These 4 Measures Indicate That Dave & Buster's Entertainment (NASDAQ:PLAY) Is Using Debt In A Risky Way

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Dave & Buster's Entertainment, Inc. (NASDAQ:PLAY) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

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When Is Debt Dangerous?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

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

As you can see below, at the end of February 2025, Dave & Buster's Entertainment had US$1.75b of debt, up from US$1.29b a year ago. Click the image for more detail. Net debt is about the same, since the it doesn't have much cash.

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

We can see from the most recent balance sheet that Dave & Buster's Entertainment had liabilities of US$433.9m falling due within a year, and liabilities of US$3.44b due beyond that. Offsetting these obligations, it had cash of US$6.90m as well as receivables valued at US$29.2m due within 12 months. So it has liabilities totalling US$3.83b more than its cash and near-term receivables, combined.

This deficit casts a shadow over the US$783.5m company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. At the end of the day, Dave & Buster's Entertainment would probably need a major re-capitalization if its creditors were to demand repayment.

Check out our latest analysis for Dave & Buster's Entertainment

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

While we wouldn't worry about Dave & Buster's Entertainment's net debt to EBITDA ratio of 3.6, we think its super-low interest cover of 1.8 times is a sign of high leverage. So shareholders should probably be aware that interest expenses appear to have really impacted the business lately. Worse, Dave & Buster's Entertainment's EBIT was down 24% over the last year. If earnings continue to follow that trajectory, paying off that debt load will be harder than convincing us to run a marathon in the rain. 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're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, Dave & Buster's Entertainment reported free cash flow worth 2.7% of its EBIT, which is really quite low. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Our View

On the face of it, Dave & Buster's Entertainment's EBIT growth rate left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. And even its conversion of EBIT to free cash flow fails to inspire much confidence. We think the chances that Dave & Buster's Entertainment has too much debt a very significant. To us, that makes the stock rather risky, like walking through a dog park with your eyes closed. But some investors may feel differently. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 3 warning signs with Dave & Buster's Entertainment (at least 1 which is significant) , and understanding them should be part of your investment process.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.