Toast (TOST 0.18%) has been a public company for less than three years. The company priced its September 2021 initial public offering (IPO) at $40 a share, and the stock surged by more than 50% on its first day of trading.
But investors who held on have seen the share price fall well below that IPO price, selling at less than half that level. While hot IPOs often garner a lot of attention after the initial surge, investors should take a rational approach to the business and valuation.
Taking a step back from the initial excitement and subsequent decline, is Toast a buying opportunity at the current share price?
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Serving all needs
Toast provides a broad range of technology solutions to the restaurant industry. These include point-of-sale systems, digital ordering and delivery, marketing and loyalty programs, and payment processing.
The company aims to serve the entire industry. Its annualized recurring run-rate (calculated from its monthly subscription service billings) was $1.2 billion. Management estimates that its addressable market in the U.S. alone is $55 billion, so it would seem that Toast has a large growth opportunity in front of it.
And it has been taking advantage. In the third quarter, Toast's annualized recurring run-rate grew by 40%, and its revenue increased by 37.2% to over $1 billion.
Potential volatility
However, most of its top line comes from outside subscription-based revenue that typically provides a degree of stability and predictability. In the third quarter, subscription services were about 13% of Toast's revenue. These are derived from customer fees for access to Toast's software, with contracts ranging from a year to three years.
The majority gets generated from financial technology solutions. These largely consist of customer fees from processing payment transactions. They are a percentage of the transaction figure plus a transaction fee. The segment has been doing well. Toast has been increasing the number of locations, and the division saw revenue increase by 36% to $856 million.
However, that revenue depends on restaurant volume, and will likely be affected by macroeconomic factors. Financial technology solutions accounted for 83% of Toast's third-quarter revenue.
Meanwhile, the company continues to produce losses, though they are narrowing. In the third quarter, it lost $31 million compared to a loss of $98 million in the prior-year period.
NYSE: TOST
Key Data Points
Decision
Over the past year, Toast's price-to-sales (P/S) ratio fell from over 3 to 2.6. That's in line with the S&P 500's average P/S multiple.
It's challenging to make a decision about whether to purchase a company's stock when the operation is running in the red. Toast was founded in 2011, when the economy was recovering from the dark days of the Great Recession. Hence, it hasn't been tested during a major economic downturn. The economic slowdown that struck at the start of the pandemic proved fleeting, and many people still ordered takeout during the health crisis.
Given that the company is valued at a P/S multiple equivalent to the broad market, but is unprofitable, operating in a risky industry where bankruptcies are common, and faces competition from the likes of behemoth Block (SQ +3.11%), I'd look to avoid Toast shares right now.
