Company Reports

Narrow-moat Toast's investor day shed light on its growth priorities but largely served to reaffirm our projections for the restaurant technology firm, with minimal impact to our outlook. Management's target for 30%-35% adjusted EBITDA as a percentage of recurring gross profit in 2026 and 2027 roughly aligns with our estimates of 33% and 38%, respectively, while the longer-term expectation of a 40% or higher margin is consistent with our projections thereafter. Elsewhere, our forecast for 24% growth in recurring gross profit over the next five years meshes well with the company's target of 20% or more annual growth. As such, we don't plan to alter our $23.50 fair value estimate. Following a 7% drop in May 29 trading, we see shares are fairly valued and attribute the decline to unduly lofty investor expectations. We remain optimistic about the restaurant technology leader's prospects, maintaining particular excitement about the firm's efforts to leverage its extensive database of payment and software touchpoints to enhance efficiency for restaurateurs amid a challenging industry environment.

We take a positive view of Toast's strategy, which seeks to capitalize on two major tailwinds in the restaurant industry: the adoption of cloud-deployed point-of-sale systems and the uptake of technology-enabled solutions, with operators looking to improve operating efficiency as industry margins remain tighter than ever. One epiphenomenon of pandemic-induced lockdown restrictions, in our view, is a structural increase in consumer acceptance of digital channels, with restaurants increasingly needing to offer some combination of delivery integration, digital ordering, and rewards programs to meet the evolving needs of today's restaurant consumer. As the market leader in a growing vertical, heavy investments in onboarding new units, building out platform functionality, developing an ecosystem of partner application programming interfaces, or APIs, and filling holes in the platform through targeted roll-up acquisitions strike us as appropriate.

We plan to raise our $19.50 fair value estimate for narrow-moat Toast by a high-teens percentage after the company's first-quarter report, leaving the shares trading in a range we consider fairly valued. While revenue of $1.08 billion was in line with our $1.05 billion projection, the fruits of restructuring far exceeded our expectations. Toast achieved 980 basis points of operating margin improvement to negative 1.4% versus our negative 6% forecast. More importantly, commentary on the call suggested further operating leverage, and with the firm raising its full-year adjusted EBITDA guidance by $50 million at the midpoint, to $250 million-$270 million, we see a clear path to GAAP profitability in 2025 and higher-than-expected equilibrium operating margins.

We take a positive view of Toast's strategy, which seeks to capitalize on two major tailwinds in the restaurant industry: the adoption of cloud-deployed point-of-sale systems and the uptake of technology-enabled solutions, with operators looking to improve operating efficiency as industry margins remain tighter than ever. One epiphenomenon of pandemic-induced lockdown restrictions, in our view, is a structural increase in consumer acceptance of digital channels, with restaurants increasingly needing to offer some combination of delivery integration, digital ordering, and rewards programs to meet the evolving needs of today's restaurant consumer. As the market leader in a growing vertical, heavy investments in onboarding new units, building out platform functionality, developing an ecosystem of partner application programming interfaces, or APIs, and filling holes in the platform through targeted roll-up acquisitions strike us as appropriate.

After digesting narrow-moat Toast's fourth-quarter results, we intend to increase our $19.20 fair value estimate by a mid-single-digit percentage. The firm posted $1 billion in sales and $29 million in adjusted EBITDA, aligning with our sales estimate and comfortably surpassing our $12 million forecast for adjusted EBITDA. We were impressed by both its 7,000 quarterly restaurant additions and a 12% annual increase in software revenue per unit, besting our 6,000 unit and 7% growth estimates, respectively. Partially offsetting this outperformance was guidance for higher-than-anticipated near-term costs, due to severance payments after a 10% workforce reduction, and slower projected growth in average revenue per user, or ARPU, in fiscal 2024 as smaller restaurants and midmarket chains are onboarded. On the latter, we now project just north of 5% growth in ARPU in 2024, down from roughly 8% previously. We view shares as fairly priced.

