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Shares of Dave & Buster's (NASDAQ: PLAY ) dropped sharply in mid-June after the arcade and themed dining owner reported first-quarter numbers that fell well short of expectations. At the same time, management reduced its full-year revenue and profit guides. Investors were disappointed. PLAY stock dropped more than 20%.
This big sell-off, though, is overdone, and with PLAY stock hovering around $40, the medium- to long-term bull thesis looks very compelling here.
To be sure, the first quarter numbers weren't good. Comparable sales growth was negative. Revenue growth dropped below 10% for the first time in a long while. Margins compressed meaningfully. Profits growth came in at a multi-quarter low.
But, if you zoom out, the long term trends here remain favorable. The shift towards an experience economy resonates well for Dave & Buster's comparable sales growth going forward.
The unit growth trajectory remains favorable, and Dave & Buster's still projects to grow its unit base by 10% per year over the next several years. Margin compression is moderating and margins should ultimately stabilize.
All in all, then, while the near term trends are negative, the long term trends are still positive. Against that backdrop, PLAY stock is trading at its cheapest valuation in recent memory. That combination ultimately paves the way for a huge rebound rally in PLAY stock over the next several months.
The Near Term Is Ugly
The situation at Dave & Buster's can broadly be summed up in one phrase: it's ugly right now, but it's pretty in the big picture.
Right now, things are ugly for the themed dining restaurant and arcade. Comparable sales dropped 0.3% in the quarter, on top of a 4.9% drop last year, so comps are down more than 5% on a two-year basis. That's not good.
Further, comps are expected to drop 0.5% this year, versus a 1.6% drop last year, so down more than 2% on a two year basis. That's not good, either. At the same time, margins are compressing, as the adjusted EBITDA margin has fallen by more than 100 basis points year-over-year for three straight quarters.
The net result? Profit growth is being muted. A few years back, this was a consistent 20%-plus profit grower. Last quarter, D&B reported just 8.8% profit growth.
The Long Term Is Pretty
But, if you zoom out, things are still pretty in the big picture.
Most importantly, the experience economy continues to gain mainstream traction, and consumers are increasingly upping spend on experiences.
This pivot towards experience-focused consumption benefits Dave & Buster's, since going to D&B is broadly seen by consumers as a fun experience that combines dining and gaming for a fun night out.
That's why D&B comps were up 7.3% in 2014, 8.9% in 2015, and 3.3% in 2016. Comps did fall flat in 2017, and have retreated ever since, but that appears to just be normalization after a red hot streak in the middle of the decade.
As the laps get easier, the comparable sales growth trend will improve, because the company is aligned with the secular shift towards an experience economy.
Further, Dave & Buster's still only operates 127 stores. Management thinks the long term opportunity is 230 to 250 stores. Thus, this company can and will continue to grow its store base by 10% per year for the next several years.
Meanwhile, margins are falling, but by less and less each quarter, so margin stabilization seems to be coming in the near future. Once comps improve, margins should improve, too.
Overall, then, while negative comps and margin compression is the norm today, it won't be the norm forever. The long term norm here is positive comps and stable margins. D&B will get back to that soon, and when they do, PLAY will rally in a big way.
Dave & Buster's Stock Has Big Upside Potential
Following the huge post-earnings slide, PLAY now trades at its cheapest valuation in recent memory with a mere 13-times forward earnings multiple.
That's dirt cheap for the restaurant sector. The average forward earnings multiple in the restaurant sector is 25. McDonald's (NYSE: MCD ) trades at 25-times forward earnings. Yum (NYSE: YUM ) trades at 28-times forward earnings. Jack in the Box (NASDAQ: JACK ) trades at 20-times forward earnings.
More importantly, this valuation discrepancy has nothing to do with growth potential. The average long term earnings growth rate across the restaurant sector is just over 10%. Dave & Buster's will drive 10% unit growth alone over the next several years.
Assuming comps come back into slightly positive territory and margins stabilize, that 10% unit growth will produce profit growth well in excess of 10%.
Thus, Dave & Buster's has a bigger forward growth trajectory than the average restaurant company, and yet PLAY trades at a huge discount to the average restaurant stock.
This disconnect makes no sense and won't last forever. But, while it does last, investors should take advantage of it. This stock has tremendous upside potential from here in the medium to long term.
Bottom Line on PLAY Stock
Dave & Buster's had a bad quarter. But, the long term growth trajectory here remains favorable. As such, with PLAY stock plunging and trading at its cheapest valuation in recent memory, now seems like a good time to take advantage of near term weakness.
In the medium to long term, PLAY stock will head considerably higher from here.
As of this writing, Luke Lango was long PLAY and MCD.
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