Here's Why Dave & Buster's Entertainment (NASDAQ:PLAY) Has A Meaningful Debt Burden

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies Dave & Buster's Entertainment, Inc. (NASDAQ:PLAY) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Dave & Buster's Entertainment

How Much Debt Does Dave & Buster's Entertainment Carry?

As you can see below, at the end of October 2023, Dave & Buster's Entertainment had US$1.29b of debt, up from US$1.23b a year ago. Click the image for more detail. However, because it has a cash reserve of US$64.0m, its net debt is less, at about US$1.23b.

How Strong Is Dave & Buster's Entertainment's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Dave & Buster's Entertainment had liabilities of US$419.3m due within 12 months and liabilities of US$3.07b due beyond that. Offsetting these obligations, it had cash of US$64.0m as well as receivables valued at US$26.3m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$3.40b.

When you consider that this deficiency exceeds the company's US$2.54b market capitalization, you might well be inclined to review the balance sheet intently. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Dave & Buster's Entertainment has net debt worth 2.4 times EBITDA, which isn't too much, but its interest cover looks a bit on the low side, with EBIT at only 2.5 times the interest expense. While that doesn't worry us too much, it does suggest the interest payments are somewhat of a burden. We note that Dave & Buster's Entertainment grew its EBIT by 21% in the last year, and that should make it easier to pay down debt, going forward. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Dave & Buster's Entertainment can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Dave & Buster's Entertainment produced sturdy free cash flow equating to 66% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

Both Dave & Buster's Entertainment's level of total liabilities and its interest cover were discouraging. But at least its EBIT growth rate is a gleaming silver lining to those clouds. When we consider all the factors discussed, it seems to us that Dave & Buster's Entertainment is taking some risks with its use of debt. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 1 warning sign with Dave & Buster's Entertainment , and understanding them should be part of your investment process.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.