Why Dave & Buster's Miss by a Penny on Profits Got a Big Reaction

After five years during which restaurant and entertainment chain Dave & Buster's (PLAY -0.63%) consistently beat expectations, the company missed in the first quarter. The analysts' consensus was for adjusted EPS of $1.14, and it delivered $1.13. In response, investors pounded on the sell button like they were zapping aliens in an arcade game, and shares fell more than 20%.

In this segment of the MarketFoolery podcast, host Chris Hill and senior analyst Seth Jayson discuss the underlying issues for the business, the guidance cut, its flattish growth and shrinking margins, and its exposure to the risk of a recession. They also look at its expansion opportunities, and weigh whether, at a two-and-a-half-year low, the stock has entered "value" territory.

To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. A full transcript follows the video.

This video was recorded on June 12, 2019.

Chris Hill: Let's start with Dave & Buster's, though. First-quarter profits came in lower than expected. That's actually the first time in five years that's happened for them. Shares of Dave & Buster's are down more than 20% this morning. I know they lowered guidance. How much did they lower it? I mean, they didn't miss by some enormous amount.

Seth Jayson: It wasn't much. Full-year guidance, they missed by a penny or something. But people are freaking out. I think once you've set up the expectation that you're going to do better than people expect all the time, then the minute you don't, all heck breaks loose. I own a stock that's done 50% or something. It's a very clever tech company. If you really want to know how to lose money, come to me. 20% in a day, a week? Nothing!

Dave & Buster's is one of those businesses to me where it seems odd it still exists. You have so much restaurant competition. You want game and food? How is everybody not at home getting DoorDash food delivered while they play Apex Legends on their Xbox?

Hill: Can I answer that? You don't always want six of your friends coming over to do that. Sometimes you just want to get out of the house.

Jayson: I suppose. The comp, slightly negative to flat, suggests that people aren't all that excited, at least in the last quarter or so. They've been getting a little growth over the years by opening new locations. The margins have been kind of creeping downward for several years now. This is not my idea of a super awesome opportunity. Free cash flow isn't really there. Unfortunately, sitting there at a price to earnings ratio of 17, sounds like a bargain today, but I think it might need to be more of a bargain before it's a real deal.

Hill: I'm glad you mentioned the comps. That was one of the things that leapt out at me when I was looking at this quarter -- their comps really aren't that great. For those who are new to this podcast or new to investing, when we talk about comps, same-store sales, by definition, those are locations that have been open for at least a year. The new locations, this is one of those things that's maybe not a red flag, but maybe it's a pink flag, not just for Dave & Buster's, but for any, whether it's a grocery store, just a basic retail operation, or in this case, Dave & Buster's. It is a little bit of a pink flag where you go, "Wait." The new locations, there's the initial excitement, Dave & Buster's has opened up in your town or your city or whatever. It's like, "Oh, let's go there!" But if they can't sustain those people -- I'm wondering how much of the gross margins creeping down has to do with an increased marketing spend? Because it does seem like they are doing a lot of promotional stuff.

Jayson: All the margins are on the way down. Their food prices were going up for a while and then we had labor and other costs going up. A lot of restaurants are experiencing that. Some of it's just plain old competition. You have to match prices in some way or another way to bring people in the door. One of the challenges I would guess exists for Dave & Buster's is, it's a super small location without much stuff in it, right? I mean, no, it's not. It's a place where you play stuff. It's not like cranking out another one of those Chipotles with the wrought-iron furniture made out of black pipe from the plumbing store. It probably costs a little more money to build these locations. If they're not paying back so quickly, your financials start to head the other way.

Hill: I think on the plus side, over the next couple of years, Dave & Buster's, to the extent that they're looking to open up new locations, will probably have more options as commercial real estate continues to face some challenges. On the flip side, whenever the conversation turns to, "Well, we think a recession is coming in the next year or two," when I think about stocks that are recession-proof, Dave & Buster's is at the other end of the spectrum. This is a business that's done well for a bunch of years, but it seems like one of the ultimate discretionary-income stocks.

Jayson: Yeah. I guess we'll find out someday, although predicting recessions has been a bad business to be in for a little while.

Hill: [laughs] Yes, it has. So, the fact that the stock is at a 2.5-year low, you're not looking at this saying, "Yeah, buy on this dip"?

Jayson: No. I have a long history with "value stocks" like this that continue becoming more and more of a value but less and less of a value, if you know what I mean.