Dave & Buster’s (NASDAQ: PLAY) stock surged more than 10% after its Q2 earnings release because the narrative went something like this: the company is growing, but growth is weak, and expectations are missed. However, the miss was tepid, creating a “meh” reaction from the market because the margin widened, driving leverage and unexpected earnings strength. 

Earnings strength is expected to stick, setting the company up for leveraged earnings growth when consumer habits shift. That is expected over the next twelve to eighteen months because the FOMC is set to reduce interest rates starting this year. Until then, the company is also building leverage and value for shoulders, setting up the restaurant chain for accelerated gains when consumer habits improve. 

There is Nothing Wrong With Dave & Buster's Results

There is nothing wrong with Dave & Buster’s results except missing analysts' consensus on the top line. However, that is offset by margin strengths driven by improving operational quality at the restaurant and corporate levels. The company’s new menu, remodeling, and growing store count combined to drive YOY growth in a challenging market and widen the margin. 

The $557 million in net revenue missed the consensus by a slim margin but is up 2.8% YOY, with growth expected to continue. The negative comp store sales raise a red flag. Still, it is mitigated by significant calendar shifts to account for last year’s extra week and management’s decision to end the period on Tuesday rather than Sunday, which optimizes fiscal reporting. 

Margin news is good. The company widened the margin at all levels in all comparisons, with the restaurant-level operating margin up 170 basis points, the adjusted EBITDA margin up 130 basis points, and the adjusted net margin at 11.7% and up 70 bps. The net result is GAAP earnings are up 65%, adjusted net earnings are up 11.7%, and the adjusted EPS is up 19% aided by share repurchases. Margin strength is expected to stick because of improved operating efficiency and restaurant-level margin strength linked to customer satisfaction, a growing loyalty base and positive price increases. 

Dave & Buster’s Accelerates its Remodel Program: Buy’s Back Shares

Among the critical details of the report are the improved cash flow and balance sheet strength. The company generated a negative cash-flow quarter due to increased investments but had an outstanding quarter and trailing twelve months nonetheless. The company generated $101.8 million in operating cash flow for the quarter, allowing it to reinvest while returning capital. Capital returns in the form of share buybacks topped $47 million in Q2 and amounted to 46% of the cash flow. 

Cash flow and balance sheet health are strong enough that remodel plans were accelerated, which will accelerate revenue and earnings growth as the projects are completed. Balance sheet highlights include a reduced cash position offset by increased total assets, ample liquidity, 2.3X net total leverage, and a 13% increase in equity. Regarding the share repurchases, the share count is reduced by 3.1% YTD and will continue to fall as the year progresses.

Dave & Buster’s is an Easy Win for Investors

The analysts’ response to Dave & Buster’s results was muted, with only a single revision issued within twelve hours of the report. That was from BMO Capital Markets, which maintained an Overweight sentiment rating but lowered its price target. The price target is a new low from analysts but highlights the deep value present in the stock. The new low is $55 or 83% above the pre-release price action, a target that puts the stock at a four-month high and on track to reach the top of its long-term trading range.