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Trading Diary

Trading Diary – 14 November 2019

We’ve exited our position in Nickel Mines (NIC) and reallocated these funds into Xero Limited (XRO). Following this transaction, we have a 18 stocks invested in the Model Portfolio.

Sell

Nickel Mines (NIC)

Sold NIC for a 4% profit. 

The Nickel price appears to have peaked at the beginning of September, and since that time has slowly trended down. The NIC stock price has followed a very similar price trajectory. We entered the stock as it made a quick recovery from its first pullback after emerging from a 20-week base. 

The stock exhibited a constructive price and volume pattern following our purchase — high volume on days when the stock was up and more subdued volume on down days. Ultimately however the stock has been unable to hold up and transition into a stage-two uptrend in the face of the falling Nickel price. As a result, we have sold our position. 

Buy

Xero Limited (XRO)

Xero makes cloud-based accounting software. It is the market leader in Australian and New Zealand and fast becoming the market leader in the UK. The company also operates in the US and several other countries around the world.

We’ve owned Xero before and participated in the uptrend that began in March 2017, until October 2018, where the stock appreciated close to 150%.

Technicals

The stock has been on a tear since the beginning of 2019. However, since July, it paused and formed a 12-week basing pattern. In mid-October, it broke out to new highs and closed above $70 for the first time. A two to three-week consolidation followed before the stock again broke to new highs on the release of H1 20 results. 

The latest rally currently looks extended, especially from the 10-day moving average. In which case, we expect to see some further consolidation at these levels. However, with that said, it appears that the stock is well and truly in a stage-two uptrend. 

Fundamentals

Xero is amongst the most expensive companies in the market. It trades at 18x revenue and generates negligible net income. The company is, however, now making free cash flow. Also, if we use the company’s current annualised recurring revenue of $764m (as opposed to sales over the last 12 months), the price to sales multiple drops to 14x. This number is still very high, however, with good reason given the company’s long-term potential for growth. 

Growth continues to be substantial, with operating revenue growing 32% year on year. The Australian business grew by 28% to 840,000 subscribers. The company accelerated growth in the UK in the last six months, growing by 51% to 536,000 subscribers. 

Subscribers numbers in the UK have now surpassed New Zealand, where the company began operations. This transition is significant as the UK is a much larger market and is now beginning to account for a higher proportion of total revenues. 

Gross margin improved by 2.4% over the prior period to 85.2% for H1 FY20. Both the ANZ and international segments saw positive gross margin trends resulting from efficiencies in cloud hosting and other platform related benefits.

Narrative

The story here is growth. The accounting software market around the world is in the process of transitioning from desktop to cloud. This transition is happening faster in some markets than in others. However, it is happening and will continue to happen. 

The cloud accounting adoption rate in Australia and New Zealand is higher than 50%. It is less than 20% in the rest of the world. Xero is the market leader in most markets outside of the US. In the US, there is space for a substantial number 2 behind Intuit. 

In the UK, Xero is fast becoming the market leader. This market has the potential to be multiple times the size of ANZ for Xero and seems to have hit a tipping point in terms of adoption. 

In summary, the market is enormous and growing. The product is fantastic, and the revenues are very sticky. As well as that, there’s the unknown potential value inherent in XRO becoming the platform for small business.   

By Danny Sandler

Founder of Ocean Asset Management.