Xero shares upgraded to 'buy' at CLSA on growing confidence in growth outlook

Xero officially consolidated its listing on the ASX this week. Photo / AAP

CLSA has upgraded its rating for Xero shares to 'buy' as the Asian brokerage becomes more confident in the New Zealand software developer's growth prospects in coming years.

Analyst Roger Samuel raised his rating for the ASX-listed shares in a note to clients on February 6, increasing his target price for the stock to A$37.30 ($40.48) from a previous price of A$34 on the expectation Xero will solidify market-leading positions in Australia, New Zealand and the UK.

CLSA's Samuel says Xero has passed MYOB in Australia and New Zealand in terms of paying customers, overtaken Sage in the UK and is poised to launch into Asia and eventually Western Europe, underpinning the Kiwi firm's earnings outlook.

"We are more confident on Xero's growth outlook, forecasting 30 per cent revenue CAGR (compound annual growth rate) over the next three years," Samuel said.

"The stock should also benefit from the consolidation of share listings on the ASX, and potential inclusion in larger indices (ASX100/200)."

Xero officially consolidated its listing on the ASX this week, coinciding with a global rout as investors became wary of rising interest rates and how they might undermine asset prices, such as equities, which have been bolstered by cheap credit over the past decade.

The shares fell 2.2 per cent to A$31.86, but are still up 1.2 per cent since the stock stopped trading on the NZX. Xero sold shares at $1 apiece in an initial public offering in 2007 and left New Zealand's stock market at $33.

CLSA's Samuel raised his forecast for Xero's 2019 earnings before interest, tax, depreciation and amortisation to A$97.4 million on revenue of A$554.5m, while trimming the outlook for 2020 to ebitda of A$141.2m on sales of A$719.6m due to "additional investments to drive penetration into new markets" while the development of new products may boost average revenue.

Samuel said that growth profile was much stronger than its peers, which made the stock relative to similar companies. Risks to that recommendation include a slower update of cloud-based accounting software as some users cling to desktop and paper-based systems, cost blow-outs in the US where Xero has grown at a slower-than-expected pace, and larger rivals outspending the Kiwi company or more rabid price competition.

While Samuel is upbeat about Xero, he downgraded his MYOB rating to 'sell', lowering its price target to A$3 from A$3.70 over concerns it may need to make more acquisitions to offset slowing organic earnings growth and a risk of needing to lift spending on research and development. The shares recently increased 0.5 per cent to A$3.195.