2023-11-08 06:09:05 ET
Summary
- Toast, the restaurant PoS platform, experienced a nearly 20% drop in stock price despite reporting Q3 results that exceeded expectations.
- The company tightened its revenue outlook for the year, but the changes do not warrant such a significant stock reaction.
- TOST has a dramatic opportunity for expansion, deepening cross-selling momentum, and is reaching profitability, making it a good long-term investment.
Amid a rebound rally driven by lower interest rate fears, it has so far been a fairly volatile Q3 earnings season. Companies that are falling even slightly short of Wall Street's mark are being punished by large downside reactions, even when the underlying news isn't so bad.
Such is the case for Toast ( TOST ), the restaurant PoS platform. After reporting Q3 results (which came in ahead of Street expectations on the profitability front) and tightening its guidance range for the remainder of FY23, the stock suffered a nearly 20% drop. It's a great time, in my view, for investors to re-assess the bull case for Toast.
I initiated Toast with a bullish rating a month ago, prior to the company's Q3 earnings release. And while I largely agree with the Street reaction that the earnings results and guidance update weren't perfect, I'm more than content with the tradeoff of buying Toast at a ~20% lower share price. In other words: I remain bullish and am using the dip as an opportunity to add to my position.
To level-set on the outlook changes that investors have reacted so strongly to: the company has tightened its full-year revenue outlook to $3.83-$3.86 billion, representing 40-41% y/y revenue growth, versus a prior outlook of $3.81-$3.87 billion (the midpoint here has actually increased). This, in turn, implies a $1.00-$1.03 billion revenue plan for Q4 (versus $1.03 billion consensus) - which represents 34% y/y growth on the high end of the range, a 3-point deceleration from 37% y/y growth in Q3.
Is this worth a ~20% downside stock reaction; in other words, were expectations already baked so high for Toast that the stock couldn't shoulder a relatively minor ~3-5 points top-line deceleration into Q4? Another consideration to take note of: CEO Chris Comparato is also stepping down, to be replaced by former COO Aman Narang. Given the transition to an existing senior leader within the company, however, I don't view this as a major shakeup that has any disruptive potential to the business. In my view, this is a great time to take advantage of market dislocation to pick up a long-term position in Toast.
As a reminder for investors who are new to Toast, here is my full long-term bull case for the company:
- Dramatic opportunity to expand both geographically and horizontally. Toast is no longer just a specialized PoS system for restaurants; the company is aiming to be the software management platform of choice for restaurants, which positions it well versus more generalized competitors like Square. Overall, Toast has estimated its TAM at $110 billion, which indicates less than 1% current penetration.
- Cross-selling momentum is deepening. More to the point above, more than 40% of Toast customers are now using six or more Toast products, versus a rate in the mid-20%s two years ago.
- Holistic platform that empowers hybrid service models. Toast no longer serves only dine-in, either. The company's software helps businesses manage takeout orders and even larger corporate catering events.
- Reaching the cusp of profitability. Greater revenue mix into software as well as growing economies of scale are also helping Toast approach adjusted profitability for the first time.
Note as well that Toast currently only estimates being installed in 10% of U.S. restaurants, suggesting plenty of runway for expansion just domestically. Stay long here and buy the dip.
Q3 download
Let's now go through Toast's latest quarterly results in greater detail. The Q3 earnings summary is shown below:
Toast's revenue grew 37% y/y to $1.03 billion, in line with Wall Street's expectations. The chart below shows that revenue growth decelerated eight points relative to 45% y/y growth in Q2:
Toast Q3 top line revenue trends (Toast Q3 earnings release)
Underlying gross payment volumes (GPV), meanwhile, grew 34% y/y, which was also equivalent to a 34% y/y growth in the number of locations that Toast is installed in.
From a product standpoint, within the quarter Toast launched a specialized offering called Toast for Cafes & Bakeries - a sub-vertical within Toast's already-verticalized software offerings. It also made significant upgrades to its mobile app for restaurant operators.
Per incoming CEO Aman Narang's remarks on the Q3 earnings call around go-to-market developments:
We added over 6,500 net locations in the quarter approximately 20% more than Q3 last year. Our local go-to-market approach continues to help drive strong momentum in our SMB business as we increase number of markets with high customer density and market tenant. While the SMB business is still the primary driver of location growth or making progress across the broader market opportunity as well [...]
As we continue to broaden our products for our go-to-market team to serve a variety of customers types and pinpoints. Our upsell team becomes increasingly important to drive growth for the adoption of our platform across our customer base. As we approach 100,000 locations and beyond our upsell teams can get bigger, and we continue to see this as a big opportunity for growth in our business over time."
ARR grew 40% y/y to $1.22 billion, adding ~$80 million of net-new ARR within the quarter.
And from a profitability perspective, Toast also hit a record adjusted EBITDA margin of 3.4% in the quarter, up 190bps sequentially and 590bps y/y, driven by opex growth rates that are far lagging revenue growth (G&A expense, notably, grew only 12% y/y to support 37% y/y revenue growth).
Key takeaways
Toast's post-earnings crash, in my view, is a massive overreaction to a business that is still growing at a healthy pace and achieving substantial margin expansion. Given low penetration in the U.S. as well as worldwide, Toast has plenty of room to expand - and its reputation as a restaurant-focused POS platform helps to differentiate it from rivals like Square ( SQ ). Stay long here and buy the dip.
For further details see:
Toast: Buy The Post-Earnings Dip