10 Reasons to Buy TOST Stock Following the Toast IPO

IPO - 10 Reasons to Buy TOST Stock Following the Toast IPO

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Toast (NYSE:TOST) went public on September 22 at $40 a share. On its first day of trading, TOST gained more than 56%. There’s no question this Boston-based restaurant software platform had a successful IPO.

So far in 2021, 328 IPOs have occurred as of October 15, 96.4% more than at the same time in 2020. In fact, there were only 221 IPOs in all of 2020. So IPO activity is 48.4% higher in 2021, with two-and-a-half months left in the year.

Looking at recently priced IPOs — those priced between September 14 and October 14 — the best return to date is Dutch Bros (NYSE:BROS), up 130.4%. People do love their coffee. Toast has the fifth-best return out of 45 IPOs.

I’d say that’s a decent performance. However, the question on most investors’ minds at this point is whether Toast has got any more room to run.

I think it does. Here are 10 reasons why investors should help themselves to a slice of Toast and buy TOST stock.

Restaurants Need All the Help They Can Get

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You would have to be living on Mars to not understand the impact Covid-19 has had on the restaurant industry. We’re more than 18 months into the pandemic, yet businesses are still struggling to remain open.

QSR commented on the National Restaurant Association’s Mid-Year State of the Restaurant Industry Update in September:

“[T]he industry remains roughly a million jobs below pre-pandemic levels. Or 8 percent down. This despite many brands generating sales well above 2019 levels due to increased off-premises business running alongside pent-up demand for dining in and reconnection.”

Restaurants are having a difficult time staffing up to meet post-pandemic demand, in many cases forcing businesses to limit hours to handle what they can.

Toast’s digital platform can help restaurants of all sizes keep up with the challenges they face.

Digitally Powered Quick-Service Restaurants Doing Much Better

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It sucks to be a fine-dining establishment these days. While QSR concepts could pivot during the pandemic, sit-down restaurants, both casual and fine-dining, had a tough time meeting the challenge.

“[Q]uick-service restaurants (QSRs) were able to shift to remote channels such as delivery and curbside pickup, self-guided ordering at kiosks, and even fully digital ghost kitchens — but fine dining restaurants had to rush to rethink their menus to even make delivery a feasible option, coming up with more transportable offerings,” Virginia Tech business professor and restaurant expert Mahmood A. Khan told Pymnts.com.

Digital acceleration during the pandemic was a big boost for Toast. It’s expected that this transition will continue post-pandemic.

Business Is Healthy

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In Toast’s prospectus, the “At-a-Glance” page points out some impressive numbers.

Its annual recurring revenue (ARR) through June 30, 2021, was $494 million. That’s 118% higher than a year earlier. In 2020, it had $326 million ARR, 77% higher than in 2019, so its business is accelerating from a very high standard set in 2020.

Toast generates revenue in four ways:

  1. It charges customers a subscription fee for the use of its software applications. That’s based on a rate per location. The rate is determined by the number of software products purchased, hardware configuration, and employees.
  2. The company’s financial technology solutions revenue includes transaction fees for payment-processing of orders and fees earned from servicing working capital loans its customers take out for their restaurants. A third-party bank originates the loans, so there isn’t any balance sheet risk.
  3. While the software applications, payment processing, and working capital loans are the meat of Toast’s offerings, its hardware, including terminals, tablets, handhelds and more, is the potatoes. The two go hand in hand.
  4. Professional services to customers such as training, business process mapping, and installation are sold separately based on their needs and requirements. The amounts for these services are invoiced in advance.

Broken down by segment, in 2020 Toast generated 82% of its $703.7 million in annual revenue from its financial technology solutions. Subscription services accounted for 10%, hardware accounted for 7%, and professional services the remaining 1%.

Overall, revenues more than doubled in 2020.

TOST Priced Above Its Range

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In the pre-IPO marketing, Toast stock was priced between $34 and $36. By coming in at $40, it’s clear institutional interest was high. In addition, underwriters exercised their option to purchase an additional 3.26 million shares. As a result, Toast sold a total of 25 million shares in its IPO, raising net proceeds of $944 million.

Nasdaq research on IPOs between 2010 and 2020 found that IPOs priced above the pre-IPO price range tend to have higher first-day returns than ones that price within the range or below it. It also found that the larger the company, the larger the pop.

That’s exactly what happened to Toast.

Gross Margins Moving Higher

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While Toast had an operating loss of $56.8 million in the first six months of fiscal 2021 through June 30, that loss was 54% less than in the same period a year ago. One of the reasons for the improvement was gross margins.

In the first six months of 2020, Toast’s gross profit was $45.0 million on $343.8 million in revenue for a 13.1% gross margin. In the first six months of 2021, it had a gross profit of $154.8 million, a three-fold increase in profitability. That translated into a 22% gross margin, 890 basis points higher than last year.

You could argue that its largest revenue generator — financial technology solutions — doesn’t have nearly as high a gross margin as subscription services, its next most significant revenue stream.

