Dave & Buster’s (PLAY) –  reports Q4 and full ’18 – IMPORTANT OVERVIEW !!

Dave & Buster’s (PLAY) reported their fourth quarter and full calendar ’18, ending 2/3/19.

I should preface the following remarks with the fact neither I nor my affiliates are currently long or short PLAY at the current time, which of course could change at any time.

Rather than rehash the quarter line by line, and make projections that are largely guided by management, we try here (as usual) to provide what we call an unfiltered commentary, in the hope of providing insights that other analysts and money managers hesitate to provide.

The results were slightly better than analysts expected so the stock has rallied several points in a market that is seemingly unforgiving and/or representing a “relief rally”. In a nutshell, comps firmed up a bit in Q4 but operating results were still down for the quarter and the year. Management reiterates that new stores are doing well, the runway for growth is still long, the new virtual reality platforms are promising, and improvements are coming for both Food & Beverages as well as Amusements. Management guidance for calendar ’19 is for results down modestly in terms of pretax income, EBITDA, post tax earnings down somewhat  more because of a higher tax rate.

We take a longer term view. This management team, led by previous CEO, Stephen King, who stepped up to Chairman in August, did a fine job of refurbishing the brand prior to bringing D&B public again in late 2014. It is important to note that hundreds of millions of dollars were spent in that effort, and it would have been disappointing indeed if operating results had not improved dramatically for at least a few years.

We have pointed out in our previous commentary that the return on the incremental investment is shrinking, just as it did when D&B was publicly held the last time. We update that discussion with the following table, which starkly shows this trend.

You can see that capex was $162M in calendar 2015, and the operating results were still ramping up, to the new “plateau” of $143M in pretax income in calendar 2016.

After that improvement demonstrated by calendar 2016 results as a result of previous spending: ($181M was spent in 2016(but we assume couldn’t have affected  the $143M of Pretax Income by much), on top of $181M in 2016, an additional 219M was spent in 2017, $216M in 2018 (a total of $616M), and pretax income is projected to be the same in 2019 ($135-150M) as 2016 ($143M).

In essence: after the ramping of results through calendar 2016, presumably as a result of the last re-invention , ($181M in 2016, 219M in 2017, and $216M, a total of $616M) will have been spent, Pretax Income will have been essentially flat, and EBITDA will be up about 30M. That’s zero current return on a pretax income basis, only about 5% on an EBITDA basis, and (we have to say again) depreciation is not free cash flow.

Management could counter that three years is not the end of the story, and there is no doubt a “tail” in terms of return on upfront investment. On the other hand, it is pretty clear that continual refurbishment of this concept is a requirement. It’s also a major feature of this story that new locations have a huge first year return. That is no doubt true, but that would mean that new stores are providing a very large part of the total results, and older stores are falling off sharply. If there is a first year return of over 50% on new stores, that would be something like $100M on the last 15-16 stores, $200M on the other 110.

In any case, if earnings at PLAY are going to continue to grow, at say 10-20% annually, more new stores have to open, materially more than the 10-12% budgeted (some of them with a smaller footprint), to offset the declining contribution from the growing base of mature stores where contribution is declining.

While most analysts may not want to talk about this strategic reality, it’s possible that PLAY’s price performance, essentially flat for the last two years, is reflecting the above discussion. At only 18x projected earnings and about 8.5x last twelve months EBITDA, the stock might seem attractive when the first year cash on cash returns for new stores  are over 50%. However, the longer term view indicates that it will be increasingly difficult to build upon the current results, especially in a retail environment that is generally unforgiving.

For more information, readers can access our full previous writeups using the “Search” function on our home page.

Roger Lipton