Dave & Buster's Amusement Business Solid, Industry Woes Rife

Dave & Buster's Entertainment, Inc. (NASDAQ:PLAY) generates strong returns, courtesy of its unique business model and favorable store economics. The company continues to perform well on the customizable experience it offers across its platforms — Eat, Drink, Play and Watch.

However, rising labor costs amid a tepid sales environment along with limited geographical presence remain potent headwinds for this Zacks Rank #3 (Hold) company. You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Recently, Dave & Buster’s reported mixed third-quarter fiscal 2017 results. The bottom line surpassed the Zacks Consensus Estimate, while the top line lagged the same. Notably, the third quarter marked the 13th successive earnings beat for the company.

Key Growth Drivers

Dave & Buster’s distinctive business model sets it apart. Along with food and beverages, the company has a robust entertainment business. In fact, in the first nine months of fiscal 2017, amusement and other revenues accounted for 55.6% of total revenues. In fact, the segment’s revenues grew 17.1% year over year as increased dependence on gaming has cushioned the company against headwinds in restaurant space. It will also drive market share and comps for the company. Also, the increased focus on its higher-margin amusement business is driving earnings.

Dave & Buster's continues to pursue a disciplined new-store growth strategy in both new and existing markets. In fiscal 2017, the company expects to open 14 new stores, including 10 large and four small outlets. The company currently has 11 stores under construction and a total of 27 times leases, and is expected to continue with the expansion in fiscal 2018 as well as 2019. In fiscal 2018, the company plans to open 14 to 15 new stores and achieve a 13% to 14% annual unit growth rate, including a combination of large and small format stores.

For third-quarter fiscal 2017, the company has planned on a smaller-store format of about 15,000 to 20,000 square feet in order to capitalize on demand in smaller and untapped markets. Management expects to open 20-40 stores in the long term, including two that are to be opened in 2018. The company believes that this new format will expand brand potential and spread growth runway. The first store under this new format will be opened in Rodriguez, AR, at the beginning of fiscal 2018.

Apart from an efficient business model and expansive strategies, Dave & Buster’s relies heavily on menu and entertainment innovation to drive sales. Notably, the company continues to evolve its amusement section on new and interesting content, including games based on some of the world’s finest movies. In this regard, the company continues to collaborate with various game manufacturing partners and remains steadfast on its strategy of including proprietary content that is exclusive to the company.

Additionally, the company believes that it can drive traffic by enhancing in-store and out-of-store customer experience via digital and mobile strategic initiatives as well as through employing better technology.

Notably, Dave & Buster's delivered return on equity (ROE) of 24.8% in the trailing 12 months, compared with the industry’s gain of 6.9%. This indicates that the company reinvests more efficiently compared to peers which drives its growth trajectory.

Concerns

Increased labor costs due to the implementation of Obamacare continues to have an adverse impact on margins of restaurant operators like Darden Restaurants Inc. (NYSE:DRI) , Brinker International Inc. (NYSE:EAT) , Red Robin Gourmet Burgers, Inc. (NASDAQ:RRGB) and many others, including Dave & Buster's. Also, pre-opening costs of outlets given the company’s unit expansion plans and expenses related to sales initiatives are driving costs and are likely to weigh on margins.

Subsequently, shares of Dave & Buster's lost 2% year-to-date as against the industry’s gain of 14.5%. The underperformance has been led by downward estimate revisions. Over the last 60 days, earnings estimates for the current-quarter and year have moved down 8.2% and 0.7%, respectively, reflecting analysts’ pessimism over the stock.

Also, a decelerating comps growth rate given the persistently challenging sales environment in the U.S restaurant space is a concern.

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