For the most part, restaurants have been slow adopters of technology. While this has not affected businesses terribly for the past decade, the consequences of delayed adoption are starting to catch up with them. With complex operational processes like delivery and digital order integration, technology is becoming more of a necessity in the restaurant world.
Toast (TOST 4.29%) and Olo (OLO 3.69%) are the leaders in this push for a technology-centric restaurant operation, and both are doing so with impressive adoption. With restaurant sales expected to grow past $1.1 trillion by 2024, there is no shortage of opportunities for either business. But which stock is a better buy today?
With over 23 services that allow restaurants to lean on technology, Toast has become the leading one-stop shop for restaurants. It offers services for everything from point-of-sale systems to payroll management, and this wide set of offerings has gained lots of traction, with over 22 million restaurants globally using it.
Toast's centralized position as the provider for everything a restaurant may need is the primary edge for this company. Considering that many independent restaurants have stalled in becoming tech-centric, it is unlikely that they will want to adopt multiple platforms, using different platforms for online ordering, payroll, and point of sale. With Toast being able to offer all of that single-handedly, it can make the switch much easier. It has taken Toast nine years to develop everything it offers today, which gives it a large lead as competitors try to catch up.
The company is losing lots of money, though, and its lack of profitability is getting worse. Toast lost over $487 million so far this year, growing 160% year over year. This widening net loss grew from 32% of revenue in the first nine months of 2020 to 40% of revenue in the same period of 2021. Revenue grew 105% year over year in the third quarter, but this wasn't enough to suppress the net loss growth.
The company's poor gross margins are part of this unprofitability problem. The company only makes a small portion of its revenue on subscriptions, with most of its revenue coming from financial services. This pulls down its overall margin to 20% for 2021. Gross margins did improve from the same period in 2020 when they were 16%, but they are still disappointing.
While the company has generated $18 million in free cash flow so far this year, its current spot in the red is worrisome. If the company can continue growing rapidly and improve its gross margins in the process (while continuing to produce greater cash flow) this unprofitability could improve. With a best-in-class product suite and a massive market ahead of it, Toast could be a wonderful investment. This path does not come without competition, though, and that's where Olo comes in.
Toast's competition consists of pure-plays in specific product areas, and Olo is the primary player in the online ordering space. The company allows restaurant chains to integrate third-party orders into their operations systems so they can offer delivery broadly. Through partnerships with Uber Eats and recently Lyft (LYFT 1.87%), restaurant chains can aggregate and deliver orders through these companies.
A differentiating factor between Olo and Toast is that Toast targets smaller mom-and-pop restaurants while Olo focuses on chains that already have a heavy tech presence in their restaurants. The company's customer acquisition strategy is very effective in the space as well. It targets the headquarters, convinces them to adopt Olo, and thus the entire chain begins to adopt its products. This has led to large restaurant chains like Sweetgreen (SG 5.09%) and Shake Shack using Olo.
In terms of financial health, Olo is leaps and bounds ahead of Toast. Olo has just $109 million in revenue so far in 2021 compared to Toast's $1.2 billion, but its gross margins are sitting high at almost 80%. Additionally, with its unique customer acquisition strategy, the company spends very little on sales and marketing. So far this year, the company has only spent $12 million, which is just 11% of its revenue, on selling its product. Still, the company has lost over $40 million in 2021 so far this year.
Olo's free cash flow generation is strong at $25 million year to date, and the company's path to profitability is quite clear. As the company continues to attract large customers, the company will be able to grow revenue while keeping expenses stable, and within a few years, this company could reach profitability.
The better buy?
Both companies have been crushed since going public this year. Olo and Toast stocks are down 52% and 46% off their all-time highs, respectively. Toast is trading at 10.5 times its full-year 2021 guidance, and Olo is currently trading at 22 times guidance.
Despite the higher valuation and smaller size, I think Olo is a better buy today. Financially, Olo is more robust than Toast, and it is pumping out more free cash flow despite generating a tenth of the revenue. While Toast might have much more optionality, I think that Olo's customer acquisition strategy and gross margins could help the business be wildly successful over the next five years.
The great thing about this comparison is that you don't have to choose. With an industry expected to be over $1 trillion in just a few years, both of these companies have the opportunity to succeed and grow immensely. While I think Olo is a better buy today, both companies could use their competitive advantages to succeed in the market and beat the market.