After years of struggling to gain traction, Dave & Buster’s (NASDAQ: PLAY) has the opportunity to reinvigorate the business with a new CEO. Former CEO Chris Morris’ surprise departure clouds the outlook and increases uncertainty about execution, but a good choice can put that to rest. The board says it's been looking for a successor, so it may take long to find a good fit. The company is in fine financial shape and can generate profits; the only question is how long it will take to turn the ship around. 

Dave & Buster’s Struggles With Headwinds in Q3

Dave & Buster’s business struggled with numerous headwinds in Q3, including economic, consumer, a significant calendar mismatch, weather, and the impact of remodeling efforts. The takeaway is that revenue declined by 3% year-over-year despite the increased store count, underperformed the consensus, and margins contracted. The revenue weakness was driven by a negative 7.7% comp adjusted for the calendar shift, as traffic and tickets were both affected. The bad news is obvious, but there is a silver lining: remodeling efforts continue to drive results at completed locations. Those locations resonate with consumers and outperform older layouts. 

The margin news is the worst in the report. The company’s margin contracted on costs, investments, and deleveraging and is not expected to bounce back quickly. The adjusted EBITDA margin contracted by 240 basis points to 15.1%, driving a 16% dollar decline. The GAAP losses widened, and adjusted profitability proved elusive, resulting in negative cash flow for the quarter. The upshot is that many items impacting the margin, including consumer headwinds and remodeling, are expected to have a diminishing impact in future quarters, leading to improved cash flow and leverage.

The company failed to provide specific guidance but gave sufficient detail to garner an optimistic business outlook. The Q4 sales may be below the forecasts issued before the release but should show significant sequential growth. Strength will be driven by seasonal trends and supported by a rebound in the events business, improving customer satisfaction, new stores, and remodels. The company is on track with its remodel efforts, showing it can execute, and the store count is up three for the quarter. The company plans to complete at least 40 remodels by the year’s end, and the store count will continue growing. 

Dave & Buster’s Buybacks Are at Risk

Dave & Buster’s continued to buy back shares in Q3, reducing the count by more than 5% on a year-to-date basis, and it will likely continue repurchasing shares. However, with the business struggling to gain traction and the cash flow negative, the pace may slow, or buybacks may be paused until cash flow improves. As it is, the company’s total net leverage ratio is within its target range at 2.6x but relatively high regarding equity at over 6x, so there is cause for concern. The company refinanced some debt during the quarter, which helped, but it could only sustain its balance sheet health for so long while burning capital. 

Analysts were not jazzed by the news, issuing numerous revisions, including several rating downgrades and more price target reductions. The takeaway is that analysts have lowered sentiment to Hold, and the consensus price target fell more than 10% overnight. The consensus implies a significant upside, about 80%, with shares at long-term lows, but the revisions are lower and suggest this stock is fairly valued with little room to advance. 

Dave & Buster’s Hits Rock Bottom, But Will It Bounce? 

Dave & Buster’s stock price tanked following the Q3 release, falling more than 15%, aided by short-selling. The short interest was high heading into the release at 16% and is likely higher now. The question is whether the market can fall any further, and the answer is yes. The price action is on a critical support target but is not showing signs of a rebound yet. The market could fall below support in this scenario and potentially confirm it as resistance soon after. That would indicate a complete market reversal, possibly resulting in a sustained downtrend and selling off to much lower levels. If the market confirms support near $30.50, it will likely continue to move sideways as it has for the last few years.