Wednesday, December 21, 2016

PLAY in Bull Flag After Earnings and Guidance Gap Up

Dave and Buster's Entertainment, Inc. (NASDAQ: PLAY) reported earnings on 6 December 2016 and continued a multi-year streak of better than expected EPS and revenue.  For Q3, they beat earnings by $0.11, and they beat on revenue by $11.96 million.  The restaurant and entertainment giant also increased their forward guidance for the fourth quarter, although they did caution in their earnings call that they expected their tremendous earnings growth to "normalize" in 2017.

The stock surged at the open on 7 December, gapping up by $6.50 and continuing the strong surge throughout the trading day.  Not surprisingly, volume was off the charts as demand for the stock soared.  Since then, PLAY traced a fairly tight bull flag that thus far has bottomed just above that 7 December open. 

PLAY Daily Chart
Volume throughout flag development continued to decline, and price is now gravitating towards the high of the flag trend-line.  Using just the pattern for guidance, the upward price target on a breakout is extremely attractive.  The 76.4% extension of the flagpole height would take us to $63.96 as measured from the current breakout point.

The current uptrend started with a breakout from a month long consolidation that formed right on top of the 200-day simple moving average.  The breakout was convincing on higher than average volume, and even the post-breakout consolidation had an upward trend to it.  The earnings gap appears to be a continuation gap, at this point. We've no evidence (yet) to suggest that it's an exhaustion gap, which means the bottom of the pattern on 7 December should roughly approximate the mid-point of the overall move.  That would certainly be possible if the current flag pattern is wave iv of a Wave 1 impulse.

Now, normally I don't look at fundamentals when analyzing a short-term trade, however given the size of the move being signaled it does appear to be prudent to see if it's practical.  Let's take a quick look at Morningstar's Industry Comparison for PLAY.  A few key ratios jump out at us:
  • P/E is 28.0 compared to 25.6 for the industry.
  • PLAY is trading at 5.6 times book compared to an industry average of 13.2 times book.
  • Price per sales is comparable at 2.5 versus 2.4.
  • Margins are a bit low compared to the industry, showing room to grow.
The challenge with PLAY is that they are fairly unique in the industry.  Their restaurants combine dining and entertainment in a game-room style setting that targets both children and adults.  Locations in malls that offer large Cineplex style theaters have no comparable competitors and have a fairly unique operating model that has a proven track record.

A price target of $63.96 would boost the P/E to 34.6.  That level is high, certainly, but is it unrealistic?  Dunkin Brands sits at 38.2, Domino's at 72.6, and Panera Bread at 35.1, yet none of those brands offer entertainment as well as dining.  Given the rate of growth PLAY continues to experience, even if "normalized" in 2017, that multiple will likely decline, continuing to make this an attractive stock.

CEO Steve King summed up the growth potential in his Q3 earnings call: "As a reminder, we are targeting 10% or more unit growth per year including combination of large and small store formats as we mentioned likely to be 12% to 13% next year. Our 2017 target is that 11 to 12 stores with that growth rate of 12% to 13% as in years past, you see entire spectrum of stores between 25,000 and 45,000 square feet and currently we have 23 signed leases and nine of those units under construction."

 The conclusion I reach is that the price target signaled by both the continuation gap and the flag pattern is indeed a realistic and achievable target.  For now, this appears to be a long only trade with little indication that there's a play to the short side.  What we will be watching for is a close above the flag pattern, at which point we'll enter long.  A protective stop will be the bottom of the flag channel, and we'll set the price target at $63.96.  As usual, we'll begin to tighten our stops at the 50% and 61.8% extensions since either of those could cause either consolidation or correction. Watch for the break of that flag, however, since we do want confirmation of the continuation gap.

Happy Trading.

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