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Omnicom’s Q3 Results Display Growing Demand for Ad Holding Firms Services

the firm has attained that position less through acquisitions and more through organic growth. With very well-recognized creative agencies and sub-holding companies such as BBDO and DDB, we expect Omnicom to maintain its market position as it generates competitive organic growth, continues to make acquisitions, and increases focus on the faster-growing emerging markets and the overall digital ad markets.

Through various acquisitions, the firm has transitioned from traditional advertising toward becoming a complete solution provider with digital (including online video, social media, and mobile), along with other services such as public relations. Compared with its peers, Omnicom has been relatively quiet on the acquisition front since it ended merger talks with Public is in 2014. However, top-line growth has been in line with or above the other ad-holding firms.

Financial Strength

Omnicom reported mixed third-quarter results as revenue slightly missed the FactSet consensus estimates while the firm beat bottom-line expectations. With strong double digit organic revenue growth, the revenue miss was mainly due to Omnicom’s disposition of ICON in June. Solid organic growth of 11.5% and favorable foreign currency exchange rates were only partially offset by negative impact from agency divestitures (negative 5.9%). Management guided to 2021 full-year organic revenue growth of 9%, which is slightly below our 9.5% projection. Operating margin of 15.8% during the quarter was slightly higher than last year’s 15.6% due to top line growth and lower costs associated with less occupancy and lower travel expenses. The firm expects full-year 2021 operating margin above 15.1% compared with our 15.1% assumption.

Omnicom has a net debt of $210 million, with debt/EBITDA and interest coverage averaging 2.5 and 9, respectively, during the past three years. These ratios will average around 2 and 14 during the next five years. While Omnicom has not been nearly as aggressive in pursuing the acquisition route as some of its peers, cash allocated toward acquisitions and dividends during the past three years has been equivalent to 4% and 32%, respectively, of the firm’s free cash flow.

Bulls Say’s 

  • Omnicom’s management team is very experienced and has delivered solid results over an extended period through a variety of economic environments.
  • Omnicom’s agencies, such as BBDO and DDB, are some of the most acclaimed in the business.
  • The strength of Omnicom’s three major global networks allows the firm to retain even dissatisfied clients by switching them from one award-winning network to another.

Company Profile 

Omnicom is the world’s second-largest ad holding company, based on annual revenue. The American firm’s services, which include traditional and digital advertising and public relations, are provided worldwide, with over 85% of its revenue coming from more developed regions such as North America and Europe.

(Source: Morningstar)

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

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Aristocrat outspends rivals on research and development improving its competitive position

Aristocrat’s research and development expenditure is unmatched by peers. This investment is the lifeblood of any electronic gaming manufacturer, especially given rapidly changing technology, and allows Aristocrat to maintain game quality, differentiate products from lower-end competitors, and defend its narrow economic moat.

Aristocrat is among the top three global competitors in the highly competitive EGM market, alongside International Game Technology and Scientific Games. EGM sales have been particularly hard-hit as coronavirus-induced shutdowns, social distancing measures, and travel restrictions weigh on the firm’s customers. With less turnover likely up for grabs in the near-term, heavy discounting could weigh on Aristocrat’s profitability in the fiercely competitive electronic gaming machine industry. Aristocrat operates in a market protected from new entrants as stringent regulatory licensing requirements in major markets create barriers to entry for new players.

Financial Strength:

The fair value of Aristocrat has been increased by the analysts by 9% to AUD 36.00 following the announcement of a AUD 5 billion acquisition of U.K.-listed Playtech, AUD 1.3 billion equity raising, and virtual release of fiscal 2021 results.

Aristocrat Leisure is in strong financial health. At March 31, 2021, the company had AUD 1.3 billion net debt, equating to net debt/EBITDA of 1.2- down from AUD 1.6 billion in net debt, equating to net debt/EBITDA of 1.4 at Sept. 30, 2020. EBITDA interest cover is comfortable at over 9 times. With the AUD 1.3 billion capital raising, Aristocrat’s balance sheet is well-capitalised to absorb the AUD 5 billion acquisition of U.K.-listed Playtech, with pro forma net debt/EBITDA of 2.6. Aristocrat is expected to return to paying out dividends from approximately 30% of underlying earnings from fiscal 2021, ramping back up to 40% by fiscal 2022.

