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Roughly 100,000 Restaurants Use Toast's Technology, but Investors Might Be Surprised by How Many Restaurants Still Don't -- and Why That's a Good Thing.

In 2011, three friends founded Toast (NYSE: TOST) in the hopes of modernizing the restaurant industry with cloud-based, scalable technology solutions. In 2015, roughly 1,000 restaurants were using the company's products. But as of the third quarter of 2023, 99,000 restaurant locations were using Toast -- nearly a 100x increase in just eight years.

This level of growth is a testament to what Toast has built. It's not the only company working in the space, but its ability to attract new customers (6,500 net new locations in Q3 alone) clearly suggests its products are compelling.

However, there is a very real cost to Toast's growth. New customers tend to purchase the company's hardware when joining. Through the first three quarters of 2023, Toast has generated $106 million in hardware revenue. Unfortunately, its cost of revenue for hardware was $181 million, leaving it with a $75 million gross loss for this segment.

There's more: Toast had year-to-date sales and marketing expenses of $299 million. This line item alone accounts for nearly 36% of its total operating expenses.

Hardware sales lose money for Toast. And it costs a lot in sales and marketing to grow its business. Its growth may be fantastic considering it has added about 20,000 net new restaurant locations in 2023. However, given the high costs associated with this growth, it shouldn't surprise anyone it had a year-to-date net loss of $210 million and a trailing-12-month net loss of $310 million.

TOST Revenue (TTM) Chart
TOST Revenue (TTM) Chart

If this was the entirety of Toast's story, it would be pretty depressing, but there's far more reason to be optimistic about the long term.

How much bigger can Toast get?

With nearly 100,000 locations using its products already, Toast is a big company. But it's nowhere close to cornering the market. According to management, the company only has 10% market share in the U.S., and it's still virtually unknown in international markets.

In short, Toast could become much, much bigger.

Though Toast's growth will be expensive, there's more to the story. Once the company gets past the expensive process of attracting a new customer to the platform, it starts generating higher-margin recurring revenue.

The highest-margin revenue stream for Toast comes from its subscription software services. This was a $131 million business in Q3, up an impressive 46% year over year. This segment accounted for nearly 13% of total revenue and had a gross margin of 67%.

Overall, Toast now has annual recurring revenue of $1.2 billion, which was up 40% in Q3 from the prior-year period. That's quite an impressive feat and an equally impressive growth rate.

What does it mean for investors?

Investors who focus solely on profits right now will struggle to see any value in Toast stock. While its growth rate is high, the business model inherently has elevated expenses related to hardware and sales and marketing.

Moreover, Toast may not see compelling profitability for a long time because it still has a long growth runway. Fortunately, it has over $500 million in cash and equivalents without any long-term debt. But those ongoing losses might not appeal to all investors.

That said, at some point, Toast's growth will slow. When that finally happens, the company's high-margin recurring revenue streams will get their chance to shine, and its financial profile will likely look quite different, in a good way.

Of course, I don't want to overpromise here: Many publicly-traded companies have had the potential for high profits in the past. However, some fail to live up to their potential when the moment finally arrives. That could wind up being the case with Toast.

However, this risk is mitigated by holding Toast stock in a well-diversified portfolio. I believe it's a stock worth buying -- shares are likely to rise along with cash flow. But by holding it in a balanced portfolio, investors won't be burned too bad if the bull case fails to play out.

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Jon Quast has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Toast. The Motley Fool has a disclosure policy.

Roughly 100,000 Restaurants Use Toast's Technology, but Investors Might Be Surprised by How Many Restaurants Still Don't -- and Why That's a Good Thing. was originally published by The Motley Fool