Dave & Busters’s – (PLAY) – The Battle of the Bulls & Bears!

Recent Development: Per Q3’17 Company Release and Conference Call

http://ir.daveandbusters.com/news-releases/news-release-details/dave-busters-announces-third-quarter-results-and-introduces-new

http://public.viavid.com/player/index.php?id=127327

Dave & Buster’s continued to perform well in a difficult restaurant spending environment, no doubt due to the “experiential” nature of their concept. 56.9% of revenues now comes from Amusements, with about 15% from alcoholic beverages, so slightly less than 30% comes from food.

Comparable stores, 75 out of 101 current locations, showed decreased sales of 1.3%, very close to the 1.1% decrease estimated by analysts, and the storms were responsible for 50 bp of that decrease. The EPS result exceeded analysts estimates by $0.03 per share, but the tax was only 28.7% vs. 37.1% YTY. Pretax income was flat YTY. Corporate operating EBITDA margin was flat at 18.2% of revenues, up 9.8% YTY. Store level operating EBITDA margin was down 20 bp, to a still impressive 25.9% of revenues.

Comp stores sales in Amusements increased 1.1% and in Food & Beverage decreased 4.2%, a continuation of recent trends. It is noteworthy that these results were against a strong quarter a year earlier when overall comps were up 5.9%, including Amusements at 10.4%.

Operating costs were well controlled, total cost of sales down 60 bp, F&B costs up 10 bp with 2.3% in food pricing, 0.8% in beverage pricing, slight commodity inflation. Cost of Amusements was down 80 bp. Labor with benefits was 90 bp better, from lower incentive pay, favorable medical claims, and the leverage from higher Amusement sales. It’s worth noting that average hourly wage inflation was 4.4%. Other store operating expenses were up by 170 bp, driven by higher rent and more marketing. As noted above, store level EBITDA margin was down only 20 bp, to 25.9%.

The balance sheet remained strong, with $316M of debt, just over one time TTM EBITDA. In the current YTD $123.4M of stock has been repurchased, at an average price of $58.76. There remains $147 million available under the current authorization.

Guidance for all of ’17 was adjusted slightly to include a decrease of corporate EBITDA growth to “low to mid teens”. This reflects the impact of the three storms, a delayed opening in Puerto Rico, the challenging macro environment, and pre-opening expenses. Since Adjusted EBITDA was up 17.6% for nine months and EBITDA was up 15.7%, that guidance implies Q4 EBITDA somewhere south of 15%. Corporate EBITDA for Q3 was up 10.8% and Adjusted EBITDA was up 12.0%. Comp sales expectations are being guided lower by about a point to “flat to up 0.75%” for all of ’17, and, importantly, management noted that Q4 has started “slower than expected”.  It was noted that this year includes 53 weeks that helps revenues by about $20M and EBITDA by $4M. It’s unclear whether the Q4 guidance has been “adjusted” for the extra week this year.

Relative to longer term expectations, management discussed at some length that increasing competition is affecting sales, in particular from TopGolf and Main Event, both of whom are expanding aggressively. There is also a cannibalization effect as PLAY opens additional stores in existing markets. As management pointed out, these elements were less prevalent even a couple of years ago. Also, analysts expressed some concern that non-comp units seem to be doing less well lately, relative to the existing comp base.  Management responded that some of the recent stores, while categorized as “large” are not at the top of the size range and with the size mix trending lower, the AUVs should be expected to decline as well. In terms of margin contraction to be expected in Q4 (and perhaps beyond), higher rents higher marketing expense, and higher commodity costs are expected to affect results.

Management declined, until early in ’18 (presumably with final fiscal 1/31/18 results) to provide guidance for next year.

Management described at some length its intention to build a smaller format store, sized from 15k to 20k square feet, with the possibility of 20-40 locations, in smaller markets, over the long term. It is expected that this format, with a cash investment of $5M (excluding Tenant Improvement Allowance) would generate $4-5M revenues, with a “steady state” C/C return in the low 20s. Management emphasized that, while the expected ROIC will be attractive, it is expected to be less than the current legacy locations. The first location would open in Rogers, AK in early ’18. This smaller format provides some extra runway for future growth, above the previously stated 200 or so US locations.

The Positives:

• (1) Cash on cash returns are still among the very highest in the restaurant and retail universe.
• (2) There is a very long runway for future growth, which  has been extended by virtue of the smaller format.
• (3) The balance sheet continues to be strong, relatively unleveraged, with substantial cash flow for unit expansion, stock repurchase, and dividends possible as well.
• (4) There is potential improvement in the food element, separately and/or in conjunction with the new smaller format, including a Fast Casual approach to food & beverage.
• (5) A lower corporate tax rate would improve future after tax EPS, though it obviously would not affect EBITDA.

The Negatives:

• (1) Comps have been coming down, narrowing overall, with a continuation movement toward Amusements, now 56.9% of revenues. With less than 30% of sales from food, D&B is more of an amusement park than a restaurant.
• (2) Average Unit Volumes are coming down, at least partially due to the increasing mix of smaller stores.
• 3) Margins at the store level have been coming down modestly, and may not recover due to higher marketing, higher rents, higher commodity prices, and sluggish traffic trends, especially within the food & beverage segment
• 4) Competition, and cannibalization is playing an increasing role in suppressing sales and margins.
• (5) Depreciation, that is the useful life of Amusements,  continues to be an underlying issue. EBITDA is a valid measure of “cash on cash” return at the store level, but it seems to require increasing amounts of original (undepreciated) capital as the years go on.  Noone can be sure of the useful life of Amusements. The Company declares that it is “between five and twenty years”. We discuss this issue at more length in the full Corporate Writeup on our  website (9/14/17) at : https://www.liptonfinancialservices.com/2017/09/dave-busters-entertainment/.  We have not seen this issued addressed in either company documents or analyst discussions. If our concerns are misguided,  we welcome further discussion of this issue by the company or the money management community.