Bulls Say:

  • Aristocrat operates in a market protected from new entrants as stringent regulatory licensing requirements in major markets create barriers to entry for new players. 
  • Unlike the mature electronic gaming machine industry, the fast-growing mobile gaming market provides an avenue of strong growth for Aristocrat. 
  • Already boasting a portfolio of highly regarded electronic gaming machines, Aristocrat outspends rivals on research and development allowing the firm to improve its competitive position and protect its narrow economic moat.

Company Profile:

Aristocrat Leisure is an electronic gaming machine manufacturer, selling machines to pubs, clubs, and casinos. The firm is licensed in all Australian states and territories, North American jurisdictions, and essentially every major country. Aristocrat is one of the top three largest players in the space along with International Game Technology and Scientific Games. Through acquisitions of Plarium and more recently Big Fish, Aristocrat now derives a significant proportion of earnings from the faster growing mobile gaming business.

(Source: Morningstar)

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Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

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Global stocks Shares

Carnival’s planning for ship deployments drives improved visibility on return to breakeven profits

The global cruise market has historically been underpenetrated, offering long-term demand opportunity. Additionally, in recent years, the repositioning and deployment of ships to faster-growing and under-represented regions like Asia-Pacific had helped balance the supply in high-capacity regions like the Caribbean and Mediterranean, aiding pricing tactics. 

However, global travel has waned as a result of COVID-19, which has the potential to spark longer-term secular shifts in consumer behavior, challenging the economic performance of Carnival over an extended horizon. As consumers slowly resume cruising after a year-plus no-sail halt, cruise operators will have to continue to reassure passengers of both the safety and value propositions of cruising. On the yield side, Carnival is expected to see some pricing pressure as future cruise credits are redeemed in the year ahead, a headwind partially mitigated by a measured return of capacity. And on the cost side, higher spend to implement tighter cleanliness and health protocols could initially inflate spending. Aggravating profits will be the fact that the entire fleet will likely have staggered reintroductions, crimping profitability over the 2021-22 time frame, ceding scale benefits. For reference, as COVID-19 continues to wane, 61% of capacity (50 ships) is expected to be deployed by November.

Financial Strength:

The fair value of Carnival is USD 26.50 which has been raised by the analysts from USD 25 with a view that more than half the fleet (50 ships, 61% capacity) is expected to be deployed by the end of fiscal 2021, giving the better visibility on the return to profitability.

Carnival has secured adequate liquidity to survive a slow resumption of domestic cruising, with $7.8 billion in cash and investments at the end of August 2021. This should cover the company’s cash burn rate over the ramp-up, which is set to increase from the roughly $500 million per month experienced in the first half of 2021 as ship start-up costs arise. Carnival has raised $5.9 billion in debt, $1 billion in equity, and has repriced its $2.8 billion term loan (2025), bolstering financial flexibility. Additionally, Carnival eliminated its dividend ($1.4 billion in 2019), freeing up cash to support operating expense. An additional $3 billion in current customer deposits were on the balance sheet. The company has renegotiated much of its debt, with less than $4.5 billion in short term and current maturities of long term debt coming due over the next year versus $30 billion in total debt.

Bulls Say:

  • As Carnival deploys its fleet, passenger counts and yields could rise at a faster pace than we currently anticipate if capacity limitations are repealed. 
  • A more efficient fleet composition (after pruning 19 ships during COVID-19) may help contain fuel spending, benefiting the cost structure to a greater degree than initially expected, once sailings fully resume. 
  • The nascent Asia-Pacific market should remain promising post-COVID-19, as the four largest operators had capacity for nearly 4 million passengers in 2020, which provides an opportunity for long-term growth with a new consumer.

Company Profile:

Carnival is the largest global cruise company, set to deploy 50 ships on the seas by the end of fiscal 2021 as the COVID-19 pandemic wanes. Its portfolio of brands includes Carnival Cruise Lines, Holland America, Princess Cruises, and Seabourn in North America; P&O Cruises and Cunard Line in the United Kingdom; Aida in Germany; Costa Cruises in Southern Europe; and P&O Cruises in Australia. Carnival also owns Holland America Princess Alaska Tours in Alaska and the Canadian Yukon. Carnival’s brands attracted about 13 million guests in 2019, prior to COVID-19.

(Source: Morningstar)

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

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State Street Performing Well, Driven by Asset Appreciation and New Client Wins

Assets under custody or administration grew to $43.3 trillion versus $42.6 billion in the previous quarter and $36.6 in the year-ago period, driven by market appreciation as well as new business wins. 

