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Why I’d buy and hold Xero shares to 2025 and beyond

Phil Harpur

While Xero Limited (ASX: XRO) hasn’t grabbed as much media attention as the other WAAAX tech shares Appen Ltd (ASX: APX), Altium Limited (ASX: APP), Afterpay Touch Group Ltd (ASX: APT) and WiseTech Global Ltd (ASX: WTC), in many ways I think it’s the best and most consistent performer of the bunch.

Xero is an online accounting software provider for small businesses. Its growth over the past 10 years has been phenomenal and there are no signs of that growth slowing down anytime soon.

One of Xero’s key differentiators over its competitors is that it is affordable and user-friendly. This makes it ideal for small businesses, unlike some of its competitors’ products, which can be expensive and more complex to use.

Finding its niche

Xero is cleverly moving beyond just being a cloud accounting platform. Small businesses are increasingly turning towards Xero to manage their entire business, not just their finances, with Xero offering them a spectrum of tools and services. For example, the Xero platform connects customers with a wide range of financial institutions, including new global fintech companies and over 700 third-party apps, providing a very useful hub for all the relevant data and tools that small businesses require.

Strong growth story continues

In its half year earnings to 30 September 2019 (H1 FY20), Xero delivered strong growth combined with an improving gross margin and improving free cash flow. Operating revenue was up 32% to NZ$338.7 million, while earnings before interest, tax, depreciation and amortisation were up NZ$65.9 million, almost double that of H1 FY19.

There was also a 30% growth in total subscribers to 2.1 million. While it took more than a decade to add Xero’s first million subscribers, it took only two and a half years to add the next million, demonstrating the increasing pace of Xero’s adoption both locally and across a growing number of overseas markets.

Australian subscribers grew by 28%, and revenue up by 26% in H1 FY20. A key driver of growth in Australia was the implementation of the Australian Taxation Office’s Single Touch Payroll initiative.

In other key markets, UK subscribers grew by 51%, New Zealand by 13% and North America by 21%. Xero also has a small initial presence in South Africa, Hong Kong and Singapore, where growth in subscriber numbers was even stronger.

Xero is also gaining further traction in overseas markets by addressing regulatory and tax issues that are hindering adoption in markets such as the US and UK.

Increasing profitability

Xero has a very high gross profit margin of 85%. Its core markets of Australia and New Zealand continue to see an improving upward trend in gross profit margin. Software-as-a-service (SaaS) platforms such as Xero are highly profitable once sufficient scale of subscribers is reached. This point has already been reached in Australia and New Zealand, and Xero’s overseas operations are also heading down that direction.

Xero became cash flow positive for the first time in FY19.

Foolish takeaway

Despite its rapid recent growth, and its share price looking fully valued right now, I believe that Xero still has a long runway for growth ahead of it over the next decade.

Although competition could increase over the next few years, especially from US rival Intuit Inc, there is still enormous opportunity for Xero to tap into global markets.

The post Why I’d buy and hold Xero shares to 2025 and beyond appeared first on Motley Fool Australia.

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Phil Harpur owns shares of Xero, AFTERPAY T FPO, Altium, Appen Ltd, and WiseTech Global. The Motley Fool Australia's parent company Motley Fool Holdings Inc. owns shares of AFTERPAY T FPO. The Motley Fool Australia owns shares of Altium, Appen Ltd, WiseTech Global, and Xero. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

The Motley Fool's purpose is to help the world invest, better. Click here now for your free subscription to Take Stock, The Motley Fool's free investing newsletter. Packed with stock ideas and investing advice, it is essential reading for anyone looking to build and grow their wealth in the years ahead. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson. 2020