Toast Stock: Innovation To Power Growth (NYSE:TOST)

Back in March, I wrote that Toast (NYSE:TOST) was one of the best growth stocks out there, serving a large market with a long runway for growth. I followed that up in September, saying a recent pullback in the stock looked overdone. The stock has been on a volatile ride since, and is down about -6% since my initial write-up. Let’s catch up on the name and its most recent earnings, which it reported last month.

Company Profile

As a quick refresher, TOST is a full-service SaaS platform for the restaurant industry. Its Toast POS system, which integrates point of sale functions and payment processing, is designed specifically for restaurants and is the centerpiece of its offerings. However, it also has a number of other restaurant specific modules, including marketing & loyalty, digital ordering & delivery, invoicing, supply chain & accounting, among others.

Q3 Results

For its most-recent quarter, TOST grew revenue 37% to $1.03 billion. That was in line with analyst estimates.

Subscription revenue jumped 46% to $130 million, while hardware revenue climbed 26% to $34 million. Fintech solutions revenue rose 36% to $856 million. Fintech gross profit, meanwhile, climbed 36% to $182 million from $134 million.

Annualized recurring revenue (ARR), which is payment gross profits and subscription revenue on an annualized basis, rose 44% to $1.22 billion.

Gross payment volumes (GPV) jumped 34% to $33.7 billion. The percentage of locations using 6 or more modules was 43%, flat sequentially and up from 39% a year ago. The company added over 6,500 new resultant locations in the quarter, bringing the total up to around 99,000. Year over year, it added 34% more new locations.

The company recorded adjusted EBITDA of $35 million, up from a loss of -$19 million a year ago. TOST generated $47 million in operating cash flow in the quarter and $33 million in FCF. The company had $71 million in stock comp in the quarter.

Turning to the balance sheet, TOST ended the quarter with cash and marketable securities of $1.03 billion and no debt.

The company introduced several new modules to the market recently, including Toast Now, Toast for Cafes and Bakeries, and Catering Online Ordering. Toast Now is an app that gives real-time insight into performance data, so operators can adjust things on the fly such as kitchen volumes and menus. Its Cafes and Bakeries product, meanwhile, is designed for the unique environment of these types of establishments.

Looking ahead, TOST forecast Q4 revenue of between $1.0-1.03 billion. It is looking for adjusted EBITDA of between $5-15 million.

For the full year, the company raised its revenue guidance to $3.83-3.86 billion, up from a prior outlook of $3.81-3.87 billion. It forecast 2023 adjusted EBITDA to be between $38-48 million, up from a prior view of $15-35 million.

The company said it saw a modest slowdown in same-store transactions towards the end of Q3. It noted that trends have remained stable since, and that it expects GPV to remain at current levels in Q4 and for GPV per processing locations to refuse year over year. At a UBS conference at the end of November, the company said the trends remain steady and that GPV per location has stabilized.

On its Q3 earnings call, CFO Elena Gomez said:

“The guidance that you’re seeing for the balance of the year really reflects the macro that we talked about, so GPV per location coming down. In September, in particular, as we start to see that trend, it’s continuing into October. And so our guidance reflects the macro playing a role. But just zooming out, the momentum in the business that we have exiting the year into Q4 still remains healthy, regardless of the macro. So as we think about the next year, if I was to give some color on that, we’re growing healthy. We’ve got a great operating leverage story. So as we enter into 2024, we’re going to go in with the same discipline, focused on growth and — as well on cost discipline. And we’ve delivered healthy growth alongside driving this operating leverage over $160 million in a year. So we’re really proud of that. So despite the macro, of course, we’re paying attention to it, but that doesn’t change the sentiment of this management team about the opportunity ahead of us. I think the one thing I’ll say is we’re going to continue to invest, obviously, in the core business, but we’ve got some investments in some of our emerging businesses as well, which will help us really position us for long-term growth.”

Since its IPO, TOST has had a history of cruising past revenue estimates, so when it reported only in-line revenue, the stock took a hit. Overall, the company is still growing quickly, although in a bit more disciplined way generating positive cash flow and adjusted EBITDA. That said, there does appear to be some fat it can still cut as well. While they grew less than revenue, its S&M and G&A costs still rose quite a bit in the quarter, so the company could still look to keep those costs more in check.

Overall, the quarter in isolation was solid, just not perhaps what investors have become used from the company given its past history of blowing away estimates. TOST is still doing a nice job of growing its restaurant base, but as a payment processor it has benefited from restaurant price inflation and higher bills, and that is likely to start to cool.

Valuation

In my view, the best way to value TOST based on the way it reports revenue is as a multiple of its subscription revenue and net fintech revenue (fintech gross profit). Based on its revenue guidance and results through the first nine months of the year, it appear that the company is on track to produce approximately $1.2 billion in 2023 subscription and net fintech revenue I’ve previously forecast. On that basis, it trades at about 6.1x its subscription and net fintech revenue.

I am, however, going to lower my 2024 growth expectations from 30% to 27%, which gets you to $1.52 billion in 2024 subscription and net fintech revenue. On that basis, it trades at 4.8x.

As I’ve discussed in the past with SaaS names, when they are growing in the 20% range these stocks often command 10x multiples EV/Revenue multiples. While transaction net gross profits can be a bit more unpredictable, this is still a pretty predictable, high value revenue stream.

At an 8-10x multiple, which seems appropriate given its growth, balance sheet, and cash flow, that would value TOST at between $25-30.

Conclusion

Outside of the numbers, TOST continues to invent, which has been one of the big keys to its success. Getting 20% adoption on Toast Now after its first week of launch is impressive and shows that the company is creating products that are meeting the needs of the restaurant industry.

Among investors, there is always a lot of talk about competition, and the space is a competitive one, no doubt. Block (SQ) is getting more focused on the space with Square for Restaurants, while PAR Technology (PAR) won a big deal to furnish its Brink POS to Burger King in October. Notably, TOST has been more SMB oriented, and selling into enterprise restaurants has its own set of challenges, such as longer sales cycles, increased complexities, and customers that wield a lot of power.

With about 10% U.S. market share, TOST still has a long runway in this fragmented market, and innovation and a better product offering are what will help it win its fair share of this market. It has some of the best technology and offerings in the space, which is why is has grown as fast as it has. Eventually, though, I think the space should start to see some consolidation, which would likely be good for all players involved.

While out of favor, I think TOST is an attractively price growth stock. I continue to rate it a “Buy” with a $25 price target.