The Underrated Growth Story of the Great White North

Marshall is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

A couple of top hedge funds are pushing for change over at Tim Hortons (NYSE: THI), but one thing investors are missing is the growth opportunities. The Canadian coffee giant has industry tailwinds, leading market share and expansion opportunities. Tim Hortons has grossly under-performed its peers, which include Dunkin' Brands Group (NASDAQ: DNKN) and Starbucks (NASDAQ: SBUX), and the broader market over the past 12 months. 

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But this should be taken as a buying opportunity. Part of its under-performance has been driven by a slipping of its death-grip on the Canadian coffee market share, while the other contributing factor has been the company's less-than-stellar foray into the U.S. market. Tim Hortons has previously enjoyed market share of over 80% in the Canadian coffee market. Helping hedge this decline going forward should be the company's initiatives to offer new menu ideas, including paninis and specialty coffees. 

Tim Hortons has consistently grown same-store sales at a 4%-plus rate, but the last two quarters saw only 2% growth. This was in part due to weak growth in sales of its U.S. stores. As I mentioned a couple of weeks ago, one of Tim Hortons hedge fund supporters, Highfields Capital, plans to push for the halting of a U.S. expansion, where U.S. stores have under-performed their Canadian stores; U.S. stores brought in a measly $20,000 per store on average of operating profit last year, compared to C$182,000 for Canadian-based stores. If the company takes Highfields advice and slows/stops U.S. growth, it should be able to return to strong same-store sale growth. 

Industry tailwinds

Thanks to steady consumption, coffee is still a hot market in Canada. The Canadian Coffee Association has found a number of notable trends, including the fact that next to tap water, coffee is the most consumed beverage in the country. Some 65% of Canadian adults bring coffee on a daily basis. Even the popular coffee drink, a "double-double," can now be found in the Canadian Oxford Dictionary. 

Tim Hortons has moved from a coffee and donut shop to a full-blown quick- service restaurant, now offering specialty coffees and lunch foods. Also, earlier this month, the coffee company also announced it would start accepting American Express as payment. 

The other growth story

Nearly 100% Dunkin's stores are franchised, which is an advantage due to the lower required capital. Franchisees provide the capital for the vast majority of costs. This allows the company to better focus on strategies and initiatives, leaving the day-to-day management to franchisees. Worth noting is that 99% of Tim Hortons' stores are also franchised. 

Dunkin plans on doubling its U.S. stores to 15,000 from its current base of nearly 7,000 over the next 20 years. Other key moves include the broadening of its presence in the New England marketsWhere Tim Hortons entered the lunch/dinner market with the launch of paninis, Dunkin is looking to drive sales higher with the introduction of new sandwiches, such as the Big 'N Toasty and gluten-free baked goods. 

Dunkin is expected to increase its distribution points by 3.5% in 2013 and post  3.5% growth in same-store sales. But Baskin-Robbins still appears to be a laggard for the company, with same-store sales expected to be flat in 2013, thanks in part to a weak European economy. 

Starbucks is always compared to the likes of Dunkin; however, Starbucks is quite a different beast. The majority of the company's stores are company owned and operated, while Dunkin has 100% of its stores franchised. The coffee company owns-operates over 6,850 stores in the U.S. and over 2,500 in the international markets. Meanwhile, there are also 4,200 licensed retail Starbucks stores in the U.S. and internationally, each. As far as revenue breaks down, the coffee company generated nearly 75% of revenue from beverages and 19% from food, while whole-bean coffee was 4% and coffee-related hardware 2%. 

Even being a $50 billion market-cap company, Starbucks is expected to grow revenue at an impressive 10% in fiscal 2014 after 12% growth in 2013, where same-store sales is expected to grow 6%. 

Some of the biggest news for Starbucks is its entry into the at-home coffee market, which is one of the biggest threats to the coffee-shop industry. I think this entry into the single-cup coffee market, and its expansion into China and India, will be long-term growth drivers of the company. 

What makes Tim Hortons great? 

It's no secret that Dunkin has impressive opportunities for westward expansion in the U.S….

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However, what's less known is Tim Hortons' westward expansion opportunities. Tim Hortons is heavily concentrated in the Eastern part of Canada, but it has opportunities to expand in Northern Quebec and Ontario, as well as farther West. 

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Tim Hortons also gets the nod in a number of other areas compared to Dunkin, including balance sheet health and returns.

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What's a Fool to do?

Tim Hortons now has the backing of a couple of activist hedge funds that are pushing the company to unlock value for shareholders, with the most likely scenario being a dividend and share-buyback increase by leveraging its strong balance sheet. This is great news for investors, but I think the possibility of strong future growth for the company is being under-appreciated. 

Although Tim Hortons is the best value and income play, Dunkin has impressive growth plans for the Western U.S. and Asia that could make the stock a growth play for your portfolio. So what does that make Starbucks? This coffee company is the industry powerhouse, and with international expansion at the top of its priority list, the company could be a large-cap growth story. I guess what I'm saying is that it wouldn't be completely unreasonable to own all of these coffee shops!

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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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