SaaS SMB accounting and payments platform $XRO reported their 1H FY26 Results today.

ASX Announcement

I might have said that the SP reaction of -9% on the day surprised me (in truth it did), but as a long term holder of this super highly-rated growth stock, you have to expect that anything much short of perfection gets punished, and the effect was amplified by today's marco data hitting several tech stocks (doubts on further interest rate cuts in light of strong October employment numbers).

However, before diving into the details, there are some contextual issues that set-up an adverse reaction, IMHO:

• Acquisition of Melio - many think this is a return to over-paying for material acquisitions that don't deliver the strategic intent. Senitment around this has dragged the SP from a high of $195 in June to a near 18-month low at the close today of $127.
• G&A lept up a whopping 48% driven by accounting treatment of Sukhinder's large remuneration package, which almost got voted down at the AGM. The official explanation is: "primarily due to higher executive personnel costs associated with the accounting treatment of option and sign on equity grants announced last year. The majority of these noncash costs are not expected to recur in fiscal '27."
• While Subscriber additions in North America were strong (+15% to pcp) , revenue growth was relatively weak at +18% on CC. With a welcome breakout of US data (for future reporting with Melio) we can see that Canada is pretty anaemic - but we know that as the economy is hurting as a result of the Trump tariffs. Quelle surprise.
• There is some ongoing concern about the level of development spend being capitalised, at 47%
• Finally, while there are limited numbers around for the 1H consensus, there are reports that EPS missed consensus by 13%.

I attended the analyst call and have sliced and diced the results in detail. Overall, I'm pretty happy.

So much so, that for the first time in ages, I have acquired more $XRO stock today just before the close, adding to my less-than-well-timed purchase yesterday. (Important context is that going in to today's result, the SP was already 28% below the TP consensus, although I think some of the analysts have lost the plot with their lofy targets, which run as high as $230!)

My Highlights

For me there are several highlights:

• CEO reiterated the target to double revenue from FY25 to FY28
• Revenue was up 20% YoY (+18% CC) driven by Subscribers +10 YoY and ARPU +8% YoY (CC)
• Reiteration of capital discipline, with the FY26 Opex Ratio upgraded from 71.5% to 70.5% (including Melio)
• CEO said Melio acquisition is performing above expectionations, and Xero will launch the US payments in $XRO in December.
• Australia performed strongly, with subs +9% to PCP, and revenue +19% in CC.
• UK performed very strongly (IMO given the macro), with subs +13% and revenue +20% in CC.
• Looking past the "one-off" G&A blowout, both S&M and R&D continued to decline as a % of revenue: -0.3pp and -0.5pp respectively. This should give confidence about continuing the operating leverage recent track record.
• Cash Generation was strong, with FCF up 54% to NZ$321m from NZ$209m in the pcp, alebit flattered by interest earned on cash raised for the Melio acquisition and a weak NZD, but strong nonetheless.
• AMRR was also up strongly +26% yoy (albeit only +19% in CC, again because of the weak NZD)
• While Monthly Churn was up slightly to 1.09%, this remains below the long-term pre-pandemic level of 1.15%
• LTV was up 9% in 6 months from $17.95bn to $19.56bn, albeit only $18.52 (+3%) if we back out the FX benefit.
• LTV/CAC weakened again in ANZ to 10.7 from 11.6 in March, explained as being due to chasing customers via the direct channel, where churn is higher for small customers who try the platform out for a few months and decide not to adopt. International stayed steady at the much lower LTV/CAC of 3.3.

My Assessment

Across the board, the results were strong. Yes, there are pockets of relative strength and weakness, if you dig deeper, but overall there is nothing that gives me concern or is surprising.

One orange flag is the need to keep an eye on the ANZ LTV/CAC trend, but this value has been so high for so long, you can argue on economic grounds that they have been underinvesting in the home markets on customer acquisition. Good to see International is stable at the less healthy 3.3, marking the more competitive international markets.

The long term target of doubling revenue by FY28, restated today confidently by Sukhinder, requires a revenue CAGR of 26% or 21% depending on how you measure it. If measured from $XRO's FY25 results of NZ$2.1bn to NZ4.2bn, a 26% CAGR is required. Alternatively, if you start from the pro forma Melio+$XRO combination of NZ$2.36bn, then the actual required organic CAGR is 21%).

This must be achieved while continuing to drive operating leverage. Both CEO and CFO are clear about that.

Clearly, that means that management are confident that Melio is going to transform and accelerate prospects in the US market.

$XRO has a focused strategy: the 3x3 of Accounting, Payments and Payroll across ANZ, UK and North America. Melio and the inegration of Gusto, gives the US business the full offering, with opportunities to sell Melio into $XRO's existing customers, and $XRO into Melio's customers, with a combined saleforce ready to go.

Sukhinder presented a clear US Pro Forma set of financials, and so the US will now be reported separately, with Canada absorbed into International. Yay! The key slide follows.

And so, we will be able to judge progress over the next couple of reports. And given Sukhinder's eye-watering compensation package, I think there will be little tolerance for mis-steps. I guess she knows that. Melio is quite clearly her "big bet" that she can awaken the US Dog that (so far) Hasn't Barked.

And that really is the big unanswered question and one that is worth a lot more than the upfront US$2,5bn paid for Melio. I say that because while ANZ and the UK are solid (with the latter still containing a long runway ahead), those two markets on their own do not justify $XRO's A$23bn market cap. At some point, there has to be an acceleration in North America. And Sukhinder has clearly rolled the dice with Melio. I'm happy she's done that, and Melio looks like a good pick.

Valuation

As I have put more of my RL portfolio into SM, I realise I've never posted my own valuation here for $XRO. And I haven't updated the model for the Melio pro forma FY25 starting point as yet.

So, as a starting point, I am putting in numbers for $XRO pre-acquisition, with simple assumption of organic annual revenue growth of 21% p,a to FY28, Opex Expense Ratio declining to 69% in FY28, $GM to 90% by FY28. (Discount Rate 10%; Tax 30%; SOI gwor at 1.1%)

While the low %GM Melio business messes this up, I am assuming that the Melio acquisition is value neutral, save for the fact that it enables $XRO to sustain revenue growth of 21% pa, with improving operating leverage out for 3 years.

The following table shows the results for this valuation (A$ shown):

I've chosen P/E's of 50, 60 and 70 because in FY28, the growth in EPS is still 26% so, the business will still likely be highly rated at that point, albeit it will have fallen significantly from recent highs!

I note that my FY28 EPS is significantly higher than this morning's analyst consensus of $3.26, so that's something to look at again once I have rebuit my valuation for the $XRO + Melio combination.

This gives my valuation for $XRO of $146 ($122 - $170) at YE FY26,

So how does this compare to the analysts? Looking to MarketScreener.com and converting NZD to AUD at 1.16, the analysts price targets have an average of $192 with a range of $96 to $231. Go figure.

Invesment Decision

Even though my valuation hasn't properly modelled the impact of Melio, I am a great believer that M&A rarely adds value on its own. The long term value comes fom how it transforms the organic economic engine. The above valuation is an upgrade to my numbers from the FY25 results, driven by my belief that Melio will transform $XRO's underweight US offering,

With the SP today falling to $127, $XRO has fallen to the lower end of my range, and therefore I am happy to top up, given that the midpoint of my range would deliver a 15% return in 6 months.

So, if Sukhinder is right, and Melio transfroms progress in the US, and ANZ and UK keep doing their thing, then today the market has offered me a chance to top up on one of my longest held ASX stocks (first held in 9-Sept-16).

I've been happy to take that opportunity, increasing my RL holding today and yesterday from 5.5% to 7.8%.