The Canadians are Coming!

By Chad Henage - July 16, 2012 | Tickers: DNKN, PNRA, SBUX, THI | 0 Comments

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In the past, I've read several articles extolling the virtues of Tim Hortons (NYSE: THI). The main thing that I knew about this company, was that it was a Canadian-based competitor to companies such as Panera Bread (NASDAQ: PNRA), Dunkin Brands (NASDAQ: DNKN), and even Starbucks (NASDAQ: SBUX). After doing a little bit of research, and looking at the company's most recent earnings report, it seems to me that some of these brands in the United States should be a little concerned, if Tim Hortons steps up its United States expansion.

Granted, we are talking some of the most well-known brands in the United States, and they won't go down without a fight. However, Tim Hortons is a value priced bakery and café shop, that is heavily franchised and knows how to make money. The fact that 99.4% of current restaurants are operated by franchisees, in my opinion, is a competitive advantage for Tim Hortons. Generally speaking, the company can afford to continue to expand, without having to take on too much debt because the franchisee is generally responsible for the opening cost. That being said, to understand the strengths of this company we need to compare their financial results, to some of the previously mentioned competition.

The part that I find the most ironic is, that Tim Hortons is so heavily franchised, similar to Dunkin Brands, and yet their free cash flow is less than one third as much per dollar of sales. In addition, you can see that Tim Hortons has some catching up to do when it comes to EPS growth expected. However, looking at the company's most recent earnings report, gives us an idea that the company's growth could speed up if they expanded into the United States with greater speed.

Overall revenues grew 9.4% in the current quarter, driven by Canadian sales growth of 8.6%, and United States sales growth of 15.8%. The reason the company's overall growth was not faster is, the large majority of restaurants are located in Canada. To prove this point, consider that Canadian sales equal almost 84% of total revenue, and net income is 96% from Canadian operations. With the United States only representing about 5% of revenue, and less than 3% of income, you can see how much expansion potential there is. Additional proof of the potential in the United States market is, same-store sales growth in Canada was 5.2%, versus 8.5% in the United States. However, I'm not suggesting that Tim Hortons can simply come into the United States and take over.

One of the first challenges is something that is happening across the food service industry. Multiple companies are seeing their cost of sales increasing faster than sales growth. In Tim Hortons case, their cost of sales increased by 15.68%, compared to 9.4% sales growth. In addition, Tim Hortons seems to have a challenge with their financials, in the sense that free cash flow this last quarter was $18.09 million, however the company paid dividends of $33 million. While this does represent only one quarter of results, this is nevertheless something investors should keep their eye on. Probably the biggest challenge for Tim Hortons coming to the United States with any amount of force, is the simple fact that their competition has much better brand recognition than the company does here. However, many new entrants into the restaurant industry have done well despite the challenges of existing competition.

Overall, given that Tim Hortons is expected to grow earnings by about 12%, has good free cash flow, and is repurchasing shares at a furious rate, it seems the stock could be a good investment. In particular, the company's share repurchase program is very aggressive. In just the first quarter, the company repurchased 1.7 million shares at an average cost of $50.50. Given that shares trade at just slightly over this amount, investors have the opportunity to buy shares at just slightly ahead of what management paid. One challenge for Tim Hortons as an investment, is the shares are certainly not cheap, trading at over 19 times forward earnings estimates. That being said, with a 1.6% dividend yield, and huge potential future growth here in the US, investors should consider adding Tim Hortons to their Watchlist today.

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