40% downside: Why does UBS rate the Xero (ASX:XRO) share price as a sell?

Here we cover some of the bearish sentiment on Xero shares…
The post 40% downside: Why does UBS rate the Xero (ASX:XRO) share price as a sell? appeared first on The Motley Fool Australia. –

The Xero Limited (ASX: XRO) share price has started the day in the red and is now at $142.20, down 2.5% from its previous closing price.

Today’s dip continues the online accounting platform’s downward run over the past week of trading. It has lost 3.2% since last Monday’s close and is also down around 3% this year to date.

This begs the question – what’s the outlook for the Xero share price?

The team at Swiss investment bank UBS has chimed in with its opinion to answer this question. It isn’t so rosy on the outlook for Xero investors, and prices in a considerable amount of downside in its valuation.

Let’s take a closer look.

What does UBS think of the Xero share price?

To put it in simple terms, UBS reckons the market is pricing Xero’s shares based on revenue rather than its earnings.

As such, the broker thinks the Xero share price is overvalued. It makes comparisons to a separate business, property classifieds specialist REA Group Limited (ASX: REA), as each has similar market capitalisations.

However, whereas REA forecasts a profit margin of 42% by FY25, UBS notes that Xero is estimated to deliver a 21% profit margin by then – half of REA’s forward estimates.

Applying an apples-to-apples valuation on both companies, UBS reckons REA is fairly priced but Xero is overvalued.

It arrives at this conclusion based on a price target of $88, which implies a downside potential of 38% at the time of writing.

It is on these points that UBS maintains its sell rating on the Xero share price – on reasons of valuation.

UBS isn’t alone in its rating

The team at Macquarie Group Ltd (ASX: MQG) is on the same page on its outlook for Xero investors.

It believes Xero’s US forecasts are overly optimistic, especially given that its local markets are approaching saturation.

With Xero’s penetration of the Australian and New Zealand markets being so high in previous years, Macquarie believes subscriber growth in these regions will normalise into the coming years.

The broker also notes that Xero’s US expansion plans may be too optimistic, and might have limited success against competitor Intuit’s Quickbooks.

Macquarie points to Intuit’s recent US$12 billion acquisition of Mailchimp that minuscules the US$300 million Xero has spent across four separate transactions.

For these reasons the broker retained its underperform rating and assigned a price target of $130 on the Xero share price. That implies a downside potential of 9% at the time of writing.

Xero share price snapshot

In the past 12 months, the Xero share price has climbed around 18%, despite a difficult year to date.

For comparison, the benchmark S&P/ASX 200 index (ASX: XJO) has gained around 15% in that time.

It should be noted that only 25% of the 16 analysts covering Xero have sell ratings as UBS and Macquarie do.

The post 40% downside: Why does UBS rate the Xero (ASX:XRO) share price as a sell? appeared first on The Motley Fool Australia.

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More reading

ASX 200 (ASX:XJO) midday update: Telstra investor day, tech and materials shares fall

Xero (ASX:XRO) share price shrugs off Macquarie warnings of ‘limited success’ in US

Xero (ASX:XRO) share price sinks: Citi says buy the dip

Brokers name 3 ASX shares to buy today

Goldman says the Xero (ASX:XRO) share price selloff is a buying opportunity

The author Zach Bristow has no positions in any of the stocks mentioned. The Motley Fool Australia’s parent company Motley Fool Holdings Inc. owns shares of and has recommended Xero. The Motley Fool Australia owns shares of and has recommended Macquarie Group Limited and Xero. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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