Fee revenue grew 9% from the year-ago period with servicing fees growing 7%. We attribute the bulk of the servicing fee growth to market appreciation with the remainder from net new business partially offset by fee compression. Assets under custody or administration grew 18% to $43.3 trillion with new servicing wins contribution $1.7 trillion, a healthy number in our view. Management fees grew 10% year over year and 4% sequentially. Money market fee waivers continue to be a headwind but appear to be moderating. Charles River Development, which the firm acquired in 2018, saw annualized recurring revenue growth of 12%.

The firm continues to manage expenses well with expenses down 1% sequentially and flat year-over-year excluding notable items and foreign exchange effects. Looking ahead, we think low-single-digit expense growth is more realistic as productivity growth is balanced with the need to invest in its business and some inflationary pressures.

Given the strong business momentum and equity market tailwinds, State Street raised its full-year outlook with just one quarter left. State Street now expects fee revenue to be up 5% for the year with servicing fee growth of 7.5%-8.5%. Net interest income is expected to be in the range of $475 million-$490 million for the fourth quarter, which implies $1.90 billion-$1.91 billion for the full year. The firm’s tax rate is expected to be on the low end of the 17%-19% range.

Company Profile

State Street is a leading provider of financial services, including investment servicing, investment management, and investment research and trading. With approximately $38.8 trillion in assets under custody and administration and $3.5 trillion assets under management as of Dec. 31, 2020, State Street operates globally in more than 100 geographic markets and employs more than 38,000 worldwide

 (Source: Morningstar)

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Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

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Ionis’ Antisense Technology supporting a narrow moat

which seeks to prevent clinical manifestation of ALS in pre-symptomatic patients diagnosed using SOD1 and filament levels. While we could see a path to approval for the drug, either with continued follow-up from the Valor study or with data from Atlas, we continue to see failure as slightly more likely. Biogen’s broad neurology portfolio and pipeline as warranting a wide moat and Ionis’ antisense technology supporting a narrow moat. 

Comapany’s Future Outlook

The Valor study focuses on a small subset of ALS patients: those with the SOD1 mutation, who compose roughly 2% of ALS cases globally. Biogen and Ionis are also studying several other potential ALS drugs that are in earlier stages of development, including BIIB078, in phase 1/2 in patients with the C9Orf mutation (7% of cases, initial data expected in 2022). Biogen and Ionis are moving additional therapies for familial and sporadic (nonfamilial) forms of ALS into testing; for example, a phase 1 study of ataxin-2-targeting ION541/BIIB105 in sporadic ALS (which could address more than 75% of the broader ALS population) started in September 2020. 

Ionis is independently testing ION363 in patients with the FUS mutation (even rarer than SOD1), with phase 3 data expected in 2024. In cardiometabolic diseases, Ionis has several programs in late-stage studies, including the wholly owned APOCIII program (data in 2023, 2024), and Novartis-partnered Lp(a) program (2024 data). Ionis is also poised to enter phase 3 for its PKK-targeting therapy in hereditary angioedema, a competitive niche indication where Ionis has potential to be best in class.

Company Profile 

Ionis Pharmaceuticals is the leading developer of antisense technology to discover and develop novel drugs. Its broad clinical and preclinical pipeline targets a wide variety of diseases, with an emphasis on cardiovascular, metabolic, neurological, and rare diseases. Ionis and partner Biogen brought Spinraza to market in 2016 as a treatment for a rare neuromuscular disorder, spinal muscular atrophy. Ionis subsequently brought two additional drugs to market via its cardiovascular-focused subsidiary Akcea, including ATTR amyloidosis drug Tegsedi (2018) and cardiology drug Waylivra (Europe, 2019).

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

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Global stocks Shares

Citigroup awaiting recovery in Credit Card balances as internal investment spending continues

international corporate banking, and card operations. It’s truly global presence differentiates the bank from all of its U.S.-based peers. With significant revenue coming from Latin America and Asia, the bank is poised to ride the growth of these economies through the coming decade. Because of its wide geographical footprint, Citigroup should remain a bank of choice for global corporations, due to its ability to provide a variety of services across borders. Developing economies should offer an attractive combination of high margins and rapid credit growth over time, especially in comparison with the low rates and declining leverage that is expected to persist in the United States and other Western economies.

On the downside, it’s still difficult to see how some of Citigroup’s lines of businesses fit together. There isn’t any material value creation seen by having multiple retail franchises in different countries, which is the case for Citi, with material operations in the U.S., Latin America, and Asia. Unsurprisingly, the bank’s global consumer franchise has underperformed peers. Citigroup also arguably remains the most complex of the Big Four and still has operational issues to solve, which the Revlon payment fiasco and resultant regulatory scrutiny highlighted once again. Overall, the bank continues to be on a path to improved returns and efficiencies.

