The Xero Limited (ASX: XRO) share price has been steadily rising this year, going up by around 30%. But can investors still make a big return if the share price is under $95?
One of the great things about looking at an ASX tech share in the current environment is that higher interest rates have pushed down the valuation of names like Xero.
In fact, since November 2021, the Xero share price has declined around 40%, despite its more recent recovery.
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Is the Xero share price a buy?
If we simply looked at the company's most recent financials and didn't worry about what was happening with the economy and share price, it would seem like the business hasn't seen any impacts on growth at all.
For the six months to 30 September 2022, it revealed operating revenue jumped 30% to NZ$658.5 million, with global subscribers rising 16% to around 3.5 million and average revenue per user (ARPU) growing by 13% to NZ$35.30.
This brought the annualised monthly recurring revenue (AMRR) to NZ$1.48 billion. That compares to the current market capitalisation of A$13.8 billion, according to the ASX. After adjusting for the exchange rate difference between those two numbers, the Xero share price valuation is very close to 10x annualised revenue, as at September 2022.
But I think the AMRR could have noticeably risen since then, making the revenue multiple look a bit more manageable.
The business expects to release its full-year announcement on 18 May 2023, which is when investors will get an insight into the full-year performance.
Xero shares have done wonderfully over the past decade, rising by more than 800%. I don't think the next decade will be as good as that. But there is one element that could help generate a lot of share price growth for investors.
Rising profit margins
Xero has committed to streamlining its operations to "drive greater operating leverage, and better balance growth and profitability".
It's planning to reduce its organisational structure by between 700 to 800 roles across the business.
The operating expense to revenue ratio is expected to "reduce significantly" in FY24.
Xero also said that it will continue to improve its operating efficiency over the long term, and take a "disciplined approach to reinvestment of cash and generating long-term shareholder value".
The business is targeting an operating expense-to-revenue ratio in FY24 of around 75% down from a range of between 80% to 85% in FY23.
This improvement in the profit margins in one year could signal that better times are to come in the longer term in terms of cash flow and net profit after tax (NPAT).
As Xero's underlying profitability starts to show, I think this can impress investors and lead to the share price going higher, even if interest rates don't fall in the short term.
With Xero's ongoing wins of new subscribers, plus the high retention rate and regular subscription price increases, the ASX tech share could have all the ingredients for the Xero share price to double over the next three years.
