XERO (ASX:XRO) The Stock Fell 8%, But Is the Market Missing the Turnaround?

Melio Mudied the Numbers, But the Core Business Still Grew 21%

Can Xero really pull off a turnaround as the market starts treating the stock like another SaaS apocalypse candidate?

There is a lot to unpack in Xero’s FY26 result, especially now that the Melio acquisition is being consolidated into the numbers which is why the stock likely fell 8% this morning.

Revenue came in at $2.753 billion, up 31%. Stripping out Melio, organic revenue still grew 21%, which tells us the core SaaS platform is still compounding at a strong rate.

The pressure point is profitability.

Gross margin slipped to 83%, largely because Melio’s payments revenue carries a much lower margin profile. We estimate Melio runs at around 35% to 45% gross margin, compared with roughly 89% for Xero’s organic business.

So this is not just a simple margin decline. It is the result of Xero integrating two very different businesses, one high-margin subscription platform and one lower-margin payments business.

The market is now pricing in a much higher risk premium. Investors buying Xero today are effectively looking through to FY28, when management expects Melio to reach breakeven.

If Melio can hit breakeven within management’s timeline, the drag on group profitability should ease. At the same time, the US opportunity is starting to build from a small base, with US revenue now reaching $330 million.

If that thesis plays out, Xero could have meaningful upside from here.

Operating Leverage Accelerating Despite M&A Investment

What we found interesting is Xero platform is demonstrating signs of improved operating leverage.

If we look at the headline operating expenses came in at 72.4% of revenue. On an organic basis, Xero’s operating expense ratio was 70.5% and is now trending lower, which shows the business is starting to scale costs more efficiently as revenue grows.

The gross margin compression is not the main issue for investors. As we noted earlier, this largely reflects the Melio acquisition. The 5 percentage point gross margin headwind looks structural for now and is likely to persist unless payments economics improve.

A more encouraging signal is how Xero is using AI internally. Around 83% of employees are now using AI in daily workflows, which has helped reduce engineering and development timelines from an average of six months to around 10 weeks. That is a real productivity gain if it continues to flow through the business.

Strong Top-Line Growth Across All Regions

Geographically, Australia and New Zealand remain the stable cash cows.

Australia generated $1.1 billion in revenue, up 20%, with 165,000 net new customer additions. New Zealand revenue increased 10% to $244 million.

The bigger growth driver is now the international business, especially the US.

US revenue reached $332 million, up 240% year-on-year, additionally annual revenue per customer increased $4.24 totalling $55.44 so the US market is seeing customer volume growth aswell as revenue growth through higher revenue per customer.

That suggests the deal is already starting to add momentum, but investors need to keep the spending context in mind. Xero has committed more than 3.9 billion to build its US growth platform, so the next test is whether this acceleration can continue without dragging too heavily on group profitability.

FY27-28 Roadmap Doubling Revenue by FY28

Xero’s FY28 aspiration is to reach $4.2 billion to $4.4 billion in revenue, with Melio expected to move toward breakeven and adjusted EBITDA margins improving to around 25%.

That implies revenue roughly doubling over three years.

Management is effectively telling the market that international growth needs to accelerate meaningfully, with the US becoming a much larger part of the story.

This is now the core investment thesis.

If Xero can keep growing the core platform, scale Melio, and push the US business toward profitability, the market may start to look through the near-term margin pressure.

But execution has to be clean. The upside case depends on Xero proving that Melio is not just a lower-margin payments asset, but a growth engine that can deepen the platform, lift customer value, and eventually support stronger group earnings.

Is XERO a buy candidate

Xero can definitely be a turnaround candidate, but in the near term investors are going to focus on the profitability hit from Melio’s consolidation.

That pressure is expected. We have seen similar dynamics across other large-cap software names, including WiseTech, where acquisitions can weigh on margins before the strategic benefits show up more clearly.

The more important metric for Xero is customer quality.

Cohorted churn for customers over 180 days remains stable at 0.81%, which tells us longer-term customers are staying on the platform. That pushes back against one of the bigger market concerns, which is that AI could start taking share from traditional accounting software providers.

At least for now, the data does not support that bear case.

We still see Xero as a cautious buy. The turnaround potential is real, but execution risk remains high. Melio needs to scale without becoming a lasting drag on margins, and the US growth story needs to keep accelerating from here.

Investors can find more coverage of ASX tech stocks here at Stocks Down Under.