenue growth seems undeniable.
Much stronger profit expected
In FY23, Xero’s free cash flow jumped by NZ$100 million. It seems that net profit and cashflow are going to surge in the coming years with management committing to ensure that its expenses are a lower proportion of revenue than the past.
To me, this suggests that profit is going to grow much faster than revenue as margins improve.
I don’t think the average investor realises how profitable Xero can become. Its software nature means it can grow quickly without needing to invest in a large asset base, and achieve strong margins.
In FY24, the operating revenue to expense ratio is expected to be around 75%. In the subsequent years I think this number will improve even further.
Final thoughts on the Xero share price
If things go well for Xero, it could achieve one of the highest EBIT (EBIT explained) margins in the ASX 100 in the future in my opinion. There’s still a lot of the world where the business can expand and scale even further, which makes me excited about its future. It’s still priced significantly lower than its $154 peak in late 2021.
