KLR - Presto Automation: ChatGPT-Style AI For The Drive-Thru

2023-07-03 14:00:23 ET

Summary

• Presto Automation, a labor automation technology provider in the hospitality industry, has seen its stock rise due to a surge in interest in AI from restaurant owners.
• The company's AI tools, such as Presto Voice, are used to enhance service quality and reduce costs in drive-through operations, with the potential for significant annual recurring revenue.
• Despite challenges in automating the drive-through ordering process and maintaining profitability, Presto's advanced positioning and proprietary technology offer the potential for growth and increased contract value.
• Despite being richly valued, it is benefiting from momentum factors.

Presto Automation Inc. ( PRST ) operates as a labor automation technology provider in the hospitality industry. It provides AI tools for enhancing the quality of service together with cloud-based solutions for its customers who operate drive-throughs (drive-thru). However, as seen in the table below, it is far from delivering the same percentage of profit margins that software and service providers in the IT sector tend to enjoy.

As such its stock should have been pressured, but, after having traded around $4 for most of this year, it has been on an uptrend since May 24 and is now past the $5.2 mark. This could be due to the CEO's recent enthusiasm while mentioning that the company is appropriately positioned to benefit from a surge in interest in AI from restaurant owners, for improving their business operations.

Thus, my objective with this thesis is to assess whether it is the hype factor that has triggered the upside or whether there is real potential to win a slice of AI for the hospitality vertical. At the same time, I will also assess measures to improve profitability and cash usage for this loss-making company.

To achieve my aim, I will primarily use data from the FQ3'23 (Q3) earnings transcript and the product portfolio, while also providing an overview of the use of intelligent software codes (algorithms) in the hospitality industry.

AI for Hospitality and Presto Voice for Drive-Thru Lanes

Noteworthily, artificial intelligence has been present in restaurants, hotels, and related businesses for years, mainly as an extension of IT service providers' software offerings, to perform functions like data analytics using smart algorithms. The objective has been primarily to gain insights into the way customers behave, especially about how they spend money. Another usage of AI is to maximize the efficiency of hospitality operations just as for other sectors of the economy.

The main difference with the ChatGPT-style Generative AI of today is that previous flavors of the technology were also based on machine learning, but did not have the same level of sophistication. Examples are virtual assistants, and conversational systems that can manage restaurant operations and predict consumer behavior. Looking deeper, with Covid, one application that started to gain in importance is voice ordering.

Here, some will remember that to limit drive-thru physical interaction with the employee manning the takeaway, we had to order through the microphone at the entrance itself while remaining in our cars. It is precisely this voice interaction that has evolved into voice AI, whereby instead of speaking to a fellow human being, you speak to a machine which then translates the orders into deliveries. Voice AI has also gained traction due to its automation features, enabling restaurant managers to reduce costs, especially at a time of high wage inflation.

In this respect, with its ChatGPT-style Presto Voice using Generative AI , the company is well-placed to tap into about $500 million of ARR or annual recurring revenue from five large restaurant brands located in the U.S. for their drive-thru lanes. These companies also have international operations with franchisees on all continents.

Well Positioned for Additional Sales Opportunities

As part of the sales effort, Presto has signed an MSA or Master Service Agreement with Carl's Jr Restaurants, a fast food chain operated by CKE Restaurant Holdings, which involves a trial and setting up of a pilot for testing purposes. Now, based on the MSA translating into actual dollar contracts, analysts are predicting $44.5 million in sales for FY'24 which would constitute a 60% surge over FY'23 as illustrated in the table below.

To be realistic, automating the drive-thru ordering process can be quite complex, especially when it comes to managing the flow of clients, for example, in the same way as human operators with 2 or 3 employees per franchise plus the supervisor. While intelligent voice bots can provide a high level of accuracy and reduce wastage by eliminating wrongly taken orders, it is also important to keep the line moving so that managers do not have to manually override the automated process to avoid chaos. Thus, as in all implementations of AI, there is a learning process, till a certain level of confidence is reached. In case this is achieved, Presto Voice can scale very rapidly.

In this respect, one of Presto's advantages over IT companies endeavoring to target the hospitality industry with advanced voice interaction tools is that it is not having to start from scratch as it already possesses proprietary technology in the form of NLU (natural language understanding) and LLM (large language models) which form the basis of ChatGPT's chatbots, as per the above illustration.

To show its advanced positioning within the industry, one can take an example from Kaleyra ( KLR ) which operates in the CPaaS (communication platform as a service) market and makes use of Conversational AI to both automate certain customer calls, but its algorithms are still mostly manual-based. Hence, the company still has to make the jump to Generative AI which requires time and additional investment, and the fact that Presto has rapidly evolved its product line to adapt to new demand shows portfolio adjustment agility.

Adopting Realism Given Valuation and Profits

This agility could, in turn, prove beneficial in helping the company bag more dollars' worth of contracts than analysts estimate, but, on the flip side, the trial at Carl's Jr could take more time to yield satisfactory results. This could cause some investors to become impatient and sell their shares, in turn imparting volatility to the stock. Also, with a forward Price-to-Sales of 10.66x or 6.66x based on FY'24 revenues as per the above table, the company is valued well over the sector median's 2.89x which means that it is no opportunistic buy in the short term.

However, for those wishing to position themselves for the longer term, this is a company also taking actions to improve profitability and move away from its actual operating loss status.

Digging into the income statement, Presto's additional AI efforts have not consumed additional expenses as these were around $5.5 million in Q3, which is more or less in line with the last three quarters as shown in the orange chart below. On the other hand, total operating expenses did rise by $6 million Y-o-Y in Q3 (blue chart) but this was due to staff expenses and transactional costs relating to the SPAC deal to go public in September last year.

As a result, there was a reduction in total cash and equivalents, to $27 million in Q3 from $38.2 million earlier for a company that consumes cash instead of generating money from operations.

Additionally, measures have been taken to reduce cash burn, namely through cost rationalization and synergies. To this end, without providing figures, the company is currently at the execution stage after having identified cost-cutting measures during Q3. Therefore, we can expect a lower cost base for FY'24, but, more risk-averse investors may prefer to wait for concrete figures to be provided as to potential cost savings, especially at a time when Presto has to dedicate additional efforts to supporting product trials.

Could Benefit from Momentum Factors

In these circumstances, it is more "voice-fueled growth" which could generate the revenue levels to engender sufficient profits for breaking even, rather than the cost savings themselves. To this end, voice AI-related progress for the drive-thru could act as a catalyst for an upside.

Looking at momentum factors (charts below), the stock price of $5.22 is well above the 10-Day, 50-Day, and 100-Day moving averages, which implies that the stock could well be on its way to surging to $6. This should be helped by the stock already having broken through the $4 resistance threshold as illustrated by the orange chart. Therefore, with a momentum grade of A+, there is an opportunity for traders to profit from the market's love for everything related to AI. This is the reason that I have a buy rating with potential gains of 15% ((6-5.22)/(5.22)).

In conclusion, by going through the company's star Presto Voice product offering which is currently undergoing trial, this thesis has shown that there can be big potential gains, also thanks to the early mover advantage. This also means that behind the hype factor, there are also more tangible opportunities to win customers looking to boost drive-thru sales and optimize their cost structures using Voice AI. This said, after the upside, valuations have become rich but, in this age of voice bots, it is more momentum factors that are guiding the stock's path as investors favor those appropriately positioned.

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