A very big restaurant industry is getting even bigger. Consumer spending on restaurants is expected to increase from $863 billion in 2019 to $1.1 trillion by 2024, according to The Freedonia Group.
As the industry grows, restaurants will likely need help with online ordering, management, and other operations. Both Olo (OLO +0.00%) and Toast (TOST +0.36%) help restaurants with these facets of the business, but which company is a better buy today?
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1. Olo
Olo focuses on the world of online delivery. Its software enables restaurants to offer online ordering and delivery directly to their guests. Instead of going through a third-party application, Olo helps restaurants build their own app or websites where they can receive online orders directly. The company also enables restaurants to directly manage order delivery, and its platform, Rails -- a service that integrates third-party orders from companies like Uber Eats onto a restaurant's own system -- enables restaurants to manage their online offerings. The Rails program also facilitates changing prices and limiting availability at some locations.
Online ordering is becoming more prevalent in the restaurant industry. Takeout and online ordering are expected to represent 70% to 80% of restaurant sales growth over the next five years, and Olo wants to be the beneficiary of that trend.
Olo has landed big customers like Applebee's, which is owned by Dine Brands, and Five Guys, along with 400 other brands. Olo has a large customer base thanks to its strong reputation. This helped the company spend just 10% of revenue on sales and marketing in the second quarter of 2021.
In the same quarter, Olo's revenue grew 48%, to $36 million, from the year-ago quarter. Since Q1 2020, the company grew its revenue by over 120%. Its average revenue per user (ARPU) grew by 13% to $486 from Q2 2020 to Q2 2021 -- demonstrating Olo's ability to expand its relationship with existing customers, which could result in strong adoption if the company were to expand service offerings. The company is on the verge of profitability, losing just $2.4 million in Q2 2021. The company could find itself in the black very soon if it continues growing its revenue at the pace it has in 2021. The company has generated nearly $15 million in free cash flow so far this year, so it can afford to absorb reasonable losses until it becomes profitable.
2. Toast
While Olo specializes in online ordering, Toast does almost everything for restaurants. Its all-in-one platform allows restaurants to manage all things from dine-in to takeout and delivery. For online ordering, Toast -- like Olo -- offers products that enable menu management and third-party integration. Plus, its software empowers restaurants to work directly with their customers.
In addition, Toast's point-of-sale (POS) software and kitchen management tools provide restaurants with in-house services. The company also provides operational management tools to handle inventory and payroll.
Toast has become a one-stop-shop where restaurants can find everything they need to operate, and this multifunctionality has contributed to Toast's remarkable success. The company had a $14.4 billion gross-payment volume in Q2 2021, and it had over $700 million in revenue in the first half of 2021, growing 105% over the same period in 2020. Eighty-three percent of its revenue comes from subscriptions and technology solutions, which have low margins. Thus, its total gross margin is still quite poor, reaching just 22% in the first half of 2021.
The company has lost $234.6 million so far in 2021. The company does, however, have a free cash flow of $39 million, which only recently turned positive from a negative free cash flow of $161 million for the full year of 2020. Its free cash flow is relatively small, representing just 6% of revenue. Investors should make sure that Toast's net income margin is approaching zero -- which will be helped by strong revenue growth -- in the coming quarters. If it can grow revenue while keeping its costs low, the company will likely improve its profitability.
Toast takes the cake
While Olo's gross margins and free cash flow margins are stronger, Toast is my better buy for two reasons. First, Toast's role within the industry could be huge. The company's 23 offerings make it the best place to find everything a restaurant may need. Once a restaurant joins Toast, it typically purchases additional services, spending over 10% more today than it did last year. This creates a sticky ecosystem, making it hard for a restaurant to leave Toast's platform once it joins. The company has spent over $73 million in the first half of 2021 to expand its offerings, which has only made Toast stronger.
Second, Toast is valued much more fairly than Olo. Toast trades at 20 times sales, while Olo trades at 30 times sales. When considering how much more Toast offers, investors might conclude that Toast would have a higher valuation compared to Olo, but that is not the case. And of course, valuation isn't the only important thing to consider when contemplating whether or not to buy a stock. But in Toast's case, because of its cheap price relative to Olo and its larger suite of offerings, I think that Toast is a much better buy today.