We take a positive view of Toast's strategy, which seeks to capitalize on two major tailwinds in the restaurant industry: the adoption of cloud-deployed point-of-sale systems and the uptake of technology-enabled solutions, with operators looking to improve operating efficiency as industry margins remain tighter than ever. One epiphenomenon of pandemic-induced lockdown restrictions, in our view, is a structural increase in consumer acceptance of digital channels, with restaurants increasingly needing to offer some combination of delivery integration, digital ordering, and rewards programs to meet the evolving needs of today's restaurant consumer. As the market leader in a growing vertical, heavy investments in onboarding new units, building out platform functionality, developing an ecosystem of partner application programming interfaces, or APIs, and filling holes in the platform through targeted roll-up acquisitions strike us as appropriate.

We see value in narrow-moat Toast’s shares after an 18% decline in Nov. 7 aftermarket trading, although we plan to lower our $21 fair value estimate by a high-single-digit percentage after digesting results. We harbor concerns about the firm’s medium-term sales prospects after net unit adds of 6,500 came in lighter than our 6,900 forecast, and we expect to trim our long-term software average revenue per unit estimates as Toast expands into smaller market segments. Commentary about “gradual” growth in ARPU going forward gave investors heartburn, and while we don’t believe that the firm is approaching the end of its high-growth phase, we do believe it is likely to see more pronounced diminishing marginal returns on new unit additions than originally anticipated. Our revised forecasts see Toast achieving closer to $10,000 in software ARPU in 2032 (down from $13,500), partially offset by an uptick in total units (to 315,000 in 2032 from 290,000) as it increases its footprint among smaller restaurant, enterprise, and international restaurants.

Narrow-moat Toast announced on Sept. 5 that CEO Chris Comparato will step down from both his executive and chairman responsibilities on Jan. 1, 2024, in a detail-light news release. He will be replaced as CEO by Aman Narang, one of Toast's co-founders, who has been extremely hands-on in a suite of cross-functional roles spanning marketing, sales, business development, relationship management, fintech, and operations, per Restaurant Business, and has worked with the company since co-founding it in 2011. Mark Hawkins, the former Salesforce co-CEO and the leading independent member of the board, will step into the chairman role. We don't anticipate making any changes to our Standard capital allocation rating or our $21 fair value estimate in response to the move and view shares as fairly priced.

We take a positive view of Toast's strategy, which seeks to capitalize on two major tailwinds in the restaurant industry: the adoption of cloud-deployed point-of-sale systems and the uptake of technology-enabled solutions, with operators looking to improve operating efficiency as industry margins remain tighter than ever. One epiphenomenon of pandemic-induced lockdown restrictions, in our view, is a structural increase in consumer acceptance of digital channels, with restaurants increasingly needing to offer some combination of delivery integration, digital ordering, and rewards programs to meet the evolving needs of today's restaurant consumer. As the market leader in a growing vertical, heavy investments in onboarding new units, building out platform functionality, developing an ecosystem of partner application programming interfaces, or APIs, and filling holes in the platform through targeted roll-up acquisitions strike us as appropriate.

Narrow-moat Toast’s second-quarter results were strong, with $1.1 billion in sales and $15 million in adjusted EBITDA, ahead of our estimates for $977 million in sales and negative $4 million EBITDA. Sales momentum was fueled by impressive net new location additions (7,500 or 35% annual growth, ahead of our estimate of 6,500), and solid software average revenue per-unit growth of 16%, outpacing our 12% forecast. While we expect to nudge up our year-end estimates for $3.8 billion in sales and negative $15 million in EBITDA to management's guided ranges of $3.81 billion-$3.87 billion and $15 million-$35 million, respectively, we remain less than sanguine about the broader restaurant sector. As evidence, Toast had a slowdown in processed payments per store in the quarter, falling from 9.4% in the prior quarter to just 0.7%, which reflected sweeping declines in customers. As restaurateurs continue to take a surgical look at costs, we expect a deceleration in average software revenue per store, at least until macroeconomic pressures abate. More concretely, we expect to lower our 2024 restaurant-level sales and software revenue per-unit estimates by 8% to $1.2 million and 2% to $5,970, respectively, resulting in an expected mid-single-digit percentage cut to our $22.50 fair value estimate. Shares continue to look fairly priced despite a low-double-digit percentage surge in after-market trading on Aug. 8.