Financial Strength:

The fair value estimate has been increased by the analysts from $78 to $83 as it incorporates a 100% chance of a statutory tax rate of 26% and also the rate hikes starting in late 2022.

Citigroup is in sound financial health. Its common equity Tier 1 ratio stood at 11.7% as of September 2021. As of the end of 2020, the bank reports that $545 billion of its roughly $2 trillion balance sheet takes the form of high-quality liquid assets, giving it a liquidity coverage ratio of 118%, in excess of the minimum of 100%. The bank’s supplementary leverage ratio was 5.9% (excluding relief), in excess of the minimum of 5%. Citigroup’s liabilities are prudently diversified, with just over half of its assets funded by deposits and the remainder of liabilities made up of long-term debt, repurchase agreements, commercial paper, and trading liabilities. Just over $19 billion in preferred stock was outstanding as of December 2020.

Bulls Say:

  • Citigroup is leveraged to the rise of Asia, Latin America, and other emerging markets, while its competitors may struggle with lacklustre loan demand in the U.S. and Western Europe. 
  • A strong economy, higher inflation, and potentially higher rates are all positives for the banking sector and should propel results even higher. 
  • Citigroup still has room for self-help, particularly around better optimizing current operations, and room to release excess capital, both levers to improve returns.

Company Profile:

Citigroup is a global financial services company doing business in more than 100 countries and jurisdictions. Citigroup’s operations are organized into two primary segments: the global consumer banking segment, which provides basic branch banking around the world, and the institutional clients group, which provides large customers around the globe with investment banking, cash management, and other products and services.

(Source: Morningstar)

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

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M&T Bank reported solid third quarter earnings; Aims to create value via acquisition with People’s United

efficient operations, and savvy acquisitions. The bank’s main stronghold is its commercial real estate operations in the northeast. M&T has a history of good underwriting and deep, on the ground relationships. M&T has also recently announced it will acquire People’s United Bank, further expanding its geographical reach in the northeast and its product offerings. We like the pricing of the deal and expected cost savings, and hope the acquisition will lead to some added organic growth in the future as well. 

M&T derives about two thirds of its income from net interest income, and with the bank’s cheaper deposit base, it is more sensitive to movements in interest rates. The remaining one third of revenue comes from non banking businesses like wealth management or deposit service fees. Much of the company’s loan book is composed of commercial loans.

The bank has an especially strong position within its commercial real estate operations in the northeastern United States. M&T has one of the largest CRE exposures under our coverage, and this has come under more scrutiny as the pandemic has developed. While certain CRE assets have come under unique pressure, M&T’s underwriting remains solid, and we expect losses to be very manageable.

M&T Bank reported solid third quarter earning; the acquisition and integration of People’s United remains the next catalyst for value creation for M&T Bank

M&T Bank reported solid third-quarter earnings. The bank beat the FactSet consensus estimate of $1.64 per share with reported EPS of $1.90. This equates to a return on tangible common equity of 17.5%. M&T Bank benefitted from a provisioning benefit once again as chargeoffs remain exceptionally low and the bank released some additional reserves.

Nonperforming assets remained stable. Expenses, however, came in a bit hotter than expected, up roughly 9% year over year during the quarter. Management attributed most of this to higher incentive based compensation, which is understandable. On the positive side, fees have done quite well.  Net interest income, meanwhile, was essentially in line with our expectations.

The acquisition and integration of People’s United remains the next catalyst for value creation for M&T Bank.

Key attraction of the transaction 

  • Unique strategic position and enhanced platform for growth: The merger will create the leading community-focused commercial bank with the scale and share to compete effectively.
  • Shared commitment to local communities: Both companies have been long recognized for their community commitments and longstanding support of civic organizations.
  •  Compelling financial impacts: M&T expects the transaction to be immediately accretive to its tangible book value per share. It is further expected that the transaction will be 10-12% accretive to M&T’s earnings per share in 2023, reflecting estimated annual cost synergies of approximately $330 million. 

Financial Strength 

We think M&T is in good financial health. The bank withstood the crisis better than peers and has maintained a credit cost advantage over the current economic cycle. Deposits fund roughly three fourths of total assets. We believe the bank is adequately capitalized, with a common equity Tier 1 ratio over 10% as of September 2021.

