Software-as-a-service companies like Veeva Systems have effectively created a one-stop shop for everything their customers need, and Toast (TOST -2.12%) is building a similarly comprehensive platform to serve the restaurant industry.
Toast's business started in point-of-sale software, but it has since expanded into offering nearly every back-end service its 48,000 restaurant partners could need. The company only began trading publicly in late September, but I think it is already deserving of a spot in any investor's portfolio.
What Toast is cooking up
Through its platform, Toast is hoping to reduce the complexity of effectively managing a restaurant. Despite how large the industry is, many restaurant owners don't use modern, cloud-based services, relying instead on legacy on-premises technology not always suited for their businesses. Because of COVID-19, however, this tide is starting to turn -- a 2020 study on restaurant technology found 39% of respondents felt held back by legacy software systems, and 59% said they plan to reduce the number of technology systems they use.
Toast wants to be the one-stop shop for these businesses, and the company has ramped up the number of services it offers -- now almost two dozen of them -- including everything from payroll to payment processing to marketing. And considering the company has spent $73 million on research and development year to date, its menu of offerings will likely continue to grow.
Toast has enjoyed strong growth and adoption. Since 2015, the company has increased the number of locations it serves at an average annual rate of 109%. Revenue was up 105% year over year in the first half of 2021. Its annualized recurring run rate (ARR) increased 118% as of June 30, and its net retention rate has been at least 110% for five years running.
Operating in just 6% of U.S. restaurant locations, the company has only scratched the surface of its addressable market, which management estimates is worth over $15 billion. With restaurant industry sales expected to reach $1.1 trillion by 2024 and Toast's strong position within the space, the company has a long runway of growth ahead of it.
But like many young growth stocks, the company is not yet profitable as it posted a net loss of $235 million in the first half of this year. However, Toast did generate almost $40 million in free cash flow over the same period, reversing the prior-year period's $129 million cash outflow.
Could investors get burned?
The typical risk for any IPO that has generated as many headlines as this one is valuation. Shares are already up over 35% from their IPO price, and Toast is trading at 23 times trailing-12-month sales as of this writing, though one of its competitors -- Olo -- sports an even higher sales multiple at 30 times. The latter is focused on online ordering, whereas Toast has a much broader offering.
And while Toast's strong brand recognition and inclusive platform in a massive industry check the boxes for an outstanding long-term holding, investors should follow the company's progress growing its ARR and top line while keeping its net retention rate stable. If the company can do this, it could end up with the No. 1 platform for the restaurant industry, and because of this potential, I believe Toast is worth the premium as one of the best IPOs to buy today.