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Why the Xero share price is defying the WAAAX meltdown

Brendon Lau
xero share price

Talk about going from zero to 100! The Xero Limited (ASX: XRO) share price is defying the market meltdown that has sent its peers plummeting in value after the cloud-based accounting platform got a big valuation upgrade.

The Xero share price jumped 1.3% to $80.80 in after lunch trade when the S&P/ASX 200 (Index:^AXJO) (ASX:XJO) index tumbled 1.5%.

More telling is the fact that the other WAAAX stocks are suffering a bigger sell-off. The WiseTech Global Ltd (ASX: WTC) share price crumbled 3.9% to $25, the Afterpay Touch Group Ltd (ASX: APT) dived 4.5% to $29.10, the Appen Ltd (ASX: APX) share price fell 2.9% to $22.90 and the Altium Limited (ASX: ALU) share price shed 2% to $35.27.

It’s all about the leverage

The WAAAX stocks refer to the hottest tech stocks in 2019 with the acronym made up of the first letters of each company.

Xero is the only one that is making gains after Morgan Stanley upgraded its price target on the stock by 39% to $90 a share.

That’s a big increase and not one you see often. It comes after the broker commented that the market is underappreciating the leverage coming through the business.

This is an important point as sceptics often refer to Xero’s inability to make a profit despite the huge increase in its subscriber base.

Margins trending up

But the company’s latest interim result showed margins are expanding with the international division’s contribution margins breaking even for the first time.

“We tweak long-term estimates to incorporate the leverage that we think this business can achieve,” said Morgan Stanley.

“Whilst near-term EPS falls 10-32% for FY20-22 due to less favourable interest rates and higher share count in the 1H20 result, our PT increases to A$90, one of the highest PT’s vs. peers, driven by long-term margin expansion from FY23-24 that is captured in the DCF [discounted cash flow] valuation.”

Xero share price heading for $110?

The upside for the stock could even be higher under the broker’s “bull case” scenario as the stock could reach $110. This is where the stock enjoys a triple tailwind of margin expansion, rising platform revenue and further growth in its international business.

“We continue to see XRO as a high growth stock, with a large global TAM [total addressable market],” said the Morgan Stanley.

“XRO is taking leadership globally, with sticky customers, operational leverage and upside from future platform revenue. It remains one of our top picks in our TMT coverage.”

The broker reiterated its “overweight” (or “buy”) recommendation on the stock.

The post Why the Xero share price is defying the WAAAX meltdown appeared first on Motley Fool Australia.

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Brendon Lau has no position in any of the stocks mentioned. Connect with him on Twitter @brenlau.

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. 2019