You may have to thank Toast (TOST 3.42%) -- at least partially -- for your latest great restaurant meal. The company isn't doing the cooking, but it is helping 99,000 restaurants improve the dining experience for guests. The cloud-based software platform offers restaurants help with everything from menu management to digital ordering and delivery.
Toast completed its initial public offering (IPO) in September of 2021 and has since gone on to increase its number of clients, broaden its offerings across the industry, and lift revenue. But shares of this growing business have not yet brought early investors great returns. In fact, investors may feel more burned than a forgotten piece of toast in their toasters as the stock has lost about 75% since its IPO. Considering Toast's strong and weak points, is the stock a buy, a sell, or a hold right now? Let's find out.
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Services tailor-made for restaurants
First, a brief look at all Toast has to offer. The company sells a variety of hardware to customers, processes digital payments, and offers many services. It tailors its offerings to specifically suit restaurant types, including fine dining establishments, bars and nightclubs, food trucks, pizzerias, and more. Other companies offer digital payment processing and related services, but Toast specifically designs its products and services for the restaurant industry.
As of December of last year, the company's customers processed more than $92 billion in gross payment volume over the trailing 12 months. Toast serves about 10% of the United States' 860,000 restaurants. A recurring revenue measure -- Toast's annualized recurring run rate (ARR) -- represented only about 2% of a $55 billion opportunity. So, the company sees huge potential to grow its presence and, eventually, its earnings, as well as additional growth internationally.
Meanwhile, in the second quarter, Toast reported positive free cash flow and adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) for the first time since the IPO. This continued in the company's third-quarter report, too.
All this is positive, but there are a couple of negative points to consider before making any investment decisions. Toast makes most of its revenue today through financial technology solutions, such as payment processing, generating $856 million in the most recent quarter. But the cost of that revenue totaled $674 million, leaving Toast with a narrow margin. And the cost of revenue for hardware surpassed the revenue hardware generates. This is a concern, even though the company's subscription services are profitable.
Toast's rivals
The next issue to consider is competition. Yes, Toast is unique because it's created its service specifically for restaurants. But many others, such as Block's Square restaurant point of sale (POS), still offer rival restaurant management platforms that could put the brakes on Toast's growth.
I don't think Toast has a particularly strong moat to guarantee the company leadership over time. Also, competition could weigh on Toast's ability to raise prices -- and difficulties in today's restaurant industry mean price may weigh greatly in a restaurant's decision about which platform to choose.
Now, let's consider Toast's valuation. The stock is trading at about 2x sales, its lowest ever by that measure, which initially looks extremely cheap. But I'm still on the fence about Toast's ability to truly stand out among competitors over time -- and its cost of revenue, as mentioned above, could represent another challenge. All this makes me cautious about Toast's long-term growth prospects.
What should investors do?
So, should you buy, sell, or hold the stock? I wouldn't wholeheartedly recommend buying the stock right now as I think other growth stocks out there offer better visibility on future market share and earnings.
But if you already own Toast shares, I wouldn't recommend selling them right now. The company has made progress when it comes to earnings, and it operates in a huge market where more than one company could become successful.
This means your initial investment might be in the doldrums today, but it could go on to recover down the road. So, if you're already a Toast shareholder, it's worth holding on and carefully watching how earnings and customer acquisitions progress.