Toast shares were thoroughly singed in intraday trading (down 15%) after the firm announced the rollback of its controversial $0.99 fee on digital orders. The move comes after a widespread outcry by the firm's predominantly small restaurant customer base, with Restaurant Business reporting that the House Committee on Small Businesses was planning to launch its own investigation of the practice. We view the rollback as strategically cogent. While the fee would have added to the firm's top line and its ability to reinvest in its increasingly comprehensive suite of software solutions, it became clear very early on that restaurants felt blindsided by the move, and competitors were already counter-positioning themselves against the leading cloud point-of-sale, or POS, provider's decision. Shares trade in a range we'd consider fairly valued after the correction. We also plan to maintain our Standard Capital Allocation Rating for the company and we note that the move marks the firm's first true strategic misfire since its IPO in September 2021, though one that could likely have been avoided with more careful test marketing.

We take a positive view of Toast's strategy, which seeks to capitalize on two major tailwinds in the restaurant industry: the adoption of cloud-deployed point-of-sale systems and the uptake of technology-enabled solutions, with operators looking to improve operating efficiency as industry margins remain tighter than ever. One epiphenomenon of pandemic-induced lockdown restrictions, in our view, is a structural increase in consumer acceptance of digital channels, with restaurants increasingly needing to offer some combination of delivery integration, online ordering, and rewards programs to meet the evolving needs of today's restaurant consumer. As the market leader in a growing vertical, heavy investments in onboarding new units, building out platform functionality, developing an ecosystem of partner application programming interfaces, or APIs, and filling holes in the platform through targeted roll-up acquisitions strike us as appropriate.

As we balance Toast’s better-than-expected net new location additions (5,500, or 37% annual growth, ahead of our 4,700 estimate) with guidance for slowing growth in average revenue per unit in the software business, we expect to increase our $21.50 fair value estimate by a low-single-digit percentage. While this move is shy of the market’s mid-single-digit rally in afterhours trading, it reflects our already optimistic view of the firm’s near-term growth road map and potential to increase per-unit software revenue above $10,000, a benchmark that Toast says 10% of its restaurants have eclipsed today.

The restaurant industry has proven surprisingly resilient despite stout macroeconomic headwinds, but between normalizing consumer spending patterns, a widening value gap with the grocery channel, and early signs of price sensitivity, we believe that 2023 is shaping up to be challenging. Despite early indications of a strong first quarter, we continue to expect a softer second half of the year, limiting near-term margin recovery as restaurants are reluctant to outprice their core customer. To this effect, traffic and items per check have declined in each of the past 10 months industrywide—through February 2023—and we continue to view exclusively price-driven comparable store sales growth as a tenuous long-term strategy. We sport a carb-heavy value menu in the industry, with wide-moat Domino's and narrow-moat Toast representing our top picks, trading at 16% and 18% discounts to our $397 and $21.50 fair value estimates, respectively.

We believe that prudent adoption of digital ordering, restaurant software, and loyalty programs can yield meaningful benefits for the restaurateurs we cover as well as for astute investors who can identify today's digital leaders. We expect investments in technology to pave the way for food-service establishments to gain share from the grocery channel, settling just north of 55% of U.S. consumer food spending, ahead of our prior 50% estimate, as technology-driven cost savings enable restaurateurs to narrow the value gap with the cheaper grocery channel. The largest chains in our coverage are poised to disproportionately benefit from technology adoption; we forecast their share of total restaurant sales to grow by 200 basis points over the next five years, with wide-moat firms like Chipotle, Starbucks, and Domino's looking particularly well positioned. Investors looking for immediate-term opportunities should consider Domino's and narrow-moat Toast, which trade at roughly 16% and 17% discounts to our $397 and $21.50 intrinsic valuations, though we'd remain eager buyers of leaders like Chipotle and Starbucks at prices below our $1,550 and $103 fair value estimates.

