When Toast (TOST 3.19%) went public in September 2021, the bulls believed it would revolutionize the restaurant industry in the same way that Shopify (SHOP 4.14%) simplified the e-commerce market for smaller merchants. That's why Toast's stock initially rallied from its IPO price of $40 to an all-time high of $65.22 in November 2022.
But today, Toast's stock trades at about $16. The bulls retreated as its growth slowed down, it racked up steep losses, and rising interest rates compressed its valuation. Could Toast still recover over the long run and become the next Shopify?
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An all-in-one solution for restaurants
Toast serves restaurants with point-of-sale (POS) payment systems, guest-facing and kitchen displays, and a cloud-based platform for managing payrolls, loyalty plans, online orders, and reservations. That all-in-one solution makes it an easy way for restaurants to digitally transform their businesses and lock in their customers.
Toast's platform was installed in nearly 100,000 locations at the end of the third quarter of 2023, which was more than double its 48,000 locations at the time of its IPO. It generates most of its revenue from its POS payment processing fees.
Toast's platform can actually be integrated with Shopify, which enables restaurants to quickly set up their own websites, online marketplaces, and marketing campaigns. However, Shopify also provides its own competing POS platform that can be installed in restaurants and other brick-and-mortar businesses. Moreover, Toast still faces stiff competition from Block, which launched its Square for Restaurants platform in 2018; as well as PayPal and Adyen, which can both integrate their digital payment services into a restaurant's existing POS systems.
NYSE: TOST
Key Data Points
How much larger can Toast grow?
Toast's revenue rose 24% in 2020, even as many restaurants closed down during the pandemic, and it soared 107% in 2021 as they reopened. Its revenue jumped another 61% in 2022, and it expects 40%-41% growth to $3.83 billion-$3.86 billion in 2023.
Analysts expect Toast's revenue to rise at a compound annual growth rate (CAGR) of 30% from 2022 to 2025 to reach $5.95 billion. By comparison, analysts forecast Shopify's sales to increase at CAGR of 21% from 2022 to 2025 and reach $10.03 billion.
Toast is growing faster than Shopify, but it still isn't profitable because it continues to rely heavily on payment processing fees. Card networks and other payment processors take a hefty cut of those fees, which doesn't leave Toast with enough money to support the expansion of its cloud-based ecosystem. The competitive pressure could also prevent Toast from raising its fees to offset those expenses. That's why analysts expect the company to remain unprofitable on a generally accepted accounting principles (GAAP) basis for the foreseeable future.
Shopify generates a lower percentage of its revenue from payment processing fees, and it sells a broader range of stand-alone merchant services and subscription plans. That diversification, along with its decision to divest its low-margin logistics business last year, should enable it to return to profitability in 2024 and beyond.
Will economies of scale kick in?
During Toast's latest conference call last November, CFO Aman Narang said that "with just over 10% for the U.S. market" on its platform, it still had "significant runway ahead." However, its long-term growth will depend on its ability to stay ahead of the competition and scale up its higher-margin subscription business, which only accounted for 13% of its sales in the first nine months of 2023. Shopify generated 27% of its revenue from its subscription-based services during the same period.
Toast's dependence on the restaurant industry could also expose it to tougher macro headwinds than Shopify, which provides e-commerce services to a wider range of small merchants. For example, the pandemic generated headwinds for Toast's restaurants but generated significant tailwinds for Shopify's e-commerce merchants. Inflation is also squeezing restaurants' margins with higher food and labor costs, but it's also driving consumers to seek out more bargains while shopping online.
Therefore, it could be challenging for Toast to scale up its business enough to dilute its costs -- especially when most of the competing products are tethered to larger digital payment platform providers that can afford to operate their POS and cloud services at lower margins. Toast might have gained a toehold in the evolving market for restaurant software, but it still hasn't firmly established an early-mover advantage in the same way Shopify carved out its e-commerce niche.
Toast probably won't become the next Shopify
Toast might initially look cheap at just 2 times next year's sales, especially when Shopify trades at 12 times next year's sales. However, that massive gap suggests that most investors simply don't think Toast will become the next Shopify. Both of these companies are digital transformation plays, but Toast still needs to break out of its niche without breaking the bank.
