Toast: Success In Balancing Profitability And Growth (NYSE:TOST)

Investment Thesis

Together with its Q4 2023 results, Toast, Inc. (NYSE:TOST) guided for a significant improvement in profits for 2024.

Now, there’s a bull and bear case. The bull case undoubtedly points to its debt-free status, with 5% of its market cap made up of cash. Thereby leaving Toast in a very strong position to continue to gain market share.

The bear case declares that Toast’s growth rates are starting to moderate. However, I maintain that there’s a high likelihood that 2024 will be a low baseline from where in 2025 Toast could reaccelerate once again.

Furthermore, as you’ll see, its total locations continue to increase at a very rapid rate, with Q4 2023 up 34% y/y.

All in all, there’s a lot to be bullish on for Toast.

Rapid Recap

Back in January, I said in a bullish analysis,

This investment thesis isn’t blemish-free. In fact, the vast majority of its revenues are tied to its payment processing revenues, which means that the vast majority of its revenues will only have razor-thin margins.

Nevertheless, I remain mostly bullish on this stock’s prospects and expect to see its share price climb to around $22 to $25 per share by mid-2025.

In the few months since I penned those words, including the breather that the market has taken recently, Toast is already sitting neatly in my previous estimate for mid-2025. And yet, looking ahead, I remain bullish on this stock’s prospects.

Toast’s Near-Term Prospects

Toast provides software solutions for restaurants to help them manage their operations more efficiently. Their platform includes tools for tasks like processing payments, managing reservations, scheduling staff, and handling online orders. They aim to support restaurants of all sizes by offering a comprehensive suite of services to improve their overall performance and enhance the customer experience.

Looking ahead, Toast appears poised for growth given its strong market position and expanding footprint within the restaurant industry.

Key initiatives such as scaling restaurant locations within its core business and driving ARR and ARPU growth through product customer-focused strategies are expected to continue yielding successful outcomes.

Toast’s ability to sustain over 30% location growth, even at its current scale, is a testament to its competitive differentiation and the effectiveness of its all-in-one platform and localized go-to-market approach.

Incidentally, close followers of my work will know that I always highlight the importance of a strong customer adoption curve.

What you see here is that Toast’s total locations continue to increase, with Q4 2023 seeing a 34% y/y increase in total locations. This neatly encapsulates this growth opportunity.

And yet, despite its promising prospects, Toast faces challenges too. For example, Toast faces intensifying competition within the restaurant technology space, with new entrants, including Lightspeed Commerce Inc. (LSPD) and Block (SQ), vying for market share.

Given this background, let’s now discuss its fundamentals.

Toast’s Non-GAAP Gross Profit Growth Rates Point to 27% CAGR for 2024

Toast saw its non-GAAP gross profits end Q4 2023 up 42% y/y. This capped a very strong period for Toast. However, as we look ahead to 2024, its underlying non-GAAP gross profits are expected to moderate to approximately 27% CAGR.

Consequently, we are faced with the following dilemma. Does Toast have enough juice left in its tank so that in 2025 Toast could reaccelerate its revenue growth rates once again?

If Toast does not reaccelerate its growth rates, then it will struggle to support its valuation. However, if it does turn out that 2024 was the “new baseline” from where Toast can reignite its growth rates back to “hyper growth”, meaning +30% stable, consistent, and predictable growth, then the stock will have no problem in justifying its valuation, which is where we turn to next.

TOST Stock Valuation — 43x Forward EBITDA

In Q4 2023, Toast saw its underlying profitability significantly increase. As you can see above, its adjusted EBITDA to non-GAAP gross profit margin went from negative 8.7% to positive 10.3%. That’s a swing of more than 19 points.

What’s more, looking ahead, this underlying profit expansion is expected to continue throughout 2024. So by the time Toast exits 2024, its non-GAAP gross profits could reach 18%, which is a further 8-point expansion from 2023.

Now, this is my question: given that it’s obvious that the bulk of the easy pickings will have already taken place in 2023-2024, what will 2025 shake out?

Let’s assume that Toast’s adjusted EBITDA margin stabilizes at 20% EBITDA to non-GAAP gross profits. This would mean that Toast’s EBITDA would be on a forward run-rate of $300 million by the time it exits Q4 2024. This would leave this stock priced at 43x forward EBITDA.

The Bottom Line

In summary, Toast’s near-term outlook is promising as it continues to provide innovative software solutions for restaurants.

However, the challenge lies in sustaining growth rates beyond 2024 to justify its valuation. With rising profitability and projected EBITDA margin expansion, Toast shows potential for significant financial improvement by the end of 2024.

Altogether, I see Toast as an intriguing opportunity with the potential for sustainable growth and value creation in the restaurant technology space.