Xero to reach profitability in three years, First NZ Capital says

Xero [NZX: XRO], the cloud-based accounting software firm, may reach positive operating earnings in 2018 and achieve bottom-line profit the following year, according to brokerage First NZ Capital.

First NZ analyst James Schofield reiterated his 'outperform' rating on Xero following the release of its full-year results yesterday.

Xero posted a 67% gain in revenue to $207 million, while its net loss widened to $82.5 million. The company said it burned through $86 million in the latest year, down from $88 million a year earlier, and its cash holdings stood at $184 million at March 31, meaning it had enough left to reach breakeven without having to raise more capital.

"The result confirmed cash burn has now peaked," Mr Schofield said in his report, adding that for now he has removed his assumption that Xero will look to raise more equity in 2018 via a US listing. The reduction in cash burn won't be in a straight line, given the company's requirements over the next few years but is likely to "drop quite materially in the 2018 financial year," he said.

Xero shares surged 7.7% to $16.60 on the NZX today, having fallen 1.7% yesterday when its results were announced. The shares have declined 17% in the past 12 months. Shareholders have been taken on a wild ride by the shares in the past five years, with a peak of $45.99 in March 2014 after a steep ascent, followed by an equally steep decline to reach $15 in October of that year.

Mr Schofield raised his target price for the stock to $21 from $20.50, reflecting "slightly accelerated medium-term cashflows." While North American customer growth was weaker than expected (a "slight miss") it was more than offset by a bigger-than-expected uplift in the UK market. He revised his estimate for customer growth to reach 1.32 million in 2018, from a previous forecast of 1.28 million.

Xero has remained "an extremely high-risk investment" because of competition from incumbents such as Intuit, Sage and MYOB, internet security, execution, managing growth and geographical spread, key man risk, especially around founder and chief executive Rod Drury, service pricing and the risk of short-term stock price volatility, Schofield said.

Paid subscribers jumped to 717,000 in 2016, from 475,000 in the 2015 March year, the full-year results showed. Australia led the growth, with a 54% increase to 312,000, while UK subscribers jumped 60% to 133,000, beating Schofield's estimate of 126,000. New Zealand subscribers rose 35% to 186,000 and those in North America gained 77% to 62,000, just missing Schofield's estimate of 64,000.

The stock is rated a 'buy' based on the consensus of seven analysts surveyed by Reuters.