Deutsche Bank rates Xero a 'sell' with target price of $18.90/share

Shares of Xero [NZX: XRO], the cloud-based accounting software firm, are overvalued on US growth prospects and have been rated a 'sell' by Deutsche Bank as it initiates coverage of the company.

The investment bank, which part owns Craigs Investment Partners in New Zealand, gave the Wellington-based company a target share price of $18.90. Shares of Xero recently traded at $23.25, well below its March record of $45.99. It last traded below $20 in October last year.

Globally tech stocks have pared gains made early in the year and the NZX Sci-tech Index, which includes Xero, bio-tech company Pacific Edge, BLIS Technologies and Windflow Technology, has fallen some 28 percent since January as investors questioned high valuations relative to earnings.

In a note "Too much blue sky baked in" analysts Stephen Ridgewell and Joshua Dale say the "market is pricing in a faster ramp up in US sales than is likely and that the share price is likely to de-rate" to $18.90 on a discounted cash flow basis. The company needs two to three more years to build its growth engine in the US, they said.

The Wellington-based company wants a million customers, and is targeting growth in the US where it sees the potential to take market share of an estimate 29 million small to medium sized business owners. According to chief executive Rod Drury's annual general meeting presentation in July, the company has 334,000 customers worldwide, two-thirds of which were in Australia and New Zealand, and 18,000 in North America.

Banking fragmentation and the complex tax and state system in the US was a technical hurdle the company had to surmount, but more importantly competition from incumbent Intuit meant Xero would take several years to build momentum, the analysts said. Xero needed to build a product suite which matched Intuit's own offerings, incorporating tax management as well as catering for the prevalence of cheques in the market.

Xero was on track to take market share in Australia and New Zealand over the next two to three years, and was gaining ground in the UK but needed banks to allow for direct data access, Ridgewell and Dale.

The stock is rated an average of 'hold', based on five analysts as surveyed by Reuters, with a median price target of $21.75.

(BusinessDesk)