We take a positive view of Toast's strategy, which seeks to capitalize on two major tailwinds in the restaurant industry: the adoption of cloud-deployed point-of-sale systems and the uptake of technology-enabled solutions, with operators looking to improve operating efficiency as industry margins remain tighter than ever. One epiphenomenon of pandemic-induced lockdown restrictions, in our view, is a structural increase in consumer acceptance of digital channels, with restaurants increasingly needing to offer some combination of delivery integration, online ordering, and rewards programs to meet the evolving needs of today’s restaurant consumer.

Toast shares tumbled roughly 20% in intraday trading after the company missed the Street’s profitability estimates for its fourth quarter. Our take on results is less than sanguine—we anticipate lowering our $25.50 fair value estimate by a midteens percentage on soft margin guidance—but it is a bit more optimistic than the market’s reaction, given our already frosty view of the restaurant industry's near-term prospects. We also plan to move our Morningstar Uncertainty Rating to Very High from High, consistent with our quantitative methodology.

We take a positive view of Toast's strategy, which seeks to capitalize on two major tailwinds in the restaurant industry: the adoption of cloud-deployed point-of-sale systems and the uptake of technology-enabled solutions, with operators looking to improve operating efficiency as industry margins remain tighter than ever. One epiphenomenon of pandemic-induced lockdown restrictions, in our view, is a structural increase in consumer acceptance of digital channels, with restaurants increasingly needing to offer some combination of delivery integration, online ordering, and rewards programs to meet the evolving needs of today’s restaurant consumer.

Narrow-moat Toast reported robust third-quarter results, with $753 million in sales and a $19 million adjusted EBITDA loss blowing past the top end of the firm's guided range and our own forecasts, which anticipated $685 million in sales and a $29 million adjusted EBITDA loss. Perhaps more importantly, the firm's success comes against a difficult macroeconomic backdrop, with one of the firm's largest lookalike competitors (Lightspeed Commerce) cutting its quarterly sales guidance and posting a dramatic slowdown in net unit growth during its earnings report on Nov. 3. While Toast's independent and small chain focus would seem to espouse heightened cyclical sensitivity prima facie, we've seen little evidence of such pressure materializing in the form of slower unit growth, uptick in restaurant churn, or difficulties driving adoption of incremental software modules. To the last point, the firm's subscription services revenue grew an astounding 96.5% from the year-ago period, with new restaurants joining the platform at an average revenue per unit, or ARPU, about 40% higher than the consolidated unit base, supporting our long-term expansion thesis. With the firm raising its full-year sales guidance by about 2.5% at the midpoint and marching ever closer to adjusted EBITDA breakeven (we project fourth-quarter adjusted EBITDA margins of just negative 2.2%, a 660 basis point annual improvement), we expect to raise our $24.50 fair value estimate by a mid-single-digit percentage. Shares continue to look modestly undervalued despite a 20% surge on Nov. 10 and aftermarket trading.

We take a positive view of Toast's strategy, which seeks to capitalize on two major tailwinds in the restaurant industry: the adoption of cloud-deployed point-of-sale systems and the uptake of technology-enabled solutions, with operators looking to improve operating efficiency as industry margins remain tighter than ever. One epiphenomenon of pandemic-induced lockdown restrictions, in our view, is a structural increase in consumer acceptance of digital channels, with restaurants increasingly needing to offer some combination of delivery integration, online ordering, and rewards programs to meet the evolving needs of today’s restaurant consumer.