Toast

We are discontinuing analyst coverage of Toast.

We will discontinue analyst coverage of Toast on or about Jan. 20. We provide analyst research and ratings on over 1,500 companies globally and periodically adjust our coverage according to investor interest and staffing.

We are discontinuing analyst coverage of Toast.

We will discontinue analyst coverage of Toast on or about Jan. 20. We provide analyst research and ratings on over 1,500 companies globally and periodically adjust our coverage according to investor interest and staffing.

Our fair value estimate of $39 per share implies a fiscal enterprise value/sales ratio of 3.2 times and price/earnings ratio of 75 times. Our discounted cash flow model uses a 9.0% weighted average cost of capital.

Our revenue forecast is driven by several factors. First, we anticipate the company will benefit from new location growth averaging 10.8% annually, primarily driven by expansion in its core market followed by increased enterprise expansion and penetration in select international markets. To a lesser extent, we anticipate new verticals such as convenience and grocery stores will also contribute to the company’s total location count. Average subscription revenue and gross transaction value per location should increase 5.3% and 2.4%, respectively, over the forecast period as attach rates increase within its client base and restaurants grow revenue. The blended average transaction take rate should remain consistent around 2.6%, as Toast seeks to remain competitive with alternative solutions. Finally, hardware and professional services should generate average negative growth of 2.2% as new location growth decelerates, resulting in reduced incremental additions offset partially by higher prices. Improved profitability should primarily be driven by gross margin improvement, which we forecast will improve by 900 basis points over the cycle. Key drivers behind the improvement are continued operating leverage within subscription services and financial technology solutions and price rationalization with respect to the implementation services associated with its hardware and professional services. Additionally, margins will benefit from the mix shift in negative-margin hardware revenue to high-margin software revenue. As revenue growth declines, we anticipate sales and marketing to continue to rationalize, declining 220 basis points as a percentage of revenue over the forecast period. General administrative costs should also continue to decline as a percentage of revenue, as revenue continues to scale, accounting for 4.4% of revenue in the terminal year of our forecast. Reductions in research and development costs should remain more muted relative to other expense line items as the company invests to penetrate new verticals, resulting in 110 basis points of improvement over the next 10 years. All together, we forecast midcycle operating margins of 15.3%.

We assign Toast a narrow economic moat supported by switching costs. In our view, several factors support switching costs within a technology solution. A key element relates to the criticality of the offering, as more integral solutions will likely have more touch points and greater integration within an organization, resulting in stronger switching costs. Operational risk can also contribute to switching costs as changing vendors can result in significant re-engineering and potential data loss. Finally, general inertia can also contribute significantly to switching costs as customers may have spent months or years relearning or redesigning deeply integrated workflows.

Qualitatively, Toast’s industry-leading point-of-sale solution touches every stakeholder within a restaurant, leading to a deeply integrated offering with numerous touch points across an organization. The host/hostess needs to understand who is sitting where and when tables will be free. The chef needs to understand what inventory is available to determine the menu and pricing. The wait staff needs to efficiently track and send orders to the kitchen. Kitchen staff needs an organized way of tracking incoming orders. Customers would like a solution that allows for item customization and various order modalities that is, delivery versus pickup and paying with card versus cash. Additionally, managers would like to track restaurant performance and manage staffing and schedules. We believe few alternative offerings provide the aforementioned capabilities on par with those provided by Toast, which has allowed it to increase its self-reported market share from 6% in 2021 to 15% in 2024. Using its position as the premier medium-size restaurant point-of-sale solution, it has been able to further integrate within customer operations, providing additional offerings such as payroll, inventory management, loyalty programs, benchmarking, loan facilitation, and more. Indeed, these complementary offerings have materialized in deeper customer penetration with 43% of locations using at least six products as of the fourth quarter of 2023 up from 32% during the fourth quarter of 2021. Furthermore, average software revenue per customer has more than doubled since 2020, with software-as-a-service, or SaaS, average revenue per user, or ARPU, in fiscal 2024 of almost $6,000 compared with $2,500 four years prior. In our view, few competitors have developed an offering as vertically integrated as Toast’s platform, making it difficult for midsize restaurants generating slightly above $1 million in revenue to switch offerings. In situations where a restaurant would like to switch away from Toast POS, it would potentially need to find a new hardware supplier, a new software supplier, find a new loyalty program provider, reestablish online ordering and delivery integrations, potentially switch payroll providers depending on if the customer utilized Toast payroll, and reconnect accounting and reporting integrations.

In assessing the strength of a company’s moat, metrics are incredibly important as one might be able to deduce the stickiness or pricing power of a business relative to a competitor. These would include total customers, customer retention, revenue retention, revenue attributable to particular end markets, and so on. Toast’s customer retention is around 90%, indicating average customer lifetime on the Toast platform is around 10 years. We view this performance as impressive given Toast services an industry characterized by high failure rates and slim margins. Depending on your source, between 17% and 30% of restaurants fail in their first year of operations. Given the majority of Toast’s churn is due to business failure, the average Toast customer is two to three times more likely to stay in business after one year, illustrating Toast's value proposition. Additionally, Toast reported net revenue retention of 110% in fiscal 2024, which is indicative of the company’s ability to quickly integrate within customer workflows and increase customer dependence by upselling its new offerings besides base point of sale solutions. A final metric we also view as supportive of our narrow moat is Toast’s payback period, which is calculated as the per unit customer acquisition cost divided by the store-level gross profit. As of fiscal 2024, Toast’s payback period was 1.6 years, which is consistent with other moat-bearing software peers and particularly attractive when considering the average customer lifetime is 10 years.

Proliferation of new solutions should expand average revenue per customer and create deeper integrations, reducing churn and increasing switching costs.

Vendor consolidation should benefit all-in-one platforms like Toast that provide a highly vertically integrated solution.

The underlying transition toward digital payments creates a natural tailwind supporting increased adoption of point-of-sale systems.

Expansion into new verticals could distract management from the core business.

Toast’s typical customer may not have the financial capability to allocate significant spending toward technology, limiting Toast’s revenue per customer.

As competitors continue to improve their capabilities, the industry may become increasingly commodified, resulting in greater pricing pressure.