Toast Q4 Results: The Market Got Ahead Of Itself, Then Overreacted

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Toast (NYSE:TOST) investors suffered much than a 22% autumn successful nan stock value aft nan institution reported Q4 results. This is being attributed to nan institution missing EPS expectations and a soft 2023 guidance. While this mightiness beryllium true, we judge nan main logic is simply that nan marketplace had gotten up of itself, pinch TOST banal astatine 1 constituent rising much than 40% twelvemonth to day without bully reason. As such, nan driblet simply brings nan valuation backmost to much reasonable levels. The truth that nan institution did not impressment pinch Q4 results is hardly astonishing fixed nan headwinds successful nan edifice industry. Despite nan headwinds nan institution still managed to present ~50% gross maturation successful nan quarter, which reaffirms our belief that Toast does person important maturation runway, moreover if maturation is decelerating.

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The Opportunity

While Toast's main business is costs processing, we are arsenic excited astir each nan add-on package modules nan institution is offering its customers. As such, nan institution is positioning itself to beryllium nan main package supplier to nan edifice industry. This further package modules see solutions for trading & loyalty, integer ordering & delivery, squad management, and proviso concatenation & accounting. The institution precocious added a caller class pinch nan acquisition of Delphi Display Systems which adds drive-thru capabilities to Toast’s platform. Another important invention announced this 4th is nan integration of nan restaurants' ordering systems pinch Google (GOOG) (GOOGL) and Google Maps.

Customers that acquisition aggregate package modules from nan institution are very improbable to move to a different supplier successful nan early fixed nan tremendous switching costs and consequence to their operations that would represent. That gives Toast a very beardown competitory moat and precocious customer retention rates. It besides explains why nan institution is being truthful fierce trying to seizure arsenic overmuch of nan marketplace arsenic it tin while nan model of opportunity is open. The institution is doing a bully occupation capturing nan opportunity arsenic reflected by nan ~40% y/y summation successful full customer locations successful 2022.The digitization of nan edifice manufacture is presently underway, and erstwhile companies prime a package supplier it will beryllium much difficult to get them to switch.

Toast Inc Investor Presentation

Growth

Looking astatine nan humanities quarterly gross y/y maturation rates, it is clear that maturation has been decelerating for immoderate clip now, and that >100% maturation is astir apt successful nan past. Still, we judge that if nan institution tin prolong a higher than ~30% maturation complaint for respective much years, it should beryllium capable to present bully returns for investors.

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In Q4 gross grew astatine ~50% to $769 million, but importantly, subscription gross and FinTech gross profit grew moreover faster. It is this recurring gross that should yet powerfulness net for nan company, and wherever investors should attraction their attention. The institution reports nan maturation successful recurring gross separately pinch a metric it calls Annualized Recurring Run-Rate. ARR reached $901 cardinal astatine nan extremity of Q4, and represents twelvemonth complete twelvemonth maturation of 59%. This is really very adjacent to nan ~60% y/y maturation successful ARR nan institution delivered successful Q3 and nan ~59% of Q2.

Toast Inc Investor Presentation

Guidance

Toast expects to present ~32% gross maturation for nan afloat twelvemonth 2023, astatine nan midpoint of guidance. It besides guided for separator betterment and to perchance scope adjusted EBITDA profitability by nan extremity of nan year.

For nan first quarter, it expects gross to beryllium successful nan scope of $745 cardinal to $775 million, representing 42% y/y maturation astatine nan midpoint. Adjusted EBITDA is expected to beryllium successful nan scope of antagonistic $30 cardinal to antagonistic $20 million. For afloat twelvemonth 2023, nan institution expects gross to beryllium successful nan scope of $3.57 cardinal to $3.66 billion, which represents 32% y/y maturation astatine nan midpoint. Adjusted EBITDA is expected to beryllium successful nan scope of antagonistic $30 cardinal to antagonistic $10 million.

A very absorbing remark during nan earnings call was that nan institution expects to run supra nan Rule of 40 moreover arsenic nan business grows into its separator profile, and based connected nan tremendous size of nan opportunity they spot ahead. As a reminder, a Rule of 40 institution has a mixed gross maturation complaint and profit separator that adjacent aliases transcend 40%. If we presume a ~10% profit separator for nan company, that would connote that Toast believes it tin prolong >30% gross maturation for respective much years.

Valuation

Valuing high-growth companies that person yet to go profitable is very difficult, but we judge that shares are now trading astatine slightest astatine what tin beryllium described arsenic reasonable levels. In nan astir caller 4th gross profit was $158 million, annualized this would beryllium ~$632 million. With Toast trading pinch a marketplace headdress of ~$10.4 cardinal and an endeavor worth of ~$9.3 billion, nan valuation is astir a 15x aggregate of gross profit. Not needfully cheap, but not unreasonable for a institution delivering beardown maturation for illustration Toast. Another measurement to deliberation astir nan valuation is to comparison nan endeavor worth to nan Annualized Recurring Run-Rate of ~$901 million, wherever we get a ~10x multiple.

Toast Inc Investor Presentation

Perhaps nan champion measurement to deliberation astir nan valuation is to presume nan institution was already operating astatine scale, and what nan net could look for illustration successful that case. The company's target P&L astatine standard is for adjusted EBITDA arsenic a percent of full subscription positive fintech gross profit to scope 30% to 35%. That would connote that if nan institution was already operating astatine scale, and pinch an ARR of ~$901 million, it would person an adjusted EBITDA of ~$300 million. This would consequence successful an EV/Adj. EBITDA of ~30x if nan institution had coming nan separator floor plan it expects to scope astatine scale. While this tin look for illustration a precocious multiple, we person to retrieve that Toast is increasing very rapidly.

Toast Inc Investor Presentation

We judge location is precocious uncertainty to what nan adjacent worth of nan institution should be, arsenic it is very limited connected really nan maturation complaint evolves nan adjacent fewer years. For 2023 nan institution is guiding for ~32% growth, which is simply a important deceleration compared to 2022. The Rule of 40 comments during nan net telephone look to hint that nan institution believes maturation of ~30%+ should beryllium sustainable for astatine slightest respective much years. At slightest nan valuation nary longer appears detached from fundamentals, arsenic tin beryllium seen from nan EV/Revenues aggregate stabilizing astatine much reasonable levels. At nan existent valuation we judge that if nan institution tin present connected nan semipermanent margins target and tin support maturation astatine slightest supra 30% for respective much years, investors could do good pinch nan shares.

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Risks

As a high-growth institution that has yet to scope sustained profitability, Toast remains very risky. It besides faces aggravated title from different costs processing solution providers, including immoderate that are not wholly focused connected nan edifice industry. This attraction connected restaurants gives nan institution a competitory advantage, but besides intends nan institution is exposed to trends that impact nan industry. Still, we judge nan biggest consequence for Toast investor's remains a valuation that reflects high-growth expectations. Should this precocious maturation neglect to materialize, shares could beryllium re-rated overmuch lower.

Conclusion

We would suffice Toast's Q4 results and 2023 guidance arsenic somewhat disappointing, particularly guidance that gross will decelerate to ~32% successful 2023. We believe, however, that nan important stock value diminution aft results was mostly nan consequence of nan marketplace getting up of itself, pinch nan stock value expanding by much than 40% early successful nan twelvemonth for apparently nary bully reason. This stretched nan valuation to a constituent wherever a mini disappointment would consequence successful a important stock value correction. We judge this value correction near shares trading pinch a reasonable valuation, and arsenic specified we are maintaining our 'Buy' rating.

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