This week, Durig Capital look again at the parent company of a long-time, beloved family entertainment restaurant. Chuck E. Cheese, whose parent company is CEC Entertainment, has long been a beloved rite of passage for children’s birthday celebrations. CEC has spent the past few years updating the venue’s image, mainly in an effort to appeal to the parents as well as their kids. The new image seems to be working. With the release of its second quarter and year-to-date results, CEC has now logged five consecutive quarters of same-store growth. Other highlights from CEC’s latest results include:
- For the six months ending June 30, 2019, adjusted EBITDA was up 8.4% year-over-year.
- Net income for the first six months of 2019 increased by nearly 3 times over the same period in 2018.
- Cash from operating activities for the first six months 2019 totaled $91.1 million, up from $65.0 million in the previous year period.
CEC management is betting that the changes they are making will attract a new generation of families looking for good food and family friendly entertainment. From the positive results over the past five quarters, it looks as if this is becoming a reality. The company’s 2022 bonds are currently trading at a slight discount, giving them an excellent yield-to-maturity of about 9.75%, making them a perfect candidate for additional weighting in Durig Capital’s Fixed Income 2 (FX2) High Yield Managed Income Portfolio, the aggregated performance of which is shown below.
CEC Entertainment Reports Second Quarter and Year-to-Date Results
CEC has been on a positive streak as its CEO, Tom Leverton, boasted in the company’s latest results.
“We posted our fifth consecutive quarter of comparable venue sales growth in the second quarter of 2019, driven by the positive impact of the All You Can Play and More Tickets initiatives. We are pleased with our results for the first half of 2019 and our flow through to earnings despite continued pressures from wage growth. We remain optimistic about the growth prospects in the business going forward.”
Here are the five quarters of growth to which he referred.
|Q2 2018||1.0 %|
|Q3 2018||2.2 %|
|Q4 2018||3.3 %|
|Q1 2019||7.7 %|
|Q2 2019||0.4 %|
The company boasted additional wins in its second quarter and year-to-date results.
- Adjusted EBITDA for the six months ending June 30, 2019 was $114.5 million, up from $105.7 million a year ago, an increase of 8.4%.
- Net income for the first six months of 2019 totaled $12.5 million as compared to $3.3 million in the same period in 2018, an increase of almost 3x.
CEC has spent the last few years updating its restaurants, both physically and in terms of their food and game offerings. It does appear that this work is beginning to pay dividends.
About the Issuer
Headquartered in Irving, Texas, CEC Entertainment. Inc. (CEC), was originally incorporated under the name ShowBiz Pizza Place. In 1998, the company changed its name to CEC Entertainment. CEC is currently majority-owned and controlled by investment funds affiliated with Apollo Global Management, LLC. For more than 35 years, CEC Entertainment has served as a nationally recognized leader in family dining and entertainment. Its brands include Chuck E. Cheese as well as Peter Piper Pizza. As the award-winning, number-one, kid-friendly restaurant for millions of families across the world, the company operates 554 venues with an additional 195 venues under franchise arrangements across 47 states and 14 foreign countries as of June 30, 2019.
Giving Chuck E Cheese a New Image
A few generations of kids fondly remember birthdays spent at Chuck E. Cheese with friends, games and a lot of pizza. Now, CEC Entertainment has spent the last few years remaking its Chuck E. Cheese signature restaurants. Gone are the kaleidoscope colors and animatronic figures. These have been replaced with muted wall colors, modern furniture and a menu that now includes sandwiches, salads and wraps in addition to the restaurant’s signature pizza offering. All of this is being done in order to appeal to parents as well as kids.
This reimagining is definitely working for the nearly 40-year old restaurant chain. CEC’s most recent quarterly results show that its most recent 25 remodeled stores, completed in the third and fourth quarter of 2018, remain better than 16 percentage points above in same-store sales growth than the rest of the chain. Guest reactions to the new, updated Chuck E .Cheese motif continues to be extremely positive.