But that would neglect the glass-half-full observation that even there, gross margins are improving. In 2020, its largest revenue generator had an 18.9% gross margin. In 2021, it was 22%, 310 basis points higher.

Further down the expense line, its operating expenses as a percentage of revenue were 30.1%, down from 49.3% a year earlier.

TOST might be losing money, but it’s still in scaling mode. Things are moving in the right direction.

Toast’s Market is Large

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Page 11 of its prospectus makes an interesting observation. In 2019, restaurants in the U.S. spent $25 billion on technology. That might sound like a lot, but it’s less than 3% of sales. By 2024, U.S. tech spending is expected to grow to $55 billion, a 17% compound annual growth rate. Globally, its total addressable market is greater than $110 billion.

At the moment, Toast believes it has a $15 billion serviceable addressable market (SAM) in the U.S. If you double its first-half sales, you get $1.41 billion. That’s less than 10% of its SAM.

So if TOST  keeps grabbing bigger pieces of that $15 billion SAM and keeps pushing its gross and operating margins higher, profitability should come in 2023.

Plenty of Cash and No Debt

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Toast’s “Use of Proceeds” page says that it intends to use the net proceeds from its IPO for general corporate purposes such as working capital. It may also use some of the funds to make an acquisition. That’s an excellent position to be in when you have no debt on your books.

At the end of June, it had $376.1 million in cash. Add in the $944 million from its IPO and its cash position is up to $1.32 billion or 4.5% of its market capitalization.

At the end of June, Toast had an accumulated deficit of $850.5 million. Founded in 2011, that works out to an average annual loss of $85 million. However, based on the cash it has on its balance sheet, it conceivably could sustain 5 to 10 years of losses without spending all of its cash hoards.

From where I sit, it’s in an excellent position to grab more market share in the U.S. and elsewhere.

International Growth

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Care to guess how much revenue Toast generates outside the U.S.?

Nothing.

That’s why international growth is one of six growth strategies the company plans to lean on in the future to grow its business. It’s a no-brainer. As Toast estimates, there are 850,000 restaurants in the U.S. Unfortunately, it serves just 6% of them.

Now extrapolate this to account for the number of restaurants across Europe, Asia, and the rest of the world. Conservatively, I would think there would be at least 10x the amount as in the U.S.

Toast has zero revenue and zero customers out of 8.5 million potential clients. But as it grows in the U.S., it should become easier to persuade restaurant owners abroad to jump on the bandwagon.

Sure, that will likely increase the cash burn, but you can’t grow exclusively in the U.S. if you want to be big. The company has to move further afield.

Work on Growing Its Subscription Revenue

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I don’t think there’s any doubt that the more subscription revenue Toast can generate, the faster its pathway to profitability. After all, its gross margin for subscription revenue in the first six months of 2021 was 66.1%, two-thirds higher than its top revenue generator.

Toast dedicates three of its six growth strategies to subscription revenues.

“Increase adoption of our full suite of products.” One of the things about data analytics is that it can tell you where you’re falling short in your pursuit of sales. Ideally, all 48,000 of its customers would be using 100% of its products.

And while it’s unrealistic to think you’ll get 100% engagement from your customer base, I’m sure Toast has a good idea of how far away it is from this goal.

Better product offerings will undoubtedly help get it there.

“Invest in and expand our current product platform.” While Toast says it’s looking to add products for both its subscription services and financial technology solutions, any good CEO can see that it has a revenue imbalance that needs to be fixed.

It mentions data analytics as an area of interest. However, I would think there are plenty of other areas that it can attack using tuck-in acquisitions, where needed, to fill customer needs.

“Further develop our partner ecosystem.” Toast’s SaaS (software-as-a-service) has approximately 150 partners that customers can utilize to run their operations. While I understand the desire to add more partners, if I were a customer, I would prefer to see 150 excellent partner applications rather than 300 mediocre.

In this case, quality over quantity is a big deal.

Toast Capital  

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Toast Capital revenue is included within its financial technology solutions revenue stream. In addition, the company points out on page 11 of its prospectus that as of March 30, 2020, there were $29.5 billion in restaurant loans outstanding in the U.S.

Toast Capital is responsible for marketing and servicing its working capital loans. Its third-party bank partner provides the capital. Toast Capital gets a servicing fee based on the outstanding loan amount and a performance fee for loans in good standing. The loans range from $5,000 up to $100,000.

As the company grows its number of customers, the fees it generates from Toast Capital will surely grow. In addition, I’m sure it will find additional ways the unit can generate increased revenues.

It’s a natural extension of its main business, helping restaurants run their businesses better.

On the date of publication, Will Ashworth did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.

Will Ashworth has written about investments full-time since 2008. Publications where he’s appeared include InvestorPlace, The Motley Fool Canada, Investopedia, Kiplinger, and several others in both the U.S. and Canada. He particularly enjoys creating model portfolios that stand the test of time. He lives in Halifax, Nova Scotia.


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