Time to be selective in growth: how Xero’s driving a digital economy

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As part of its approach, Pendal Horizon Fund invests in companies that enable and lead in the transition to a more sustainable and future-ready Australian economy, while avoiding those that cause significant harm.

An example is business software innovator Xero, a leader in the trend to digitalisation which is changing the way we work.

Pendal equities analyst Elise McKay explains in a short video above.

ASX-listed technology stocks — particularly so the so-called WAAAX stocks Wisetech (WTC), Afterpay (APT), Altium (ALU), Appen (APX) and Xero (XRO) — have been favourites among many investors in recent years.

A key part of this has been the benefit of low-bond yields, which have lifted valuations for growth companies —  including many tech names — worldwide.

This tailwind has receded in recent months as yields have begun to rise. Meanwhile vaccines have provided a pathway to re-opening, boosting sentiment around more cyclical stocks. As a result market leadership has shifted from growth stocks to cyclical and value.

In our view this does not mean a shift to a stance of “sell growth, buy value”.

There are plenty of value stocks that are structurally impaired. At the same time, we think there are compelling opportunities in tech stocks. Stock selection is as critical as ever.

In the tech sector we think the market will start to discern between companies with less tangible prospects that are not delivering cashflow — and those that are profitable with good earnings visibility.

We see accounting software provider Xero as one of the latter. It is our top pick in the ASX tech sector.

In this video above Pendal Research Analyst Elise McKay shares insights into XERO, the ASX tech sector and the five-factor framework by which we assess companies.

XERO is included in Pendal Horizon Fund (formerly Pendal Ethical Share Fund) and Pendal Focus Fund.

Pendal named 2020 Fund Manager of the Year in Zenith Awards.

“We use this framework to find those companies like Xero that are generating strong, sustainable returns on the capital that they’re investing today in unlocking a large global addressable market and creating significant value in the future,” says McKay.

In Xero’s case:

  • The industry structure and competitive landscape is favourable and there is a large global addressable market
  • Xero is well placed in the cycle as secular trends drive the adoption of cloud accounting products
  • It’s investing heavily in innovating the next generation of products.
  • The culture of the company is strong, and it’s able to internally create the products it needs.
  • And finally, the capital return and unit economics of the business are attractive.

“One of the great things about Xero is that it has accelerated digitalisation of the economy, particularly for small businesses.”

Digitalisation refers to the use of digital technologies “to change a business model and provide new revenue and value-producing opportunities” according to research house Garnter. (It’s distinct from digitisation, which simply means converting things such as bank accounts or books from analog to digital.)

“This platform opportunity allows Xero to be the plumbing into so many more solutions being offered to this community.”

Digital tools are rapidly becoming essential for small business in Australia, according to McKay, who says businesses adopting digital are on average able to save 10 hours a week and generate 27 per cent more revenue.

She believes the fast-growing cloud accounting provider is at the start of a multi-year journey to unlock an enormous global market and become a platform for transforming small business.

XERO is included in Pendal Horizon Fund (formerly Pendal Ethical Share Fund) and Pendal Focus Fund.

 

About Elise McKay

Elise is an investment analyst with Pendal’s Australian equities team. Elise previously worked as an investment analyst for US fund manager Cartica where she covered a variety of emerging market companies. She has also worked in investment banking and corporate finance at JP Morgan and Ernst & Young.

About Pendal Horizon Fund and Pendal Focus Australian Share Fund

Pendal Horizon Fund (formerly Pendal Ethical Share Fund) is a concentrated, high-conviction portfolio aligned with the transition to a more sustainable, future-ready economy.

Pendal Focus Australian Share Fund is an actively managed, concentrated portfolio of 15 to 30 of our best investment ideas across the Australian share market.

Both funds are led by one of Australia’s most experienced portfolio managers, Crispin Murray. Crispin is backed by one of the largest, most experienced Australian equity teams.

Pendal is an independent, global investment management business focused on delivering superior investment returns for our clients through active management.

Find out more about Pendal Focus Australian Share Fund here.

Contact a Pendal key account manager here.

This article has been prepared by Pendal Fund Services Limited (PFSL) ABN 13 161 249 332, AFSL No 431426 and the information contained within is current as at March 12, 2021. It is not to be published, or otherwise made available to any person other than the party to whom it is provided.

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