Dave & Buster's (Play) Reports Q2—Stock Up 7%—How Is Big Bet (Virtual Reality) Doing?
Roger is an investment professional with decades of experience specializing in chain restaurants and retailers, as well as macro-economic monetary developments. He turns his background, as restaurant operator and board member of growing brands, into strategic counsel for operators and perspective for investors.
An archive of his past articles can be found at RogerLipton.com.
Dave & Buster's Entertainment reported their second quarter results last Thursday and the stock responded positively, up 7-8% on the slight sales "beat," the more material EPS beat, and positive company commentary regarding results of the new Virtual Reality platform.
Conclusion: The upward move in PLAY stock was mostly a function of "beating" expectations for comps and EPS, which have been coming down in the last six months, and a short position among traders who are inclined to panic. Forward guidance was raised by the company, but the amounts were modest, and there were reductions in certain negative expectations, rather than inspiring confidence that traffic and margin trends will turn positive any time soon.
On the positive side, initiation of a dividend, providing a yield of about 1%, and continued stock buybacks are positive factors. However, management has distinguished itself by its unwillingness to hold shares outright, promptly selling shares acquired by way of options. On balance, we view PLAY stock as "fairly priced," with a still strong operating model generating impressive levels of store level EBITDA. This apparent attractiveness, however, is offset by the risk element of the "fashion driven" amusement segment that is the main driver of profitability and cash flow.
The most pertinent details of the Q2 report are as follows:
Comp store sales were down 2.4% (estimates were for down 2.7%), on top of a 1.1% increase in 2017. Adjusted earnings per share were $0.84 vs. $0.59 a year earlier and $0.67 which was the latest analyst estimate. Adjusted corporate EBITDA was up 7.4% on a comp week basis, excluding a litigation settlement in 2017. The comp store decline was driven by 2.6% decrease in walk-in sales, 0.1% increase in special events, negative 1.2% in Amusements and Other, and negative 4.1% in Food & Beverage. Since there were price increases of 1.1% in beverages and 1.9% in food, traffic in F&B was negative by 5.5-6.0%. On a line by line basis: Total cost of sales was 10 basis points higher in Q2, reflecting a decline in both F&B and Amusement margins, but helped by the higher percentage of the more profitable Amusement sector. Amusements and Other comprised 59.2% of total revenues up 150 basis points YTY, continuing the long-term trend toward becoming an Amusement Park rather than a Restaurant. F&B costs were 40 basis points higher, Cost of Amusement and Other was 30 basis points higher. Payroll and Benefits was 10 basis points higher, at 23.1%, due to "deleverage in comp stores, the unfavorable impact of about a 4% wage inflation and incremental payroll supporting the Virtual Reality launch." This was partially offset by year-to-year improvements in the non-comp store set. Other store operating expenses were up 40 basis points, due to higher occupancy costs at non-comp stores, slightly higher marketing expenses that include tests in the digital media space. Management pointed out on the conference call, explaining the slightly higher labor component that "newer stores tend to be less efficient from a labor perspective relative to mature stores." We have to interject here that this has been the case for many years now, and the number of stores opening (versus the mature base) is not rising. We conclude that new stores are therefore costing more per store in opening "inefficiencies," probably including heavier marketing. Indeed, the strong performance of the newest stores, as described by management, has been a positive recent feature of this situation, and overall, that's a good thing. Overall store level EBITDA was down 60 basis points year-to-year, resulting in a still very impressive 29.8%.
Wrapping up the P&L discussion of Q2, it seems to us that the fundamentals were "acceptable," modest sequential improvement, most impressive because of the estimate "beat." In essence, actual results beat expectations for relatively flat operating income.
Of course, the introduction of the new Virtual Reality platform, the reception of the ride/game, and the general effect on the overall business were very much on everyone's mind. On the conference call, management indicated "guest response has been strong and bodes well for future game releases on this platform." Just as we and some other observers had predicted, the Jurassic Park based Virtual Reality ride/game only seemed to help by a point or so (two at the most), and if guests stayed longer, came more frequently, or spent more, neither the Amusement or F&B comps demonstrated it. We stand by our discussions over the last six months, to which we have linked below, that Virtual Reality is unlikely to be a "game changer" and materially change the lackluster trajectory of comp sales. The company confirmed what we pointed out months ago, that there is a labor content to this ride/game/platform because the attraction must be attended to with at least one crew person. The profitability of this offering may or may not enhance overall margins, because higher margin activities would be taking place in the same space, and it may take more than a point or two of incremental sales to offset the higher labor component. The Jurassic Park Virtual Reality experience was introduced midway through Q2, and Q2 showed higher labor expense. Our observation, about which we have written before, is that the VR platform is one of the quieter places in the facility. Even when occupied by "riders," there is very little "energy" in the immediate vicinity, compared to almost all of the rest of the Amusement area. We also question the notion as suggested by management that the ride doesn't have to be attended to at all times. Our observation is that most of the time, the ride/game has to be "sold" by a well-trained attendant. The attendant (or two) that manage this platform, has to be personable, attentive, and diligent in efficiently loading and unloading riders, as well as cleaning the viewing goggles and seats.
Also on the conference call, an intensified focus on the F&B side of the business was described, including a fast casual taco concept that will be installed at a Dallas location this fall. It makes sense to us that many PLAY customers don't want to sit down for a full-fledged meal, but could respond to a taco offering "on the run." It's possible that a "food court" of sorts could replace at least part of the current "Bar & Grill" area, and success with this experiment would be a major positive development.
Other than the above, it is more or less "business as usual" opening stores as planned, the latest class of stores doing well, more Virtual Reality games (and others) to come, more effective promotions and better training. No details were provided as far as the cost of developing Virtual Reality or other games, the incremental traffic necessary to justify that expense, or the expected lifespan of these offerings. Clearly, though, as we have described before, PLAY is more of an Amusement Park than a Restaurant. With Amusements & Other at almost 60% of total sales, and Alcoholic Beverages about a third of the remaining 40%, only 26-27% is from food. Since a great deal of capital (the amount not disclosed) is being spent on "proprietary" game content, PLAY becomes dependent on the ability to correctly predict gaming trends, an order of magnitude more risky, than most restaurant/retail operations we can think of.