On Friday, RBC Capital raised its outlook for Xero Limited (XRO:AU) (OTC: XROLF) stock, shifting its rating from Sector Perform to Outperform and increasing the price target to AUD155.00 from AUD130.00. The upgrade was prompted by Xero's robust financial results, which surpassed RBC Capital's expectations in terms of EBITDA and free cash flow (FCF).
Xero's improved cost management and operating leverage, coupled with a significant increase in average revenue per user (ARPU), led to an 8% beat on the firm's EBITDA estimates and a 60% beat on its forecast for FCF. RBC Capital highlighted that Xero's "Rule of 40" metric, which combines sales growth and FCF margin, has been achieved years ahead of the consensus estimates.
The firm's analyst pointed out that Xero's fiscal year 2025 cost-to-revenue guidance of 73% appears conservative. RBC Capital's own estimate stands at 72%, considering increased research and development spending will likely be balanced by the benefits of operating leverage and slower growth in marketing and administrative costs.
Xero is experiencing strong momentum going into the first half of 2025, with an annualized monthly recurring revenue (AMRR) of $1,961 million. Additionally, price increases in Australia are set to take effect two months earlier than usual, in July instead of September, which is expected to provide further near-term tailwinds for the company. Based on these factors, RBC Capital has raised its free cash flow estimates for fiscal years 2025 and 2026 by 32% and 13%, respectively.
The new valuation of $155 per share reflects the anticipated return, leading to the upgrade to Outperform. This assessment underscores the firm's confidence in Xero's financial trajectory and its potential for continued growth in the market.
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