Canadian Coffee Giant Still Looking to Score in the U.S.
Tim Hortons (NYSE: THI) is Canada’s leading coffee chain, with 3,468 outlets in the country, as well as 807 in the U.S. and 29 in the Middle East.
The company’s roots run deep in its hockey-mad homeland. It was founded by Tim Horton, a four-time Stanley Cup–winning defenseman who played for the Toronto Maple Leafs, New York Rangers, Pittsburgh Penguins and the Buffalo Sabres during his career.
To supplement his hockey salary, Horton went into the doughnut business in 1964, opening his first store in Hamilton, Ontario. By 1967, he had expanded the chain to three outlets, and by 1974—the year Horton was killed in a car crash on the way home from a game—there were 40 Tim Hortons coffee shops operating in Canada.
Canadians Can’t Go Without Their Timmies Fix
Now, according to market research firm NPD, Tim Hortons controls 77% of Canada’s out-of-home coffee market. With its dominance in Canada—where it’s affectionately referred to as “Timmies”—firmly established, it’s aiming to keep growing both at home and through its expansion in the U.S., where it has mostly set up shop in northern states whose residents are more likely to be familiar with it.
The company has been on the radar of our Investing Daily analysts since November 2009, when they issued a buy call on the northern coffee giant in an article in our Personal Finance advisory.
They cited Tim’s strong presence at home—where it benefited from Canada’s resilient economy during the financial crisis—its franchisee-owned outlets and expansion opportunities, including selling more products through grocery stores, as key factors behind its investment appeal.
Nearly four years later, the call has paid off nicely, with Tim’s shares rising 104.0% since that article was released. The company has also paid a dividend since it was spun off by Wendy’s (NYSE: WEN) in 2006 and has raised its payout every year since 2008. It currently yields 1.76%.
The shares currently rate a hold in our Canadian Edge advisory’s How They Rate universe, which gives you constantly updated advice on 150 Canadian stocks.
“There are twice as many Tim Hortons per capita in Canada as there are Starbucks per capita in the U.S.,” wrote Canadian Edge chief investment strategist David Dittman when the advisory began covering Tim Hortons in July 2012. “And each Tim Hortons does about C$2 million a year in sales versus roughly US$1 million for a Starbucks in the U.S.”
Americans Have Been Slower to Develop a Taste
As is the case in the U.S., Canada’s fast-food restaurant market remains hotly competitive. One challenger that has been pushing hard to pick up market share is McDonald’s (NYSE: MCD), which continues to upgrade its restaurants and add to its McCafé menu lineup.
McDonald’s share of the Canadian coffee market has more than doubled, to 10.3%, though Tim’s has mostly held its own in the face of those gains, suggesting that McDonald’s is mostly taking share from other competitors.
Tim’s continues to look to the U.S. for growth, but its expansion there has proven difficult. Over the last decade, the company has poured about $660 million into its southern growth strategy, and it currently has only a 2.7% market share to show for it, according to retail consulting firm Technomic.
As Investing Daily managing director John Persinos pointed out in a recent article, a major competitor in the U.S. is fast-growing Dunkin Brands (NYSE: DNKN), which is also mainly concentrated in the Northeast. Dunkin continues to add new menu items, renovate existing stores and rapidly expand by striking deals with new franchise partners.
New CEO Brings a Fresh Perspective
Partly in response to pressure from two activist investors, Boston’s Highfields Capital Management LP and Scout Capital Management LLP of New York (which together hold 9.6% of Tim’s shares), the company is now reshuffling its U.S. expansion strategy.
Under its new plan, it will partner with well-capitalized franchisees that will be able to hold multiple stores in a certain area. The company feels this will cut the cost of growing in the country starting in 2014. It also has the potential to accelerate its expansion.
“We’ll be looking for partners that not only have the capital but more importantly understand the market and have access to things we don’t have access to, i.e., real estate and media,” Tim Hortons’ new CEO, Mark Caira, who took the reins on July 2, recently told Bloomberg.
The company is also borrowing $900 million to repurchase shares (in response to another demand by Highfields and Scout). Tim’s balance sheet is healthy, so it can easily afford this move.
For its part, Scout called the above initiatives “a good first step.”
These are the first significant moves made by the Caira, a former executive at Nestle SA (NYSE: NESN) who helped expand that company’s hot and cold beverage division.
Caira plans to increase Tim’s sales with a number of new initiatives, such as improved customer service to ease long lineups at the company’s Canadian stores. Tim Hortons is also adding double-lane drive-throughs and beverage express counters designed to get customers past the checkout counter faster.
In addition, Caira has mentioned going after younger customers with more milk- and juice-based drinks, along with marketing focused on health and wellness. Other options under consideration include selling more Tim Hortons products through retail stores and vending machines and offering dinner items, an appropriate counterpunch to fast food chains like McDonald’s moving into the company’s core coffee market.
Canadian Dominance Gives Tim’s a Strong Backbone
In the second quarter, results for which Tim Hortons released on August 8, revenue rose 1.9% from a year ago, to C$800.1 million. Net income increased 14.5%, to C$123.7 million. Per-share earnings rose 17.0%, to C$0.81, on fewer shares outstanding. That topped the consensus forecast of C$0.74 a share, though revenue missed the analysts’ expectation of C$818 million.
Same-store sales rose 1.5% in Canada, partly due to price increases, and 1.4% in the U.S.
“Despite what we would consider a very tough operating environment, we do think these guys have the locations, customer loyalty and the brand that allows them to succeed in that environment,” Edward Jones analyst Bobby Hagedorn recently told the Canadian Press. “People are going after their core breakfast segment, so we do think the company needs to get back on track. We do think they’re going to be able to do that.”
The shares trade at 21.5 times the company’s last 12 months of earnings, compared to 38.6 for Dunkin Brands and 36.8 for Starbucks.
The company reaffirmed its 2013 earnings outlook of C$2.87 to C$2.97 a share this year, up from C$2.59 in 2012. The average analyst estimate calls for earnings of C$2.94, rising to C$3.33 in 2014. The stock trades at 19.7 and 17.4 times those figures, respectively.
Meantime, investors will have to wait to see precisely what Caira has up his sleeve to accelerate growth when the company unveils a new strategic plan later this year.