When I reviewed accounting software provider Xero (XRO) last November, I concluded:
“To re-rate, it will need to demonstrate an increase in profitability, progress on the “Rule of 40” measure or substantive progress in the UK or North America”. (see https://switzerreport.com.au/is-xero-too-expensive/ )
And that is exactly what it has achieved. Last Thursday when announcing its FY24 profit result, it confirmed that it had hit the magic “rule of 40”, increased profitability and made solid progress in the UK and North America.
The extent of the re-rating was brought home to me when I reviewed Macquarie’s commentary on the result and their target price for Xero which is now stands at $180.70. Last November, it was only $87!
Let’s have a closer look at the profit result and consider the question about how much higher it can go.
Xero (XRO) – 5/19 to 5/24

Source: nabtrade
Xero’s full year
Xero’s CEO Sukhinder Singh Cassidy headlined their full year result with “revenue up 22% to NZ$1.7bn and delivers Rule of 40”.
The “rule of 40” is a favourite metric used by high performing global SaaS (software as a service) businesses. The rule suggests that revenue growth (%) plus free cash flow as a % of revenue should add to over 40%. In FY24, Xero delivered revenue growth (in constant currency terms) of 21% plus free cash flow of 20% to hit 41%, an improvement of 9.1% on FY23.
Adjusted EBITDA rose by 75% to NZ$527m with the second half generating NZ$322m compared to NZ$205m. The margin expanded from 21.6% in FY23 to 30.7% in FY24.

Revenue momentum came from a net increase of subscribers of 11%, plus an increase in ARPU (average revenue per unit) due to price increases and favourable foreign exchange movements. Churn remained low.

In Xero’s most mature markets (Australia and New Zealand), it added a net 243,000 subscribers. Internationally, it added 176,000 subscribers, with growth accelerating in the second half to 111,000 net additions.

Tighter management of operating expenses saw Xero’s margin of operating expenses to operating revenue improve (fall) to 73.3%, with the second half coming in at 68.2% (down from 79.1% in the first half). Together with the expansion in revenue drove the increase in free cash flow.
Xero grew its net cash position by NZ$324m from NZ$97m to NZ$422m, and with more than NZ$1.5bn in available liquid resources, has considerable balance sheet flexibility.
Looking ahead, Xero says it will seek to balance growth and profitability in its approach to capital allocation. It is targeting an operating expense to operating revenue ratio of around 73% for FY25, about the same it achieved in FY24. It expects product design and development costs as a % of revenue to be higher.
Xero’s aspiration is to be a world class SasS business. It believes it has the opportunity to both double the size of the business and deliver Rule of 40 or greater performance. As it grows, it will also seek to deliver a more balanced outcome between subscriber growth and ARPU expansion.
For FY25 to 27, it has four strategic priorities:
- To win what it calls the “3 x 3” – completing the three critical jobs (product features or enhancements that customers need) in the three critical markets of Australia, UK and USA.
- Winning with its “Go to Market” playbook – making it easier for customers to find, use and grow with Xero. An example is in Australia, where simplified product packages will be launched from 1 July (for many customers, this will also result in a price increase).
- Focussed bets to win for the future (on AI, mobile and the Xero ecosystem); and
- Enabling the Xero team to move faster and perform at a higher operating level.
What do the brokers’ say?
The major brokers are now generally positive on Xero, with 4 “buy” recommendations, 1 “neutral” recommendation and 1 “sell” recommendation. According to FN Arena, the consensus target price is $138.58, about 5.6% higher than its closing price on the ASX of Friday of $131.19. The range is quite wide, from a low of $78.00 through to a high of $180.70.

The brokers were generally impressed with the result and raised earnings forecasts for FY25 and outlying years. Highlights were beating the ‘rule of 40’ rule ahead of schedule, robust revenue growth, the increase in ARPU and free cash flow expansion. Queries remain relating to whether Xero is achieving positive unit economics in international markets.
What’s the bottom line?
Xero has demonstrated that it has real pricing power in Australia/NZ and customers are incredibly sticky. With further price changes to take place on 1 July, revenue is set to grow strongly in FY25.
The jury is still out on Xero’s international expansion, but there has been progress over the last six months in the USA with subscriber growth increasing and the UK looking a lot better. From an investor/shareholder confidence point of view, achieving the ‘rule of 40’ is a key milestone
As a SaaS business, Xero is probably without peer amongst ASX listed companies. In an environment where the technology lead from the US markets is so strong, Australian investors will seek out quality Australian tech companies. With its re-rating, Xero again fits that bill.
This means Xero can go higher. If the US markets continue to stay positive (which we expect because of the anticipation that interest rates will fall), I expect Xero to test the $150 level again shortly.
Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.