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.
