With a full-year 2022 revenue increase of 60%, restaurant technology company Toast (TOST 4.70%) will undoubtedly be enticing to growth investors. But with a full-year net loss of $275 million, value investors will likely deem this stock too risky.
But it's important not to succumb to investing labels like "growth" and "value." The reality is that revenue growth is extremely important for market-beating investments. But not all high-growth companies create shareholder value over the long haul.
Therefore, I'll explain why I believe Toast might be worth buying despite its losses.
Toast's business
Toast offers restaurants a comprehensive selection of products, including Android-based software for orders and payments, hardware point-of-sales devices, and even lending via Toast Capital.
With such a comprehensive offering, Toast is attracting customers with relative ease. It ended 2022 with over 79,000 restaurant locations using at least one of its products, which was a 40% year-over-year increase. That's not far behind competitor Olo (OLO 4.68%) whose software is used by 87,000 restaurant locations.
Moreover, Toast facilitated $91.7 billion in gross payment volume in 2022 -- the dollar value of the transactions it handled. By comparison, Olo handled just $23 billion, and this has to do with the mix of products being used. Both companies offer a comprehensive line of products. But the average Olo customer was only using three of its products. Toast doesn't give out this number, but it's likely higher considering 41% of its customers use six of its products or more.
As you might imagine with such product diversity, Toast's income streams vary greatly in profitability. Indeed, hardware is sold at a loss, but fortunately it was only 4% of revenue in 2022. Toast's largest revenue source is financial-technology (fintech) solutions, at 83% of revenue. With fintech, the company generates revenue by charging a fee per transaction as well as charging a percentage. However, this is a relatively low-margin segment. Fintech solutions had a gross profit margin of just 21% in 2022.
The more attractive part of Toast's business is its subscription revenue that's generated by charging for access to its software. This segment had a 65% gross margin in 2022. The bad news is that this segment accounts for only 12% of the company's revenue. The good news is that it's a fast-growing segment, jumping 92% year over year in 2022.
Taking this all in, it appears Toast is quickly gaining widespread adoption in the restaurant space, outpacing the growth of important competitors, including Olo. That indeed bodes well for the company's growth potential.
Toast stock
Toast checks the box for growth. But thinking about it as an investment, it's important to consider its earnings potential. One thing to note is that Olo is far more efficient than Toast, especially when it comes to spending on sales and marketing, as the chart below shows.
TOST sales and arketing expense (quarterly) data by YCharts.
Olo tends to focus its sales efforts on higher-level executives of large chains, which can result in less-frequent wins. But the wins are big when they come. It has been more profitable than Toast not just because of more-efficient spending on sales. Rather, Olo's gross margin is much higher: 69% in 2022 compared to a gross margin of just 19% for Toast.
However, this seeming disadvantage could be a hidden tailwind for Toast. Hardware devices are good starting points for new customers. But the profit potential is low compared to the software modules that could be deployed over time. Accordingly, one would expect profitability to improve with greater adoption of Toast's products.
It might be a little early to celebrate, but Toast's gross margin has been ticking higher in the last few quarters.
TOST gross profit margin (quarterly) data by YCharts.
This coincides with a big jump in the amount of Toast products being used by its customers. Remember, subscription revenue is growing fast. As mentioned, 41% of its customers were using six or more products at the end of the fourth quarter. That's up sharply from 32% in the prior-year quarter and up from 39% in the third quarter.
And as its customers rely more and more on its software, Toast's products become stickier in theory. This could lead to lower sales and marketing expenses because customers will be too integrated with the platform to want to switch. Toast isn't yet profitable, and it's guiding for ongoing losses in 2023. However, its profit potential is pointing up in the long term, in my opinion.
Therefore, an investment in Toast stock isn't necessarily a slam dunk. But trading at less than 4 times sales (reasonable considering its forward growth rate), it may be worth a smaller, more-speculative position. And if margins continue trending in the right direction in future quarters, investors could then add to their starter positions.