Bull Says

  • M&T’s acquisition of People’s United was at a good price and should drive additional future growth. 
  • A strong economy, higher inflation, and potentially higher rates are all positives for the banking sector and should propel results even higher. 
  • M&T has loyal customers, and good management, and investors shouldn’t have to worry much about being burned by bad underwriting.

Company Profile 

M&T Bank is one of the largest regional banks in the United States, with branches in New York, Pennsylvania, West Virginia, Virginia, Maryland, Delaware, and New Jersey. The bank was founded to serve manufacturing and trading businesses around the Erie Canal.

 (Source: Morningstar)

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

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Global stocks Shares

Sensient Is Well Positioned to Meet Growing Demand for Natural Ingredients

Sensient has been focused on optimizing its portfolio, divesting less profitable, commodity-like business lines primarily in the flavors and extracts segment.Longer term, we expect consumer preferences will continue to shift toward natural flavors and colors and away from synthetic ingredients. However, with a growing natural ingredient portfolio, we think the company is well positioned for the transition. 

Although Sensient serves both large and small customers, it primarily targets middle-market customers rather than large consumer packaged goods customers. The company’s most valuable business relationships involve the manufacture of customized formulations from proprietary technologies that allow Sensient to be a sole supplier. 

Sensient reports three segments. The color segment is the largest .This business produces natural and synthetic color systems for a variety of end markets, including food, beverage, cosmetics, and pharmaceutical applications. The flavors and extracts segment (a little more than 40% of profits) sells both natural and synthetic taste and texture ingredients. 

Financial Strength 

Sensient is in very good financial condition. At the end of the third quarter of 2021, net debt/adjusted EBITDA was around 2 times. Sensient has historically remained safely below the leverage ratio and above the coverage ratio.We forecast the company will continue to generate healthy free cash flow, which it has consistently done over the last decade. Sensient should have no problem servicing existing debt. The company has only a small pension liability and no other major liabilities that will require material cash outflows in the coming years. Sensient has historically maintained a low cash balance, preferring to return excess cash to shareholders via dividends (management targets a 30%-40% payout ratio) or share repurchases.

Bull Says

  • Sensient’s restructuring program will lead to materially higher margins and ROICs as low-margin facilities are closed. 
  • The demand shift to natural colors from synthetic colors should drive higher volume for Sensient, boosting profits. 
  • Management’s 20% long-term operating margin goal is achievable as specialty colors and flavors will generate an increasing proportion of total sales, driving a mix shift-based margin expansion.

Company Profile

Sensient Technologies manufactures and markets natural and synthetic colors, flavors, and flavor extracts. The company has a widespread network of facilities around the globe, and its customers operate across a variety of end markets. Sensient’s offerings are predominantly applied to consumer-facing products, including food and beverage, cosmetics and pharmaceuticals.

 (Source: Morningstar)

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

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Netflix’s Growth Will Increasingly Come From Outside the U. S

fintech icon on abstract financial technology background represent Blockchain and Fintech Investment Financial Internet Technology Concept.

The firm has used its scale to construct a massive data set that tracks every customer interaction. It then leverages this customer data to better purchase content as well as finance and produce original material such as “Stranger Things.

We believe that many consumers use, and will continue to use, SVODs like Netflix as a complementary service, especially as SVOD prices increase and pay television bundle prices decrease. Larger firms like Disney and WarnerMedia have launched their own SVOD platforms to compete against Netflix. We think this usage pattern and increased competition will constrain Netflix’s ability to raise prices without inducing greater churn. 

We expect that Netflix will expand further into local-language programming to offset the weakness of its skinny offering in many countries. This will likely generate a competitive response from the firm’s global and local rivals, which will augment their own first-party content budgets. In turn, we think Netflix’s international expansion will continue to hamper margin expansion.

Netflix’s Growth Will Increasingly Come From Outside the U. S.

Netflix reported decent third-quarter results as subscriber growth beat the low guidance issued a quarter ago but this is below the previous two years. The lower subscriber growth reflects not only saturation in its largest markets but strong competition in the regions with the most potential growth remaining, including Latin America and India. 

While we now project that EMEA will have more members than the U.S. by the first quarter of 2022, its revenue and implied margin contribution will remain much lower as its ARPU only hit $11.65 in the quarter. We continue to project price increases for the region but still expect a large gap between it and the U.S. to persist over the next five years.

