Xero shares open lower as Morningstar says pricing power may be exhausted
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The news: Xero shares opened lower on the ASX, even as Jarden and Morningstar hiked their respective target price and fair value estimate on the company.
The numbers: Xero shares dipped 0.7% to $169.84 at market open, paring gains from Thursday, when shares closed 5.9% higher after the company reported its first-half result.
Jarden kept its 'overweight' rating on the stock and raised its target price from $151 to $177.
Morningstar raised its fair value estimate by 6% to $90. However, analyst Roy Van Keulen said at currently levels Xero's share price was materially overvalued.
The context: Van Keulen said while the company saw an acceleration in revenue growth to 25% on the prior corresponding period due to strong price increases he did not expect the pace of price increases could be maintained.
Jarden analysts said that Xero's "strong" first-half result reiterated their fundamental view of the company. They noted that there is further upside potential in the second half of the year, given the Xero's "conservative" operating expenditure ratio guidance.
The analysts said that Xero's opex ratio in the first half was "surprisingly low", with lower-than-expected total product design and development (PDD) costs and a higher capitalisation rate of PDD. Xero has consequently lowered its total PDD cost outlook to "similar to FY24" as a percentage of revenue, compared with its previous guidance of "higher" than the prior year as a percentage of revenue.
What they said: "Price hikes were the main driver of growth during the period ... Subscriber growth continued to slow, which hints at a potential exhaustion of pricing power," Van Keulen said.
"Subscribers increased by a mere 6% on the pcp, down from 13% a year ago and 16% two years ago. The company disclosed that on an underlying basis, which removes the impact from the company’s removal of some low-value customers, it believes subscriber growth would have been 10%."
The sources: Jarden research, Morningstar research
