The restaurant industry has undergone major changes over the past decade, particularly since the start of the COVID-19 pandemic. Small businesses now need to serve multiple delivery businesses while offering a seamless online ordering process across different mobile devices to compete with fast food giants like Mcdonalds.
This type of service is something that a small business cannot build on its own and that is why restaurants typically outsource their technology needs. Toast (NYSE: TOST) is a company that offers these services to individual restaurants, and its shares have just been floated on the stock exchange through an initial public offering (IPO) at the end of September. Let’s take a look at this catering tech company and see if it can be a good long term investment.
Technology for restaurants
Unlike some of its point of sale (POS) and fintech competitors, Toast only focuses on serving the restaurant industry with its technology offerings. Its goal is to offer a restaurant owner the most complete range of products to choose from. This includes both software applications and payment solutions. Toast’s software solutions include point of sale, restaurant operations, kitchen dashboards, online ordering and delivery, and marketing. Restaurants pay a monthly fee to access these products to help them run their business.
In 2020, Toast reported total revenue of $ 823 million. The company’s subscription revenue was $ 101 million, growing 62% year-over-year, with segment gross profit of $ 61 million. With only $ 140 million in total gross profit in 2020, growth in subscription services will be vital for Toast in the years to come.
Toast’s payment solutions include point-of-sale processing, working capital financing, and payment processing for vendors and employees. Like most other point-of-sale products, Toast charges a small fee – called the take rate – on every order it processes. Last year, Toast’s payments segment generated $ 644 million in revenue, which would make you think the segment is way bigger than subscription services. However, since it has to pay part of its fees to credit card companies and payment networks like Visa and MasterCard, it likely only brought in $ 135 million in gross financial payouts / profit last year.
The company also has hardware and professional services divisions, but these both have negative gross margins and won’t really matter to the entire business in the long run.
He has a lot of growth to come
At the time of its pre-IPO filing, Toast’s products were in 48,000 restaurants, up from 33,000 and 20,000 in 2020 and 2019, respectively. Currently, it only works in the United States. Clearly, Toast’s offerings are resonating with restaurant owners right now. But with over 860,000 restaurants in the United States, there is plenty of room for this business to grow.
It is unrealistic to expect it to serve every restaurant, and it competes with market leaders like Square. But if you think every restaurant needs services like Toast to survive and thrive in the 21st century, then chances are Toast has a ton of room for expansion. And that’s only in the United States. There are approximately 22 million restaurants around the world, all of which over the next several decades will need technological solutions to improve their offerings to customers.
Finally, Toast has historically achieved consistent growth from existing locations. Its net revenue retention, which measures revenue growth for existing customers, has exceeded 110% every year since 2015. This means that customers who have been using Toast for more than a year have increased their spend by 10% or more year after year for the past six years.
But Toast Stock Ain’t Cheap
While a lot of Toast’s business and financial data looks great, the stock is trading at an extremely high valuation after the IPO. With a market cap of $ 25.6 billion and gross profit of just $ 254 million in the 12 months ending June 30, the stock has a price-to-gross profit ratio of 101. This means that even though the company ends up converting 100% of its gross profit to profit (which it doesn’t), the stock would trade at a price / earnings ratio of 100.
Even Square, Toast’s competitor which is one of the more expensive stocks on the market, is trading at a P / GP of around 30. AP / GP of 100 is well above the market average of 6-8 and indicates that investors expect Toast’s gross profit to grow at a high rate for many years.
Can the company meet these expectations? May be. But even though this company looks solid, there aren’t many (if any) stocks worth trading at a P / GP of 101. Unless the stock price drops drastically. significantly, I stay away from Toast actions.
This article represents the opinion of the author, who may disagree with the “official” recommendation position of a premium Motley Fool consulting service. We are heterogeneous! Questioning an investment thesis – even one of our own – helps us all to think critically about investing and make decisions that help us become smarter, happier, and richer.