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Tim Hortons: On the Power Play

By Chad Fraser on May 15, 2014

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Tim Hortons (NYSE: THI, TSX: THI) is the undisputed king of Canadian coffee. According to the company, nearly eight of every 10 cups sold in the Great White North come from its outlets.

“Canada runs, walks, dines, free WiFis, cuts business deals and does just about everything around Hortons,” wrote Boston Globe sportswriter Kevin Paul Dupont in the May 11 edition. 

It’s no exaggeration. To Canadians, Timmies, as it’s affectionately known, is more than a coffee chain—it’s an icon. That’s partly because it’s directly tied to the country’s national obsession: hockey.

Stanley Cup-winning defenseman Tim Horton opened the first outlet in 1964 as a way to add to his hockey salary. The tiny store, in Hamilton, Ontario, had just two items on the menu: coffee and doughnuts.

Fast-forward 50 years and Horton, who was killed in a car accident on his way home from a game in 1974, would likely be shocked to see what his company has become.

Tims now boasts 4,524 outlets, including 3,610 in Canada, 870 in the U.S. and even 44 in the Middle East. The menu has ballooned to include muffins, cookies, soups, iced coffee, cappuccinos, wraps, and breakfast and panini sandwiches.

Investors Have Scored Growth and Tasty Dividend Hikes

Tim Hortons merged with Wendy’s International (NYSE: WEN) in 1995. In 2006, activist investor Bill Ackman successfully pressured Wendy’s to spin off Tims as a separate company.

The stock has performed well since, gaining 72% on the New York exchange. It has also been a reliable dividend payer, raising its payout nearly fivefold since its IPO. The current annual rate of C$1.28 a share yields 2.1%. ($1 Canadian = $0.92 U.S.)

A big part of Tim’s future growth hinges on the success of its U.S. expansion. But Americans have been slower to develop a taste for the company’s fare than its loyal Canadian fans.

Why? For one, unlike in Canada, Tims is small fry in the massive (and hotly competitive) American quick service food market. In 2012, it was the 43rd-biggest U.S. chain by sales, at $532.2 million, according to QSR magazine.

By comparison, McDonald’s (NYSE: MCD) held down first place with $35.6 billion, while Starbucks (NYSE: SBUX) was in third at $10.6 billion. Another rival, northeastern powerhouse Dunkin Donuts (NYSE: DNKN) posted sales of $6.3 billion, good for seventh spot.

Another reason? Tim’s strategy has largely relied on transplanting its Canadian approach to the U.S., when a more local recipe is what’s called for.

Keying in on American Tastes

“I think that was part of the problems of the past,” said CEO Marc Caira, who took the company’s top job last July, in a May 8 Toronto Star article. “Perhaps we relied too much on Canadian thinking, Canadian products for the U.S. consumer. And that’s wrong.”

Caira frequently refers to Tim’s U.S. expansion a “must win battle.” Prior to taking the coffee chain’s top job, he was an executive at Switzerland’s Nestle SA, where he helped grow that company’s hot and cold beverage division.

So, do Canadians and Americans really differ when it comes to their morning cup of joe? Turns out they do, according to Caira. “In some cases, the U.S. consumer likes a lighter coffee and larger doughnuts than the Canadian consumer,” he said in a May 8 Wall Street Journal article.

To speed up its product development south of the border, Tims has opened a new testing facility in Columbus, Ohio. Last month, it launched two new U.S.-only menu items, one of which is its Frozen Hot Chocolate, which is made with real cream, blended with chocolaty syrup and layered with whipped topping.

The other is its Extreme Italian Sandwich, which is topped with mozzarella and a creamy sundried tomato sauce and served on a soft, fresh parmesan and herb-topped bun.

New products like these are aimed at luring more afternoon traffic away from big competitors like Starbucks and McDonald’s, which are increasingly taking aim at Tim’s core breakfast market in both Canada and the U.S.

New Expansion Approach Relies on Local Knowledge

The company is also cutting the cost of expanding in the U.S. by teaming up with bigger franchisees.

“We have always expanded by building the restaurants ourselves, putting our own capital in,” Caira told the Toronto Star. “We’re now going to partner with different people that want to do business with Tim Hortons, and there are lots of them. We’re going to use their capital.”

The company has recently entered into licensing deals for almost 100 outlets in Youngstown, Ohio; Fort Wayne, Indiana; Fargo and Minot, North Dakota; and St. Louis.

Notably, this is the same approach Tim Hortons uses in the Middle East with local operator the Apparel Group, which brings expertise on the area’s real estate and media markets to the table.

In Canada, meanwhile, the chain aims to move customers through its checkout lines faster with things like new easy-to-read digital menu boards and two-lane drive-thrus at some locations.

It’s also trying to boost Canadian per-customer spending with add-ons, like its new hash browns, and premium menu items, including a new chicken sandwich, green tea beverages and warm kettle chips. There’s room for growth here, as the average Tims bill is 23% to 45% lower than its competitors’ according to the company.

These moves are all part of Tim’s new five-year plan, unveiled in February, that will see it add 800 new outlets in that time: 500 in Canada and 300 in the U.S.

Meanwhile, the company’s first quarter sales rose 4.8% from a year ago, to C$766.4 million. Same-store sales gained 1.6% in Canada, while U.S. same-store sales rose 1.9% on higher per-customer spending. The American division also saw its operating income jump to C$4.4 million from just C$910,000 a year ago.

Net income rose 5.5%, to C$90.9 million, while per-share profits gained 16.9%, to C$0.66, after Tim Hortons bought back $1 billion worth of shares between August 2013 and April 2014. However, the latest results still fell short of the consensus estimate of C$0.68 a share in earnings on C$778.2 million of revenue.

The bottom line? Tim Hortons will undoubtedly continue to face rising competition at home and abroad in the cutthroat quick service restaurant market, but Caira’s new plan appears to have the right ingredients for growth. The dividend and regular buybacks add flavor.

A Complete Guide to the Best Canadian Stocks for U.S. Investors

Tim Hortons is one of the 150 stocks we keep under constant review in our Canadian Edge advisory’s How They Rate universe, a complete collection of the Canadian stocks our in-house expert, David Dittman, sees as ideally suited for investors like you.

If you’re a Canadian Edge subscriber, you can already access this service, which contains David’s latest buy/sell advice on all 150 stocks—including Tim Hortons. If you haven’t tried Canadian Edge yet, now is your chance. For a limited time, we’re offering you the opportunity to road test this unique advisory risk-free for 90 days. Click here to start now.

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Stock Talk

  1. avatar
    49cent Reply May 19, 2014 at 7:45 AM EDT

    I am always astounded when the author of an article hedges their analysis of
    a company with phrases such as “new plan appears to have the right ingredients
    for growth.” The implication is that the author doesn’t really know. As the old
    saying goes, appearances can be deceptive.
    I will also never consider a pitched stock without disclosure of the author’s
    actual investment in the stock.