The games have also been updated. Game tokens have been replaced with Play Pass game cards that can be loaded up with points. Also, in 2018, the chain launched the “All You Can Play” game model. This new model allows for unlimited play for an hour or longer. This new gaming method also showed significant growth in the company’s most recent quarter. 62% of guests chose the “All You Can Play” model in Q2 2019, up from 57% in Q1 and 50% at product launch last year.
While CEC already has foreign operated franchises of its Chuck E. Cheese brand, the company is looking to expand this. For the balance of 2019, CEC Entertainment is targeting 12 new international locations. So far, in the company’s third quarter, CEC’s international franchise team has already signed three additional development agreements for seven additional stores, including two new markets in Malaysia and Morocco. This brings the year-to-date new development agreements to ten, which comprises 30 additional stores.
High Margin Activities
CEC’s most recent results reveals that the company realizes more than half its revenues from its gaming and merchandise sales. And this percentage share has continued to grow. In the company’s first six months of 2019, sales from gaming and merchandise made up 56% of sales, up from 53.5% during the same period in 2018. For CEC, this is just good business as the company’s gaming and merchandise sales have much higher margins as compared to its food and beverage sales. In the second quarter of 2019, 23.2% of total revenues went to the cost of food and beverage, with a much smaller 8.1% of total revenues going to the cost of games and entertainment.
For bondholders, interest coverage is a measure of an issuer’s ability to cover its existing debt. For the second quarter, CEC had operating income (without the effect of non-cash depreciation) of $33.4 million and interest expense of $20.0 million for an interest coverage ratio of 1.7x. CEC also had outstanding cash from operations for the first six months of 2019 of $91.1 million. This is up from $65.0 million for the same period in 2018.
As of June 30, 2019, CEC reported a healthy level of liquidity. Adequate liquidity helps companies to smooth out variations in cash flow from quarter to quarter. As of June 30, 2019 the company had cash and cash equivalents of $114 million, with another $86.5 million available on its revolving credit facility.
The risk for bondholders is whether CEC can continue its streak of growth and continue to capitalize on its new image, including its newly remodeled restaurants, improved menus and games. For five consecutive quarters the company has logged increases in same-store sales. The new feel and designs of the updated venues are attracting a new generation of families. The company plans to remodel all of its locations, which should ultimately translate into increased revenues. In consideration of CEC’s excellent results over the last five quarters, the over 9.5% yield-to-maturity on its 2022 bonds does appear to outweigh the risks identified.
Generally, there is reduced risk for investors who invest in Durig Capital’s Fixed Income 2 (FX2) Managed Income Portfolio due to its diversification across many bond issuers and industries as compared to the purchase of individual bonds. Also, the FX2 Portfolio has historically outperformed the portfolios where investors have chosen bonds individually. Durig Capital currently holds this bond in its FX2 Portfolio.
In general, bond prices rise when interest rates fall and vice versa. This effect tends to be more pronounced for lower couponed, longer-term debt instruments. Any fixed income security sold or redeemed prior to maturity may be subject to a gain or loss. Higher yielding bonds typically have lower credit ratings, if any, and therefore involve higher degrees of risk and may not be suitable for all investors.
Summary and Conclusion
Time will tell whether CEC’s image makeover of its signature Chuck E. Cheese restaurants will be successful, but things look good so far. Five successive quarters of growth along with increased sales at its remodeled stores as compared to non-remodeled stores attest to the success of the transformation thus far. The company did attempt to go public earlier this year, but ultimately chose not to pursue that avenue further at this time. If CEC chooses to go down that road again, this would likely mean an influx of cash, which could be used for paying down debt. For now, CEC’s 2022 bonds are still trading at a slight discount, pumping up the yield-to-maturity to over 9.5%. Durig Capital already holds a position in these 2022 bonds, but with CEC’s continued solid performance, these are ideal for additional weighting in Durig Capital’s Fixed Income 2 (FX2) Managed Income Portfolio, shown above.
Issuer: CEC Entertainment Inc.
Symbol: CEC (inactive)
Ratings: Caa2 / CCC
Yield to Maturity: ~ 9.77%
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Disclosure: Durig Capital and certain clients may hold positions in CEC’s February 2022 bonds.
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