Dave & Buster's (NASDAQ:PLAY) shareholders aren't having much fun these days.

The purveyor of games, food, beverages, and sports has consistently posted disappointing results in recent years as comparable sales have fallen and profit growth has stagnated. The stock is down about a third from its 2019 peak.

The company's third-quarter earnings report, which came out after hours on Tuesday, showed those trends continuing. Comparable sales declined 4.1% in the quarter, and earnings per share declined from $0.30 to $0.02. The turnaround that investors have been hoping for does not seem imminent, despite efforts that have included rolling out new virtual reality games, adding new menu items, reformatting its locations, and improving its app.

The entrance to a Dave & Buster's location

Image source: Dave & Buster's.

Where are the customers?

The chart below shows Dave & Buster's comparable sales results over the last nine quarters.

Quarter Comparable Sales Growth
Q3 2017 (1.3%)
Q4 2017 (5.9%)
Q1 2018 (4.9%)
Q2 2018 (1.8%)
Q3 2018 (1.3%)
Q4 2018 2.9%
Q1 2019 (0.3%)
Q2 2019 (2.9%)
Q3 2019 (4.1%)

Source: Dave & Buster's.

As you can see from the numbers, comparable sales at the "eatertainment" chain have declined in eight of the last nine quarters. Equally troubling is the recent trend. After a period of more than a year when the metric was steadily improving, not only are same-store sales falling again, but the rate of decline has accelerated for three straight quarters. On a two-year comparable sales basis, the most recent quarter was the company's worst as a publicly traded company with comps falling 5.4%.

It's not clear what's caused this downturn in comparable sales. In the two and a half years that followed its late 2014 IPO, Dave & Buster's comps routinely jumped by mid-single digits or better and the stock surged. On recent earnings calls, management has blamed the company's troubles on competition, though there are no other chains that offer its combination of games and restaurant fare on a national scale. Still, it is competing for customers with both casual dining chains and conventional entertainment options like movie theaters and bowling alleys. 

Other factors outside of the company's control may also be weighing on it. Casual dining sales have been declining more broadly;  the rise of third-party delivery apps is keeping more diners at home; and "Fortnite" may have been occupying some potential Dave & Buster's customers' free time, too. The popular (and free) battle royale video game launched in July 2017, which is right around the time when the company's comparable sales turned south. 

Still, after two years of declining comps, it's a bad sign that the company hasn't found a way to turn things around.

Time to focus on the base

One part of Dave & Buster's strategy that hasn't changed in recent years is its focus on adding new stores. Over the last two years, the company has opened 33 new locations, growing its total by nearly a third to 134, and management says it sees room in the North American market for as many as 250.

Despite those ambitious expansion plans, the business isn't performing like a growth stock, and customers are sending the company a message by not visiting as often, essentially saying they need better reasons to come back to D&B. Expanding the chain so aggressively while comparable sales are falling is a recipe for problems down the road at its new stores as well, as the company needs to invest in the brand and its existing store base. However, management insists that its newer locations have been performing well.

Increasing sales at previously open locations is always more profitable than opening new stores to grow sales, especially for a business like Dave & Buster's, where the incremental cost to it of a customer playing one of its games is almost nothing.

Over the first three quarters of 2019, revenue was $1.01 billion, an increase of 20.7% compared to the same period two years ago, but net income fell 11.8% to $75.3 million. That is clearly a problem, and one that opening new stores can't fix. Despite the falling profits, earnings per share have actually risen due to aggressive stock buybacks, but that isn't a solution to the declining comparable-sales problem either.

The company would be wise to learn from peers like Chipotle Mexican Grill and BJ's Restaurants, both of which scaled back the pace at which they were opening new stores when their comparable sales swooned, and both of which successfully returned to comps growth. Opening new restaurants, after all, requires human resources and financial capital, which can reduce the resources available to be dedicated to other priorities -- such as finding ways to drive traffic to a chain's already-open locations.

On the most recent earnings call, management said the company would open fewer stores next year than it did this year, though it didn't say how many. That's a step in the right direction. Slowing down its expansion pace will help management get its focus back on its existing restaurant base, and on figuring out how to draw more customers in, whether that's through new games, new menu items, better marketing, or better customer service.

Dave & Buster's shares are trading at a P/E of 13, which looks cheap, especially if you believe the company can double its store base and return to growth. The upside potential for the stock is clearly there, but investors shouldn't expect to see the share price trending in the right direction again until (and unless) the company gets its comparable sales growing.