Dave & Buster's (PLAY) reported strong revenue growth in the third quarter, but it came at far too high a price. This has been a trend through the year; as PLAY has been forced to put more and more effort (i.e. cash) into driving its sales higher. This is damaging operating income in a way that can't be overlooked. Investors should take caution of this, and take particular notice that record revenue means nothing if you're not inducing expanded profits from it. There are also addressable issues with the way Dave & Buster's is creating that higher revenue, which I will address later.
We've admittedly seen a huge recovery from 2014 where the company was making a brutally small $2.17 million a year in net income and $7.64 million in 2015. That's a meager amount of money when you consider the company brought in $746 million that year. PLAY has also succeeded in driving annual revenue growth in the double digits consistently. The same cannot be said for annual operating income and net income. The stock needs earnings to really justify itself, and I'm not seeing it.
The imbalance of growth
In the third quarter, revenues grew 12.9% to a record $282.1 million. That's great. Who doesn't love revenue growth? When you look deeper into that revenue growth, it doesn't seem as promising. Comparable store sales were reported as increasing sequentially, but actually declined 1.3% year over year in the third quarter. The sales growth instead stemmed from new store openings that created sales great enough to cancel out the decline in same store sales. I personally don't care for revenue growth that requires new locations to help prop up failing old ones. It's a natural thing in certain instances, but the trend doesn't bode well for Dave & Buster's over the long term. Bare minimum, we need to see year over year comp sales remain flat. Well, at least I do.
Pieces of the business that keep suffering include weaker walk-in sales and lower event sales. They also had a 5% hit in food and beverage. That's a problem. Non-comp store sales were what really shined, with a $43.1 million increase year over year (or 135.5%) to $75 million in new revenue growth. So basically the new stores opened this year are the ones gaining the traction. For the year, PLAY is expecting to open 15 stores representing a 14% increase in unit growth.
The tactic might work for now, but I don't like the long-term implications. If comp stores continue to fall, eventually you'll see a problem where overall revenue growth potential becomes limited by the fallout in their older locations. You can already see the weakness in the rest of the income statement. Higher operating expenses, including pre-opening costs, resulted in a 22% decrease in operating income year over year. You can absolutely point to the $4.74 million in pre-opening costs and consider the fact that operating income would have grown ever so slightly to a little over $20.2 million without those costs. Alas, that's not the case. The company is spending money to push these store openings -- all the while failing to stem off the declining comp store sales. Interest expenses are up 54% to $3.32 million, which put an added damper on lower income taxes. Net income decreased 2.4% to $11.86 million. Thanks to share buybacks (a move that I disagree with) diluted earnings increased $0.01 to $0.30 per share. The decreased share count and its subsequent (though small) effect on diluted earnings make the whole thing unimpressive to me. In my eyes, the company accomplished very little in the third quarter.
Through the first three quarters of the year, revenues are up over 9% to $388.8 million. Through that same time frame, operating income is down 2.6% to $120 million. Again, there are pre-opening costs at play, but the company's full year guidance has comparable store sales in a single digit decline. So the only thing driving the company's business remains the new store openings. Net income for the full year is expected to be $106 to $113 million. Going off the high end of that, Dave & Buster's will see net income fall 6.57% vs. last year's $120.95 million. When looking at a stock as an investment, I have a real problem with that.
The saving grace will be the company's continued share buybacks, which means the company will keep spending (and probably borrow) money, but that doesn't change the fact that we don't see a super strong growth story here. What we see is a company compensating for weaker comp sales by pushing into new markets. It's a natural progression, but it's a progression that ends with new stores eventually getting cannibalized when the failing stores are closed down. A 1.3% decrease in comp sales doesn't mean we're about to see a ton of store closures, but it does mean the growth story is complicated -- and the growth story is what will drive the stock price.
Current year estimates of $2.79 per share would mean the stock is currently trading around 17 times full year earnings. At this point in the economic cycle, I'm just don't see the appeal of that price. Six months ago this stock was running at $65 a share. That's expensive. I could easily see more downside ahead as there isn't a very clear picture for the company's ability to fix this comp sales trend. Furthermore, Dave & Buster's definitely seems like the type of business that would suffer from any economic slowdowns. If push comes to shove, you're not going to spend money on games at D&B. Long story short, this one continues to not impress me.