This Coffee Shop Gets a Shot of Caffeine

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The Canadian-based quick-service restaurant Tim Hortons (NYSE: THI) got a big vote of confidence from the Scout Capital Management hedge fund last week. Per an SEC filing, Scout now owns some 5.5% of the coffee company, and is now calling itself Tim Hortons' second-largest shareholder (check out Scout's top stocks).

Scout Capital looks to find investment opportunities via special situations; it appears that Tim Hortons could offer investors a special situation, having ineffectively used capital to generate shareholder returns. Earlier this year Highfield Capital also took an interest in Tim Hortons, buying up a 4% stake (check out Highfield's top stocks).

What do hedge funds want from Tim Hortons?

Basically, these hedge funds will be pushing the company to unlock shareholder value; Scout plans to engage management to start a discussion concerning its capital structure, capital expenditure plan and stock-buyback program.

This includes exploring the possibility of expanding debt levels to either boost share buybacks or its dividend. The company already pays a 1.8% dividend yield, which is above many of its coffee-shop peers. 

Highfield supports the use debt to fund capital returns, but also wants to see a halting of U.S. expansion. There were 804 Tim Hortons restaurants in the U.S. at the end of 2012, concentrated along the Canadian border in New York, Michigan and Ohio. 

The U.S. store problem is that that these stores have grossly under-performed their Canadian cousins. The U.S. stores brought in a measly $20,000 per store on average of operating profit last year, compared to C$182,000 for Canada-based stores.

In other news, Tim Hortons is looking to improve performance with new menu items, such as the Panini and specialty coffee drinks, as well as increasing traffic with the redesign of stores -- this includes focusing more on opening drive-through locations. The industry tailwinds for the company should be a rebounding economy in both the U.S. and Canada, but their could be a better way to play the coffee industry. 

A better latte

Dunkin Brands Group (NASDAQ: DNKN) and Starbucks (NASDAQ: SBUX) are two of Tim Hortons' most notable competitors. Dunkin has about 10,500 Dunkin' Donuts locations and 7,000 Baskin-Robbins.

Dunkin could be one of the great coffee growth stories, with opportunities to expand in the Western part of the U.S. and in international markets, namely Asia-Pacific. Revenue is expected to be up 7.2% in 2013 after an impressive 4.8% rise in 2012. 

Over 85% of Dunkin's U.S. stores are concentrated in the Northeast part of the country, but about two-thirds of Dunkin's new U.S. store openings are expected to be in the Western part of the country by 2015. And of course, no westward expansion would be complete without California, which will be a big part of the expansion plan. 

Despite not having stores in 12 U.S. states, Dunkin has opened stores in 31 countries outside of the U.S. Key planned international expansion for the company lies in South Korea, the Middle East and emerging markets. 

Green Mountain Coffee Roaster is the key provider of premium and specialty coffees. Green Mountain is one of Tim Hortons' under-appreciated competitors. The company is able to capture customers looking to brew their own coffee, whether it be in the office or at home. The other advantage that Starbucks and Dunkin Donuts have over Tim Hortons is their partnership with Green Mountain to offer their drinks in K-cups. 

Starbucks is the higher-end coffee shop and likely the most recognized coffee name in North America, if not the world. Starbucks has been aggressive at opening stores in new markets and plans to have more than 20,000 retail stores on six continents by 2014. Beyond coffee, the tea business offers a big market for Starbucks, especially in Asia. 

Recent performance has been strong for Starbucks, with same-store sales up 2.9% in April compared to a 0.3% decline in February and a 1.3% increase in March. Fiscal 2013 same-store sales are expected to be up 6% in the Americas and an impressive 9% in China. 

Bottom line

With Scout Capital and Highbridge Capital pushing for change at Tim Hortons, investors could see management reward shareholders in the interim. Billionaire Jim Simons of Renaissance Technologies is also one of Tim Hortons' big-name hedge fund owners (see Simons' new stocks). 

However, for investors looking to invest in growth, Starbucks might be your best bet -- it is expected to grow EPS at an impressive 18.7% annualized over the next five years. Dunkin has impressive expected growth at 15.6%, but its valuation appears to be a bit rich for the time being. Dunkin trades at 45.5 times earnings, while Starbucks is at 33 times and Tim Hortons at 22 times. 

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Marshall Hargrave owns shares of Starbucks. The Motley Fool recommends Starbucks. The Motley Fool owns shares of Starbucks. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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