Top 100 Stocks to Buy: Toast's Journey Back to $60 Appears Promising

I’ve been a fan of restaurant software provider Toast (TOST) for a long time. I’ve written about the company’s positive attributes for other publications many times, going all the way back to its September 2021 IPO at $40.  

As far as I know, I’ve only covered Toast stock one time since I started writing for Barchart in February 2022. That was in July 2019. The headline read Is Toast Stock Toast After Doing the Right Thing? The company had just said it would charge a 99-cent fee to its customers’ customers for online orders over $10. The stock tanked on the news.   

“Ever since Toast introduced the controversial 99-cent fee, everyone and his dog has had an opinion. For or against the fee, it takes a lot of guts to introduce something that bypasses your immediate customer while affecting the end user,” I wrote on July 19, 2023.

“Here's the weird thing about how some people have reacted to the 99-cent fee. PepsiCo (PEP) have been hosing their end-users over the past two years of inflationary prices. And yet, many consumers blamed the grocery store chains for these higher prices.”

I suggested it was a tempest in a teapot and would hit GAAP profitability by the end of this year. It hit its first operating profit of $9 million in Q2 2024 and $34 million in Q3 2024. In the first nine months of 2024, its operating loss was $16 million, down from $231 million a year earlier. There’s a very good chance it will deliver an operating profit for all of 2024.     

Early in Tuesday morning trading, Toast stock jumped nine spots to 62nd place in Barchart’s Top 100 Stocks to Buy. It’s up 192% from its November 2023 low of $14.45. 

Next stop $60? I think so. Here’s why. 

The Business Is Getting Stronger

Toast’s business has certainly improved since its IPO in September 2021. Consider these five key metrics.

Metric	2020	Q3 2024	% Change
ARR  (Annual Recurring Run-Rate)	$326.0 million	$1.6 billion	390.1%
GPV  (Gross Payment Volume)	$25.4 billion	$41.7 billion	64.2%
Total Locations	~48,000	~127,000	164.6%
Adjusted EBITDA	-$93.8 million	$357 million (Midpoint of 2024 estimate)	480.6%
Free Cash Flow	-$160.7 million	$229 million (Annualized)	242.5%

The company’s business model operates like a flywheel. The more locations it adds, the higher GPV, which is turned into ARR through payment processing fees, restaurant working capital loans, hardware sales, data analytics, professional services, and subscription services. And, finally, with cost controls in place, positive free cash flow.

While it reports three buckets of revenue: Subscription Services, Financial Technology Solutions (FTS), and Hardware, it is FTS that generates the lion’s share of revenue. It was responsible for 82% of Toast’s Q3 2024 revenue of $1.31 billion. 

In the latest quarter, FTS’s gross margin was 21.7%, 460 basis points more than a year earlier. Subscription Services’ gross margin was a healthy 70.4%, 320 basis points higher. However, it accounted for just 14.5% of the company’s revenue.

FTS continues to be the company's main driver of growth.  

Growth Strategy Has Plenty of Levers

In the Q3 2024 conference call, CEO and co-founder Aman Arang emphasized the company’s four priorities it set earlier in the year. 

1) Scaling locations and market share in our core business.

On the first priority, Arang mentioned that Toast has just 14% penetration for its platform despite doubling its market share over the past three years. It finished 2023 with approximately 106,000 locations. So, in 2024, it’s already added 21,000 locations with a full quarter left in the fiscal year. If it adds another 7,000 in the fourth quarter, it will finish the year with 134,000 locations, 26% higher than in 2023. 

As long as it can grow locations by 20%+ each year, the flywheel will deliver plenty of upside for its core business.

2) Expanding our offering for restaurants with products customers love.

In many ways, I look at Toast and think Shopify (SHOP) for restaurants. The e-commerce platform has a market cap of $144 billion, about 6x larger than Toast. I could see Shopify management having an interest in Toast. 

In the meantime, it continues to launch new products for its platform to help its restaurant owners win more customers.

“But we’re not just expanding our offering by releasing new products. Our vertical SaaS strategy goes deep and focuses on a wide range of unique restaurant-first capabilities, what we refer to as our ‘thousand little things,’” Arang said in the conference call.

3) Expanding our addressable market into new adjacencies.

Sometimes, given its growth, it’s easy to forget that Toast generates almost no revenue, relatively speaking, from outside the U.S. 

The CEO did say in the conference call that Toast Now, the company's mobile operator app, is available to customers in Canada, the UK, and Ireland. Not now, but in the future, Toast will have to break out its international business in quarterly reports. That’s a good thing.   

4) Setting up the company to deliver ongoing operating leverage as we scale.

So far in 2024, it has increased its operating expenses by just 4.1%, while revenues and gross profits have risen by 28.1% and 41.0%, respectively. 

As it continues to balance its growth initiatives with cost containment, there will be times where it has to sacrifice growth for profits and vice versa. 

“In 2024, we reshaped our cost structure, positioning us to invest behind the priorities we've laid out to drive durable growth over the long term while continuing to expand our margins towards the targets we presented at our Investor Day. I am confident in our teams ability to make the right tradeoffs and set us up for the future,” Arang said in the conference call.

The Play

Up 136% in 2024, Toast’s total enterprise value of $22.83 billion is nearly 4x its revenue in the latest 12 months, according to S&P Global Market Intelligence. The multiple hasn’t been this high since Q2 2022. So, yes, it’s pricier than it’s been in some time. 

However, its overall gross margin in Q3 2024 was 24.8%, 790 basis points higher than in Q2 2022. Its positive operating margin of 4.3% is much better than -8.0% in Q2 2022, so the multiple expansion is justified. 

A possible play would be to buy 100 shares at the current price of $42.50, sell one June 20/2025 $65 call for an annualized return of 5.3% ($1.25 bid) and sell one June 20/2025 $35 put for an annualized return of 10.5% ($2.43 bid) for a total income of $368.

Should it fall to below $35 and you have to buy 100 shares, you’re getting 100 more for 23% less than you paid for the first 100. And if it jumps past $65 at expiry next June, you’re locking in nearly a 60% return. 

As far as I can tell, Toast is anything but toast.