2023-12-20 04:43:23 ET
Summary
- Toast shares have experienced recent drops due to weak guidance and macroeconomic factors affecting same-store sales growth.
- The company continues to add new restaurants, cafes, and bakeries as customers, demonstrating growth potential.
- TOST has seen improvements in profit margins and has a strong balance sheet, making it an attractively priced investment compared to other high-growth payment companies.
When it comes to Toast ( TOST ) shares, investors tend to go from euphoria to panic quite regularly. This is something we commented on our last article , where we rated shares a 'Buy'. Shares are modestly lower, while the S&P 500 index ( SPY ) ( SP500 ) has significantly increased, leading to considerable underperformance. We will go through recent results and guidance, to update our opinion.
The most recent drop came from weak guidance, and the company described macroeconomic headwinds that were slowing same-store sales growth. Toast is expecting to exit the fourth quarter with average revenue per user growth in the mid-to-high single digits compared to previous expectations of ten percent.
We believe this slowdown is normal given that there are indeed indications that people are dining out less frequently in response to lower discretionary income. Which itself is the result of consumers facing higher interest costs, and are still adjusting to the higher than usual inflation. While consumer behavior will inevitably have some cyclicality, investors should pay more attention to the number of restaurants, cafes, and bakeries that the company keeps bringing in as new customers.
In the most recent earnings call , the company shared that it added over 6,500 net locations in the quarter, which was roughly 20% more than in the same quarter the previous year. This is a good number of additions in the quarter, especially considering there was fear that the controversy over the company's $0.99 fee for online orders would have a negative impact. To its credit, the company reacted quickly when restaurants complained and removed the fee in just a few days.
Powering Restaurants
As a reminder, Toast provides advanced and modern payments technology to restaurants. It has been adding more software and technology offerings, which increase switching costs and broaden its competitive moat.
Growth
While revenue has continued growing at an impressive rate, there is no denying that growth is decelerating. We view this as natural, and investors who were expecting 60%+ growth to continue for many years were not being realistic.
Also, while overall revenue growth has decelerated to around 37%, subscription revenue grew last quarter at 46%, and this is arguably the most attractive type of revenue.
During the prepared remarks of the third quarter earnings call, CFO Elena Gomez added some color to their growth expectations. It sounded like they expect headwinds in the short term, but remain optimistic about the long-term.
We plan to exit Q4 with SaaS ARPU growth in the mid- to high single digits reflecting lower ARPU for new go-live cohorts, as we continue to optimize our upfront sales to balance sustained location growth velocity, as well as some impact from mix shift. Our long-term growth algorithm remains the same. We have a long runway to increase ARR through both locations and ARPU with just over 10% of US restaurant locations on the platform, a proven differentiated SMB go-to-market motion and growing traction across the full breadth of restaurant segments, as well as green shoots internationally, we're well positioned stained healthy growth location for years to come.
Financials
One thing going in the right direction is profit margins, with the company seeing massive improvements in gross profit, operating, and net profit margins. Toast reported last quarter recurring gross profit streams of $280 million, up 39% year-over-year. Adjusted EBITDA was $35 million, representing a margin of 13% on their recurring gross profit streams, a 22% margin improvement year-over-year. As can be seen below, even on a GAAP basis Toast is getting close to profitability.
Toast also has a strong balance sheet with over a billion dollars in cash and short-term investments and no long-term debt.
Innovation
Toast has been reinvesting around 10% of revenue into R&D, which is reflected in new products and services. For example, it recently announced a tailored product specifically designed to cater to the needs of cafes and bakeries.
Valuation
Compared to other high-growth payments companies, Toast appears attractively priced. For example, Affirm Holdings ( AFRM ) is trading with an EV/Revenues of almost 10x, while Adyen ( ADYEY ) is above 5x. StoneCo ( STNE ) which has a very similar business model to Toast, but operates mainly in Brazil, is slightly cheaper but has currency and emerging market risk. Still, we believe StoneCo is attractively priced at the moment as well.
According to the average analyst estimates found on Seeking Alpha, expectations are for earnings per share to reach $1 in FY27. If the company hits this goal, then it can be argued shares are currently undervalued.
We believe the company might be able to grow revenue above 20% on average over the coming ten years, which could result in earnings growing at ~30% assuming profit margin improvements. Based on our estimates for future earnings we calculate a net present value for the earnings stream of $33. Of course, there is a lot of uncertainty as to whether the company can deliver these results, but at current prices close to $18 we believe there is a good margin of safety, even if uncertainty is high.
EPS | Discounted @ 10% | |
FY 24E | 0.19 | 0.17 |
FY 25E | 0.52 | 0.43 |
FY 26E | 0.72 | 0.54 |
FY 27E | 1.00 | 0.68 |
FY 28E | 1.30 | 0.81 |
FY 29E | 1.69 | 0.95 |
FY 30E | 2.20 | 1.13 |
FY 31E | 2.86 | 1.33 |
FY 32E | 3.71 | 1.57 |
FY 33E | 4.83 | 1.86 |
FY 34E | 6.27 | 2.20 |
Terminal Value @ 3% terminal growth | 68.95 | 21.97 |
NPV | $33.65 |
Risks
There are significant risks with Toast, including the risk of further growth deceleration. Another important risk is potential conflicts with customers if it implements changes to the fees and commissions it charges. The relevance of this risk became apparent this summer when there was significant backlash to their 99 cents fee for online orders. On the positive side, the company is now cash flow positive and has significant liquidity in the form of cash and short-term investments.
Conclusion
We believe investors overreacted once again to the near-term headwinds to growth that resulted in relatively weak guidance for the next quarter. The company sounds confident that the long-term opportunity remains significant. Shares have already started to recover from the post-earnings decline, but we believe they remain undervalued. While we consider Toast shares to have above-average risk, they also offer significant growth potential. For these reasons, we are maintaining our 'Buy' rating.
For further details see:
Toast: Growth At A Reasonable Price