Toast Has A Huge Opportunity In Front Of It (NYSE:TOST)
After a post-earnings sell-off, Toast (NYSE:TOST) looks poised to rebound as it continues to capture the huge market opportunity in front of it.
TOST is an all-in-one restaurant SaaS platform. The platform consists of solutions in the areas of restaurant operations & point of sale, marketing & loyalty, digital ordering & delivery, supply chain & accounting, team management, financial technology solutions, and platform & insights.
Its restaurant operations & point of sale solution is highlighted by its Toast POS system, which integrates point of sale functions and payment processing. It’s designed specifically for restaurants and has features such as kitchen tickets and color-coded tables. The solution also has invoicing, mobile order, multi-location management tools, as well as hardware offerings.
Its marketing & loyalty solution, meanwhile, has modules for customer loyalty programs, email marketing campaigns, and gift cards. Its digital ordering & delivery solution gives restaurants the ability to take off-premise orders directly commission free. It also has modules to help manage both first-party and third-party deliveries. For supply chain & accounting, the company’s xtraCHEF module provides back-office tools for inventory management, ingredient price tracking, and account payables automation.
On the Team Management side, TOST has offerings for payroll, onboarding, scheduling, pooling tips, and employee benefits. For financial technology solutions, it offers a payment processing solution, while with Toast Capital it offers restaurant loans via bank partners that are automatically paid back by holding back a portion of credit card transactions. Its platform & insights solutions, meanwhile, can provide real-time analysis on things like sales, labor, and menu data.
Opportunities and Risks
TOST has done a really great job of innovation over the years. When the company first started out, its main selling point to restaurants was that its POS system was run on Android instead of OS, and thus cheaper to operate. Today its software solution helps restaurant owners manage their entire operations. Innovation will continue to be a key priority for the company, whether developed in house or acquired, like how the company bought Delphi to offer drive-thru capabilities for QSRs.
Its biggest opportunity is to continue to grow its restaurant location count and scale the business. The restaurant industry is absolutely enormous, both in the US and globally, and TOST’s solutions are designed to operate everything from a global QSR to a local ice cream shop. Given the opportunity TOST has, it has aggressively put money into sales and marketing, as well as generally let hardware be a loss-leader to get into restaurants.
However, the company notes that 2/3 of new locations come from inbound inquiries, and that 20% of new locations come from referrals. That network effect should help the business scale down the road. TOST is currently in only about 10% of restaurant locations in the US, so it still has a lot of growth runway in front of it.
Increasing its SaaS ARPU (average revenue per user) is another opportunity. As noted above, the company has done a great job of innovation, and it certainly has more modules to upsell to existing clients and offer new customers. In Q4, 65% of restaurants had 4+ elective modules and 41% had 6+ elective modules.
Speaking about its ARPU opportunity at a Morgan Stanley conference earlier this month, CFO Elena Gomez said:
“If you think about what’s driving SaaS ARPU, we have seen momentum throughout 2022, and that’s driven because our customers are adding more of the platform upfront, which is obviously, a good testament to what the reps are doing on the ground, and we are investing in upsell.
“So, the combination of those two drives that ARPU that you’re seeing. When you look at the actual data points that we’re talking about, SaaS ARR grew 60% year-over-year and double digits in terms of sequential. And then SaaS ARPU in Q4 grew 20% and sequentially also grew. So when you think about that, that’s just a testament to what I just talked about, which is landing more of the platform upfront but also building that upsell motion, which we’re very encouraged by as well. Embedded in the upsell motion is also to shop where customers can go into their Toast web and purchase product.”
Given its payment processing solution, TOST also grows as its customers grow their same-store sales. Over the long term this is a nice opportunity, and over the past year or so, inflation has nicely benefited restaurant sales, as operators have raised prices in response to food inflation. The company saw its GPV (gross product value) grow a strong 7% per location in Q4 against this backdrop. However, it does expose the company to recessionary risk, as if restaurant sales go down, so does TOST’s payment processing revenue per location as well.
TOST is also looking to expand the use of its Toast Capital product to help restaurants in their financing needs. Given the credit risk involved with the offering, the company is looking to grow it prudently, but it has expanded the loan programs offered from 90 days, to 270 days, to launching a 360 day program last fall. Toast Capital contributed $24 million to gross margins last year, and is a solid opportunity.
That said, Toast Capital does add credit risk, as while bank partners do the lending, TOST can incur losses up to 15% of the loan amount. However, the company uses its POS and payment processing data to help underwrite the loans, which should give it unique insight into the risk profile of these loans. Loans are also paid back through holding back a fixed percentage of daily restaurant sales as well. This should lessen the risk as well.
When looking at other risks, churn would be one, as it’s not uncommon for restaurants to go out of business. TOST management has not given any specific churn numbers, but has consistently said on calls that it has been low, even during Covid. It says most of its churn is from restaurant closures, not competition. Its annual net retention rate, meanwhile, was 128% in 2022, showing both strong retention and upsells.
In my view, TOST has the best restaurant POS and management platform out there. Meanwhile, it’s a large market where it has barely scratched the surface of penetrating, leaving a long runway for growth.
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, I think the company can generate about $1.13 billion in 2023 subscription and net fintech revenue. That would be growth of about 40% over 2022 levels. On that basis, it trades at about 6.8x its subscription and net fintech revenue, which is pretty attractive given its growth rate.
TOST stock took a tumble on its Q4 results, but that was against high expectations. Overall, its results were strong, with subscription revenue soaring 76% to $95 million and fintech gross profits jumping 71% to $137 million.
I think this growth company has prudently re-set the bar to jump past results in 2023, which bodes well for the stock to rebound from here. I see upside to $25+, which is less than 11x multiple of its subscription and net fintech revenue.