Xero Earnings: Impressive Operating Leverage but International Segment Remains Challenging

We increase our fair value estimate for narrow-moat Xero by 9% to AUD 85 per share. The increase is primarily driven by better-than-expected improvements in Xero’s operating leverage, borne out in the fiscal 2024 result. Operating expenses, excluding nonrecurring costs, declined to 73% of revenue during fiscal 2024 from 81% the year prior. This exceeded management guidance of 75% for the full year, which it reiterated in its half-year results—already an ambitious implied improvement from 79% in the first half. We had expected a more gradual improvement and for Xero to report operating expenses equating to 77% of revenue for the full year. Given Xero’s rapid improvement, we raise our midcycle operating margin assumption for the company to 34% from 32% previously.