Restaurant, sports bar, and arcade chain Dave & Buster's Entertainment (NASDAQ:PLAY) is having another forgettable year. Though the company continues to expand, shares are down 30% over the past two years, underperforming both the broad market and restaurant industry by a fair margin. Ouch. 

What was in the recent past just a menu problem has turned into something much bigger. The list of entertainment options keeps getting longer, and the arcade half of the business is finding it difficult to differentiate itself -- though it's still the better-performing segment. The stock appears cheap, but it's beginning to seem cheap for a reason.

Another quarter, another drop in traffic

To be completely fair, Dave & Buster's did grow its revenue 6% year over year to $299 million during the third quarter. However, that was due to store count increasing to 134 compared to just 118 in the prior-year period. Comparable sales (which combines foot traffic and average guest spending, or "comps" from here on out) at existing locations fell 4.1%.  

A group of young people at a bar having drinks.

Image source: Getty Images.

To be fair again, this is a problem throughout the restaurant industry, not one unique to Dave & Buster's. According to research group TDn2K, average U.S. restaurant comps fell 0.4% in the third quarter, led by a 3.5% decline in foot traffic. There are simply too many stores, and consumers aren't visiting them fast enough to keep dining rooms full. Nevertheless, Dave & Buster's has fallen into the common industry trap: It's picking up sales as it opens new locations, but it's losing patrons at existing ones.  

The main problem used to lie primarily with the menu, as the restaurant half of the equation has consistently lagged behind the arcade and entertainment side (which the company categorizes as "amusements and other revenue," good for 58% of total sales). But in the third quarter, Dave & Buster's woes expanded and lost significant traffic in its flagship offering.  

Period

Amusement and Other Comparable-Store Sales

Food and Beverage Comparable-Store Sales

Combined Comparable-Store Sales

Q1 2019

1.8%

(3.3%)

(0.3%)

Q2 2019

(0.8%)

(3.2%)

(1.8%)

Q3 2019

(3.9%)

(4.4%)

(4.1%)

Data source: Dave & Buster's Entertainment.

Macrotrends turning against the business

Besides the restaurant business being the usual hyper-competitive challenge it is, there's simply too much entertainment out there for consumers to choose from and not enough time to spend on it. Besides other arcades and amusement parks, Dave & Buster's competes with home entertainment, too -- from video games to TV streaming. Live sporting events are always a big draw for bars, but enthusiasts can even catch a football game at a movie theater these days. Management acknowledged that competition was the leading contributing factor to the business' recent performance.  

The upshot is that Dave & Buster's is upgrading stores with new 40-foot LED screens (the "Wow Wall") for live events, refreshing arcade games, and continuing to run promotions to entice diners. Meanwhile, the stock trades for just 15 times trailing 12-month free cash flow (money left after cash operating and capital expenses). However, free cash flow is down this year, and there's a good chance it will continue to decrease if the company can't reverse those negative comps at its existing locations.

I will say this much: If Dave & Buster's can begin to turn things around and rekindle some comps growth, the stock is worth considering. It's still on my watch list, but until that rebound happens, the stock doesn't look cheap enough to me to warrant a purchase.