The Xero Limited (ASX: XRO) share price suffered terribly in 2022, falling by around 50%. Indeed, it was a tough year for many ASX tech shares as valuations plunged.
It's not as though many of them have reported a dramatic plunge in revenue. Investors have sold down Xero and other technology names amid the changing investment environment with higher interest rates.
Why do interest rates matter so much?
In 1994, at the Berkshire Hathaway annual general meeting, legendary investor Warren Buffett said:
The value of every business, the value of a farm, the value of an apartment house, the value of any economic asset, is 100% sensitive to interest rates because all you are doing in investing is transferring some money to somebody now in exchange for what you expect the stream of money to be, to come in over a period of time, and the higher interest rates are the less that present value is going to be. So every business by its nature…its intrinsic valuation is 100% sensitive to interest rates.
With that said, are Xero shares now an excellent, beaten-up opportunity at this lower level?
Strong growth at high margins
The last time we heard, the ASX tech share continues to grow at an attractive rate. Year after year growth can certainly compound into very impressive numbers.
For a business with pleasing unit economics, higher operating revenue means the underlying profitability is increasing all the time.
In the first half of FY23, Xero's total subscribers increased 16% to 3.5 million. Its average revenue per user (ARPU) grew by 13% to $35.30, which helped operating revenue jump 30% to $658.5 million. This level of growth is good news for Xero shares, in my view.
Xero's gross profit margin was 87% in the FY23 first half, which is very high. That means most of the new revenue can be invested in growth efforts, such as marketing and software development. Over the long term, this can really pay off because Xero had a subscriber retention rate of over 99% in FY22 and the first half of FY23.
I think that its management is being very intentional about investing for the long term, rather than generating profits in the short term. This makes a lot of sense to me.
With a global addressable market, I think Xero still has a very long growth runway. As the business gets even larger, I think its operating profit margins will quickly start rising as management slows down the level of investment in percentage terms.
Is the Xero share price an opportunity?
I think it certainly is. In my opinion, it's one of the most impressive businesses on the ASX. I don't think its outlook has changed much despite everything that has happened. It's just that we're now able to invest in Xero shares at a much cheaper price than a year ago.
According to the analyst ratings that Commsec has collated, 12 of them think that the ASX tech share is a buy, with only one suggesting it's a sell.
The broker Goldman Sachs currently rates Xero as a buy, with a price target of $115, according to Commsec, suggesting significant upside over the next 12 months.
