120,000 Reasons to Buy This Wide Moat Stock

Toast (NYSE:TOST) is a cloud technology provider that specializes in restaurant point-of-sale systems. The company’s software allows restaurants to process sales, track and manage inventories and even manage payroll and HR functions. To use these tools, restaurants purchase Toast’s POS, giving the company an effective competitive moat in every restaurant that decides to use it.

Unsurprisingly, this unique technology startup has found a warm reception in the restaurant industry by streamlining tasks and helping small restaurants more efficiently manage their operations.

Here’s why TOST is a candidate to buy now and hold for the next decade to take advantage of strong compounding growth.

Key Points

• Toast serves 120,000+ restaurants, with its POS technology creating a high customer retention rate.
• Recently profitable, Toast has no debt and a large cash reserve, enabling sustainable growth despite high marketing expenses.
• With a low U.S. market share, Toast has substantial growth potential domestically and internationally, reinforced by institutional investor interest and a share buyback program.

A Look at Toast’s Performance So Far

Toast has seen explosive growth over the last few years, to say the least. As of Q2, the company’s technology was being used in 120,000 locations, an increase of 29% compared to the year-ago quarter. Annualized revenue from subscriptions was also up 29%, rising to $1.5 billion.

A look at Toast’s historical revenue growth shows consistently strong performance. Q2 saw the company report record revenues of $1.2 billion, up 27% from a year earlier.

Toast’s first quarter of publicly available earnings was Q1 of 2021, during which the company generated just $282 million in revenue. With revenues multiplying by about 4x in just over three years, it’s clear that Toast’s growth strategy has been extremely successful.

Although Toast is turning in exceptional growth performance, it’s worth noting that the company has only very recently begun turning a profit. Q2 was Toast’s first quarter of net profitability.

During the quarter, the company delivered a net income of $14 million. Free cash flow also jumped considerably in Q2, rising from $39 million last year to $108 million this year.

The good news is that Toast has managed to keep its financial house in good order despite having lost large amounts of money until quite recently. The company carries no long-term debt and still has a cash hoard of $691 million.

How Much Growth Potential Does Toast Have?

For investors, the real story when it comes to Toast is the company’s large forward growth opportunity.

Despite Toast’s popularity in the restaurant industry, the company’s market share in the US remains in the low double-digit range. As such, continued growth in the US is likely to see revenues keep rising at high rates for quite some time to come.

For the moment, Toast has a high cost of revenue that is reflected in the net losses it was incurring until very recently. In Q2, for instance, the company spent about $956 million to generate its $1.2 billion quarterly revenue.

$115 million was spent during the quarter on sales and marketing, an expense line that has remained fairly high for Toast throughout its history. This spending, however, has been crucial in accounting for Toast’s remarkably high growth rates.

Given that Toast is gradually becoming a major force in the restaurant industry, it’s likely that the company will eventually be able to ease off the gas when it comes to marketing expenses. For the moment, these costs appear worthwhile given the results they have produced.

Now that Toast is profitable, it’s also likely that the company will be able to expand its net income fairly quickly. Though management hasn’t offered GAAP net income guidance for the year, it did upgrade its adjusted EBITDA outlook for FY2024 in the Q2 earnings report.

Previously, adjusted EBITDA was expected to fall in the range of $250 million to $270 million. That outlook has now been raised to $285 million to $305 million.

Is Toast Stock Undervalued?

Despite its large growth potential, Toast shares aren’t priced at especially lofty multiples. The stock currently trades at about 3.1x sales, a level that’s somewhat high but not at all out of line with the kind of revenue growth it has been able to deliver.

With that said, Toast’s price-to-book ratio is quite high at 10.4, though this isn’t particularly unusual for a software company with limited physical assets.

For the moment, Toast may be trading at or near its fair value. The median 12-month analyst price forecast of $30 per share is almost exactly in line with the stock’s current pricing, suggesting that investors may not see enormous returns from TOST shares in the short term.

Future revenue growth and net profitability will support higher prices as the company continues to build its operations.

Growth Stock to Hold For the Next 10 Years

With 120,000 restaurants using Toast’s technology and a high ongoing growth rate, it will likely only continue to expand its impressive foothold over the next 10 years. Although Toast lacks a durable history of profitability, the company appears to be in a very strong position for long-term success.

Because restaurants that use Toast buy its POS hardware up front, the cost and difficulty of switching will very likely lead to a high long-term customer retention rate.

Looking forward, these dynamics appear to give Toast a highly attractive growth runway. Not only is there still plenty of market opportunity in the US, but Toast also has ample room to expand to restaurants overseas.

Given the fact that the company has only recently reached net profitability, the opportunity appears to exist for many years of net income growth.

This view also seems to hold sway on Wall Street, where institutional investors have snapped up nearly 83% of the company’s shares. Over the last 12 months, buying activity has outweighed selling by a factor of approximately 3-to-1, suggesting that institutional investors aren’t especially concerned with TOST’s valuation.

Finally, it’s worth noting that Toast is also showing an inclination for returning cash to its shareholders through share buybacks. In February, the company authorized a $250 million buyback program, a move that helped to balance share dilution from stock-based compensation.

As of Q2, Toast still had $101 million remaining in warrants to repurchase stock. If the company continues to repurchase shares beyond this initial authorization, shareholders may well see a slow but steady concentration of their ownership positions over time.