Asia-Pacific, Netflix’s supposed long-term growth engine, increased revenue year over year by an impressive 31% in the quarter but ARPU remained under $10 and actually declined sequentially. We expect ARPU to decline going forward as the firm rolls out low-price plans in more countries across the region. 

Financial Strength 

Netflix’s financial health is poor due to its weak free cash flow generation, large number of content investments that require outside funding (primarily debt), and content obligations. Debt has been taken on to fund additional content investments and international expansion. The company’s weak free cash flow due to this spending is a concern, as we don’t see the need to spend decreasing in the near future. As of June 2021, Netflix has $14.9 billion in senior unsecured notes that do not have borrowing restrictions, but a relatively small amount due in the near term ($500 million due 2021, $700 million due 2022, $400 million due 2024, and $800 million due 2025), as the firm generally issues debt with a 10-year maturity. Netflix also has a material quantity of noncurrent content liabilities ($2.7 billion recognized on the balance sheet and over $15 billion not yet reflected on the balance sheet).

Bull Says 

  • Netflix’s internal recommendation software and large subscriber base give the company an edge when deciding which content to acquire in future years. 
  • Netflix has built a substantial content library that will benefit the firm over the long term.
  • International expansion offers attractive markets for adding subscribers.

Company Profile

Netflix’s primary business is a streaming video on demand service now available in almost every country worldwide except China. Netflix delivers original and third-party digital video content to PCs, Internet-connected TVs, and consumer electronic devices, including tablets, video game consoles, Apple TV, Roku, and Chromecast. In 2011, Netflix introduced DVD-only plans and separated the combined streaming and DVD plans, making it necessary for subscribers who want both to have separate plans.

 (Source: Morningstar)

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

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Xero Investors Should Check Its ARPU and CAC in Its Interim Financial Result

SME accounting software users have historically shown little inclination to switch providers, and Xero enjoys annual customer retention rates of over 80%.

The transition from desktop- to cloud-based products offers a rare opportunity for relatively new providers to win market share via the transition of customers to cloud-hosted SaaS products that offer material productivity improvements. We expect switching costs to recapture their earlier resilience once customers transition to cloud products and accounting software becomes more integrated with third-party software.

Xero Investors Should Check Its ARPU and CAC in Its Interim Financial Result

Xero has announced little of note since its fiscal 2021 financial result in May 2021. However, the company will announce its interim fiscal 2022 financial result next month, which is likely to reignite investor attention. However, Xero shares are materially overvalued and the current market price of AUD 145 per share is significantly above our AUD 50 fair value estimate. 

Although Xero reported a NZD 20 million profit after tax in fiscal 2021, this was partly due to the company’s decision to cut back on spending in the first half.In the long term, we expect Xero’s EBIT margin to expand significantly, from 7% in fiscal 2021 to 30% by fiscal 2027.

We expect investors to largely overlook Xero’s profitability at its interim result and instead focus on other metrics like subscriber growth, revenue growth, customer acquisition costs, or CAC, and annual revenue per user, or ARPU. Particularly focused on ARPU because it forms a key component of our investment thesis, and expected that strong price-based competition to limit Xero’s ability to raise prices. This will be interesting because a strong subscriber growth figure may be supported by weak ARPU growth or possibly strong CAC growth, indicating Xero is competing harder for customers.

Financial Strength

 Xero is in reasonable financial health but needs to maintain high revenue growth rates to increase profits and justify its market capitalisation. We expect EBIT margins to expand to around 30% by fiscal 2025, in line with peer companies. As the company matures, we expect the capital-light business model to enable strong cash generation. Strong customer retention rates of over 80% should mean earnings volatility will be relatively low in the long term.

Bulls Say 

  • Xero is experiencing strong revenue and customer growth driven by the transition of desktop accounting software to the cloud, a trend we expect to continue for at least the next decade.
  • Xero operates in the software sector, which is typically an industry with low capital intensity and strong cash generation. We expect Xero to generate strong returns on invested capital and free cash flow in the long term. 
  • Xero has already achieved dominant positions in the New Zealand and Australian cloud accounting markets and is a leading competitor in the U.K. and U. S. markets.

Company Profile

Xero is a provider of cloud-based accounting software, primarily aimed at the small and medium enterprise, or SME, and accounting practice markets. The company has grown quickly from its base in New Zealand and surpassed local incumbent providers MYOB and Reckon to become the largest SME accounting SaaS provider in the region. Xero is also growing internationally, with a focus on the United Kingdom and the United States. The company has a history of losses and equity capital raisings, as it has prioritised customer growth.

 (Source: Morningstar)

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.