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Dave & Buster's Banks on Unique Business Model, Costs Ail

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Dave & Buster's Entertainment, Inc.’s (PLAY - Free Report) unique business model, rigorous sales building initiatives and relentless expansion plans are encouraging. However, high costs, a tricky consumer spending environment in the U.S. restaurant space along with the company’s limited international presence raise concerns.

Recently, the company posted decent results in the fourth quarter of fiscal 2017, wherein earnings surpassed the Zacks Consensus Estimate while revenues met the same. Adjusted earnings of 61 cents surpassed the consensus estimate of 59 cents by 3.4%. Earnings, however, declined 3.2% year over year.

Although Dave & Buster’s continues to perform well on the back of unique customizable experience that it offers across its four platforms, “Eat, Drink, Play and Watch”, high operating costs might have led earnings to fall in the past few quarters.

The company’s shares have also lost 30.3% in the past year against its industry’s growth of 10.8%.

Distinct Business Model Favors Revenues

Dave & Buster’s exclusive business model focuses on the company’s entertainment business, alongside its food and beverage offerings. This dual model helps the company generate favorable store economics and strong return.

In fiscal 2017, amusement and other revenues accounted for 56.6% of total revenues and grew 16.6% year over year. This is because, increased dependence on gaming has cushioned the company from the headwinds of consumer discretionary spending that characterizes the restaurant industry and is in turn driving market share and comps. Also, the shift toward increased focus on amusement is driving Dave & Buster’s earnings, given its higher-margin business.

In fact, the company has a proven track record of identifying operational efficiencies for the past five fiscal years and adjusted EBITDA margins improved approximately 720 bps in the same time period. It is in fact this unique model that sets it apart and we expect the company’s entertainment business to carry the growth story forward.

Rapid Store Openings Bode Well

Dave & Buster's continues to pursue a disciplined new store growth strategy in both new and existing markets, given the broad appeal of its brand. Management believes that it can grow the concept to more than 200 units in North America over time. Currently, the company has eight stores under construction, and plans to further ride on new store growth in 2019 and early 2020.

In fiscal 2018, the company anticipates to open 14 to 15 new stores, including two of the latest 17-K format stores, and achieve 13-14% annual unit growth rate, including the combination of eight stores in new markets for D&B, with the remaining stores located in markets where the brand is already established.

Meanwhile, in addition to the growth potential that exists in North America, management is positive about the brand’s significant appeal in certain international markets. Notably, the first international opening outside of Canada is anticipated in 2018.

High Costs Amid a Competitive Industry Hurt Dave & Buster’s

Higher labor costs due to increased wages and those incurred due to implementation of the Affordable Care Act are expected to continue keeping profits under pressure. This means that restaurant operators such as Dave & Buster’s that has numerous company-owned units and laborers will have to continue shouldering increased labor costs, which in turn will hurt margins.

Further, the non-franchised model makes the company susceptible to increased expenses. Since all the restaurants are owned and operated by Dave & Buster’s, instead of signing franchise agreements and putting the burden of costs onto the franchisee, the company is solely responsible for the expenses of operating the business.

Moreover, the retail restaurant space is highly competitive, as numerous restaurant operators are adapting advanced and prudent strategies to increase their sales. These initiatives involve high costs. Dave & Buster’s is also bearing the brunt of higher operating cost from these sales building initiatives. In fact, in fiscal 2017, total operating costs increased 14% from the prior-year quarter.

Amid such stiff competition, Dave & Buster’s is also missing out on international presence that other restaurant chains like McDonald's (MCD - Free Report) , Domino’s (DPZ - Free Report) and Yum! Brands (YUM - Free Report) are aggressively pursuing.

We believe that the company needs to expand its presence beyond the United States in order to offset the impact of cut-throat competition in the saturated domestic market.

Zacks Rank

Dave & Buster’s carries a Zacks Rank #3 (Hold). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

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