Few businesses have been hit harder by the coronavirus pandemic than Dave & Buster's Entertainment (NASDAQ:PLAY). Its stock is down 66% this year, highlighting a difficult environment for indoor entertainment companies.
Dave & Buster's "Eat Drink Play and Watch" strategy has a been a differentiator, allowing guests to enjoy high-quality food and beverage choices, participate in interactive games for both adults and families, and watch sports and other entertainment. Over the past four fiscal years, sales and profits grew at a compound annual growth rate of 11.8% and 13.9%, respectively. As of May 3, there were a total of 137 Dave & Buster's locations in North America.
With recent coronavirus-related developments significantly affecting the business, let's dig a bit deeper to see if the company's long-term potential is still intact, and if the stock is a buy.
The effects of COVID-19
By mid-March, most parts of the U.S. had issued shutdown orders amid the pandemic, and Dave & Buster's followed suit. By March 20, all the chain's locations were temporarily closed, and the company was forced to take drastic steps as a direct response to the spread of COVID-19. This included furloughing all hourly store employees and 94% of store management, suspending its cash dividend and share repurchase program, drawing down nearly all of its revolving credit facility, and issuing equity three separate times.
Sales and earnings were growing at a healthy clip before the pandemic. But revenue in the first quarter (ended May 3) fell to $159.8 million, a 56% decrease from the prior-year period. Comparable-store sales decreased 58.6% as the company swung to a net loss of $43.5 million.
Most retail businesses have been absolutely devastated by shelter-at-home orders, and Dave & Buster's is no different. Having high fixed costs is a boon when sales are strong, but they can crush any business when revenue is so far down. As Dave & Buster's slowly begins to reopen locations, it's hard to tell if customers will feel safe enough to show up.
Because a key growth strategy for Dave & Buster's is to open new locations, liquidity requirements are very high. In fact, over the last five fiscal years, capital expenditures have far exceeded operating income in any given year. As a result, total debt was almost twice as high at the close of fiscal 2020 (which ended Feb. 2) as it was at the end of fiscal 2016.
I have no problem with a company borrowing money to finance growth, as long as the return on invested capital (ROIC) is attractive. By looking at the chart below, it's obvious that this is not the case for Dave & Buster's. In 2018, ROIC started to gradually decline, signaling deteriorating business prospects as it relates to new store openings. Dave & Buster's should only increase its debt burden if ROIC remains steady or is rising, which would result in value creation.
The company ended the first quarter with $157 million in cash and cash equivalents. With additional capital raised of $111 million subsequent to the end of the quarter, Dave & Buster's should have enough liquidity to survive the rest of the year.
The final verdict
Based on everything discussed thus far, I don't think Dave & Buster's stock is a buy. The coronavirus pandemic has shown just how sensitive the business is to economic shocks. Even with a slow reopening of the economy and retail businesses, it is still very unclear when or if people will go back to their normal routines.
Dave & Buster's differentiating factor is its interactive and entertaining gaming setup. The high-touch nature of this product is now a weakness, as germs can easily spread and sanitation is of even higher importance. There is also too much uncertainty around when the world will get past this epidemic.
Furthermore, we still don't know if football is going to take place this fall. This will hurt not only Dave & Buster's, but also many other businesses whose success depends on live sports. With too many negatives far outweighing any positives for this company and stock, investors should look elsewhere.