2023-11-08 03:13:33 ET
Summary
- Toast faces the challenge of moderating revenue growth rates in a competitive market.
- Customer adoption curve and increasing total locations reflect the value customers place on Toast's offerings.
- The company's 80x forward EBITDA valuation prompts a closer examination of its competitive position and future growth prospects.
Investment Thesis
Toast ( TOST ) has a lot going for it. For now, irrespective of what anyone says, its customer base loves its product, evidenced by a rapid customer adoption curve.
However, what is weighing on the stock is that Toast appears to be rapidly decelerating its revenue growth rates. And while I remain bullish on this stock, it's important to recognize that paying 80x forward EBITDA for Toast is a very high multiple.
Quick Recap,
In my previous bullish analysis, I said,
Toast is a very fast-growing business. But what makes it stand out against many other businesses is that it appears that looking ahead to the back end of this year, its growth is still expected to be strong.
Naturally, our thoughts now move to 2024, and what Toast's growth rates could be then. And I believe that we should see at least the high-30s%. Why? Primarily due to the fact that Toast's comparables with this year should be an easier hurdle than its comparables with 2022.
Simply put, my thesis, and apparently everyone else's too, was that Toast could grow around the high 30s% CAGR in 2024. But now, I'm not convinced Toast will manage to reach this high hurdle.
That being said, I'm not ready to throw in the towel on this business. That's not due to some preconceived commitment bias. Even though I recognize that is one of investors' biggest sins, but rather, that I continue to believe that this is an attractive business.
Toast's Near-Term Prospects
Toast appears well-positioned for continued growth, leveraging a suite of products and services tailored to the restaurant industry. With a focus on SaaS offerings and fintech, Toast has successfully expanded its presence in the market, driven by a strong competitive program and an efficient go-to-market strategy.
The company's commitment to product innovation is evident through its emphasis on delivering transparent value-based pricing to its customers, enabling them to access a range of solutions spanning point-of-sale systems, kitchen display systems, online ordering, and payment processing.
Furthermore, Toast Capital, an integral part of its financial services, has demonstrated healthy demand, fostering customer loyalty and bolstering revenue streams.
Furthermore, as I've frequently stated, as long as a company is seeing a steady increase in customers or users, that is the best indication of the company's long-term prospects.
As you can see here, Toast's total locations are up 34% y/y, coming very close to 100K locations. This growth is neither small nor starting from an insignificant base. I believe this is an unmistakable reflection of the value that its customer base puts on its offering.
Given Toast's focus on innovation, customer-centric approach, and expansion into various segments of the restaurant industry. The company's recent product launches, such as the Toast Now app and Toast for Cafes & Bakeries, showcase its commitment to providing tailored solutions for different types of restaurants, thereby enhancing operational efficiency and customer experiences. Toast's emphasis on building a comprehensive platform that integrates various restaurant management functions, including inventory management, employee scheduling, and catering, positions it as a valuable technology partner for businesses seeking to streamline their operations and improve overall performance.
Moreover, Toast's continued partnerships with both small and large restaurant groups, as well as its dedication to serving a wide range of customers, highlight its ability to cater to diverse market needs and maintain a strong presence across the restaurant industry.
Now, let's get to what's weighing down the stock.
Revenue Growth Rates Are Moderating
As I alluded to already, in my previous analysis I stated that I believed that Toast could grow in the high 30s% CAGR in 2024.
However, given that Toast's guidance for Q4 points to the mid-30s%, together with the fact that Q4 was meant to be the easiest quarterly comparison, it appears more likely than not that Toast will enter 2024 with mid-30s% CAGR, which is a significant deceleration in revenue growth rates in 12 months.
One of the key challenges facing Toast relates to maintaining its competitive edge amid an evolving market. With the emergence of competitors such as Square, Clover, and Shopify, the company needs to innovate its product offerings continuously and remain vigilant about pricing strategies.
Aman Narang's acknowledgment of the need to increase prices over time while emphasizing the importance of transparent value-based pricing highlights the delicate balance Toast must strike between generating revenue and retaining customer trust.
Additionally, Elena Gomez described during the earnings call the opportunities to optimize costs and negotiate with partners in the fintech COGS line underscoring the necessity of managing operational expenses effectively.
Similarly, the company's dependence on sustained same-store sales and customer acquisition in the face of a softening consumer spending environment presents a pressing challenge. Toast must ensure that it continues to offer competitive solutions to its customer base while adapting to changing market dynamics to maintain its growth trajectory.
TOST Valuation -- 80x Forward EBITDA
Here's the problem facing Toast. While its investors believed that Toast was growing at a very high 30s% CAGR, nobody was overly concerned about its underlying profitability.
But now that its growth rates have slowed down so significantly, even though investors are still not fully focusing on its underlying profitability they are starting to think slightly more about its profitability profile.
According to my estimates, in the best-case scenario, next year, Toast will deliver $100 million of EBITDA. This leaves this stock priced, including the premarket drop, at 80x forward EBITDA. And that's really expensive for a company that is clearly under a lot of competitive pressure.
The Bottom Line
In conclusion, while Toast faces the challenge of moderating revenue growth rates in the midst of competitive pressures from players such as Block's Square, Clover, and Shopify, its strong customer adoption curve and growing total locations reflect the underlying value customers place on its offerings.
The company's commitment to innovation, demonstrated through product launches like the Toast Now app and Toast for Cafes & Bakeries, underscores its dedication to providing tailored solutions for diverse restaurant needs and enhancing operational efficiency, and customer experiences.
Nonetheless, the deceleration in growth rates and the need to navigate competitive market dynamics highlight the importance of sustaining customer trust and operational excellence for Toast's continued success. As investors contemplate the company's 80x forward EBITDA valuation, the focus on maintaining a balance between growth and profitability becomes increasingly crucial for Toast's future prospects in the market.
So, even though I remain bullish on Toast stock, I have to acknowledge that this wasn't a blemish-free report.
For further details see:
Toast Earnings: Revenue Growth Challenges In A Competitive Market