Dave & Buster's Stock Hits New All-Time Highs, but It's Not All Fun and Games

In this Market Foolery segment, Chris Hill and Jason Moser discuss the impressive quarter at this restaurant, bar, and amusement destination. The company is delivering consistent same-store sales growth despite weakness in the sector, but there are still some important questions about its short-term strategy and long-term outlook.

A full transcript follows the video.

This video was recorded on June 7, 2017.

Chris Hill: Dave & Buster's (PLAY 0.13%) is hitting a new high after first-quarter profits came in higher than expected.

Their same-store sales were a little over 2%. That was lower than analysts were looking for. I get that, but I look at this environment, I look at the restaurant space, and I think the stronger headline is, Dave & Buster's had positive comps.

Jason Moser: Yes. You can't argue with that. It was 2.2% comps in the face of a restaurant industry right now that is having a difficult time figuring out what direction it needs to head. Again, we go back to what we were talking about with InvenSense and Ambarella, I think that on the surface, Dave and Buster's had a nice quarter here. Most of that growth on the top line came from opening new stores, though, even though they had positive comps. Really, most of that growth came from new stores. When we look at Dave and Buster's today, they have about 100 stores, and they see their opportunity in North America, the U.S. and Canada, as about 200 stores. So, they're basically halfway there.

We're watching something play out here already with Buffalo Wild Wings. Sally Smith leaving notwithstanding, before that news came out, we knew that Buffalo Wild Wings was starting to hit a little bit of a ceiling there as far as growth goes. So, identifying what is it that's separated Buffalo Wild Wings for so long? And it wasn't the food, it was the experience. It was the fact that you could go into one of those restaurants and there were going to be 60 TVs and they were showing you virtually any game you wanted to see. I would make the argument, and I've never been to Dave & Buster's, but I don't think what separates them is the food. I think it's pretty replicable. What separates them is the experience. That's why we see 55% or so of their revenue coming from the Amusements side of that business. So it's an experience-based story. And I think what you have to look at here is, based on the market opportunity, how many stores they had to open, it's maybe 100 more. Perhaps that's a little bit of an overestimation, too. I think a lot of times these companies overestimate the actual market opportunity. They're going to open probably 10 stores a year, so it's going to take them 8 to 10 years to get there, if that prediction is actually correct.

Again, when you look at what separates them, just being the experience, and given all of the dollars that are out there competing for our attention today in the entertainment space, I don't know that I look at Dave & Buster's as necessarily the most attractive opportunity to go for. I appreciate that they've done well to this point. But again, with investing, we're looking forward. And you have to be thinking five years down the line, what does this company look like? Five years down the line, they probably have 150 stores, maybe a little bit less or a little bit more. But I don't know necessarily that at that point in time the market is going to be looking at this and saying, yeah, this is just a revolutionary company that is changing the face -- I mean, restaurants are a very difficult business, especially to really gain a tremendously loyal following. So need experience, I think they're doing a lot of good things to get the business where it is today. I look at what they're doing right now with repurchasing shares, and I have to push back on them a little. I hate to see a company this young in its public life buying back as much stock as they're buying back.

Hill: I was surprised by that, too. And it's not like they're buying a ton of stock, but just the fact that they're buying any, and as you said, as young a company as it is, I saw that in the release and I was like, wait, why are they spending $1 repurchasing stock?

Moser: I don't know. I think sometimes these young management teams think that it creates a shareholder-friendly headline. People generally look at that and their first take is like, "Oh, they're buying back shares, it must be a compelling value. Shareholder friendly management team there." We've seen, there's all sorts of proof out there that, for the most part, management teams tend to get share buybacks wrong. And it's very clear, these guys are buying back shares of the stock at an all-time high, they have net debt on the balance sheet, and they still have a lot of growth that they need to fund. I just don't think it's a good decision. I don't like seeing it. So for me, that's almost the nail in the coffin. I feel like, if I'm going to invest in a restaurant, this isn't going to be the first one I touch.

Hill: And as we often say, if you're buying back stock, sometimes that's an indication that you don't have a better idea of what to do with that money. And when you look at the debt and the opportunity in terms of opening stores -- and I'm not even suggesting that Dave & Buster's should be looking to ramp up in a significant way the speed with which they are opening new locations. But just sock that away. Even if you just put it toward paying off a little bit of that debt. Now, on the flip side, give them credit for their margins, because they grew their margins. And yeah, 55% is coming from the Amusements side. They also sell alcohol. And that's always high margin.

Moser: Yeah, I think you're right there. 

Hill: Unless you're doing it wrong. If you're selling alcohol and you're not doing it in a high-margin way, you're doing it wrong.

Moser: They are doing a lot of things right. And they do have a good loyalty program that I think brings back customers. Again, though, it's a business that requires a lot of capital, because they have to stock those restaurants with all sorts of games and entertainment devices and whatnot. So they're not cheap to open. And like you said, I think at this point in the game, there's got to be something more you can do with that money than just buying back stock at all-time highs. And then you look at the balance sheet and you actually look at the share count outstanding, it's going up, not down. So all things considered, if we look at comparable there with Chipotle, when we're talking about buying back shares, we put Chipotle through the wringer here over the last 18 months, and they deserved it. They screwed up big time. And it took them a little while to actually come to grips with it and communicate it well. But all throughout that, they did a really good job of buying back that stock at seriously depressed levels. So in hindsight, when we look at what Chipotle did in buying back a lot of their shares, assuming this recovery continues and there are no more health scares, that would be considered a very shrewd use of capital. Also, when you consider, they have a stacked-with-cash balance sheet with no real debt to speak of. So those are the two ends of the spectrum there. Chipotle is certainly a much more mature company, whereas Dave & Buster's is not. Yeah, like you said, I think there's probably a better use for that capital.