This Company Could do so Much Better
Chad is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
If I were an investor in Tim Hortons (NYSE: THI), I feel like I'd be pounding on management's door asking what the hold up is. This company is sort of a happy medium between a fast food restaurant like McDonald's (NYSE: MCD) and a bakery-café like Panera Bread (NASDAQ: PNRA). While the company has been reporting decent results, its huge presence in Canada is hurting the massive growth opportunity in the United States. Though the company is taking a slow and steady expansion approach, they could do so much better by taking advantage of their unique concept in the U.S. market.
Overall Earnings Were Good
To get an idea of the difference in the growth rates at Tim Horton's in their traditional Canadian markets versus the United States, you only have to look at the company's last earnings report. Overall sales increased 6%, and through share repurchases and cost efficiencies, diluted EPS increased almost 19%. While I'm sure investors are very pleased with an almost 19% increase in earnings, this is not the longer-term expectation as analysts are looking for 12% EPS growth over the next few years. I honestly believe if Tim Horton's capitalized on its expansion capabilities in the United States this growth rate would increase at least several percentage points. Let's take a look at the company's recent earnings report to show you what I mean.
Canada Drives Results
The majority of Tim Horton's restaurants are located in Canada with the current count being over 3,300 locations. Total sales growth from the region was 5.3%, which was driven by a 1.8% increase in comparable sales. The company is expanding its menu and operating hours to try to drive better results. Specifically, the company said an improved product mix, including hot espresso and latte beverages, increased sales. Also, the company's “breakfast” sales increased with the extension of their opening hours from noon to 11 AM. With 96.71% of total income generated in Canada you can clearly see that as Canadian sales go, so does the company. Though the United States represents a very small part of Tim Horton's overall business, the opportunity for growth is much greater.
The U.S. Is The Future
In the U.S. sales increased 12.8%, driven by strong same-store sales (up 4.9%). Income increased 40%, but this was from a very low base of just $4 million last year. The company cited new product introductions, such as espresso-based iced beverages, and the popularity of their panini sandwiches and specialty bagels as key drivers of higher average checks. While these numbers are extremely impressive, unfortunately for Tim Horton's investors, the U.S. represents just 3.29% of total income. Compared to the over 3,300 restaurants the company operates in Canada, in the United States there are only 734 total restaurants. In addition, the company only opened 13 new restaurants and with this level of growth it will be a long time before the U.S. results represent a substantial contributor to profits.
Impressive Cash Flow That Would Be Better If Management Were More Aggressive
While the company has some work to do to make the United States the true growth driver that it could be, management is doing as much as it can with the company's current cash flow. Tim Horton's regularly retires shares, and diluted shares are down 4.88% versus last year. The company's adjusted operating cash flow increased 11.28% the first six months of this year. This increased cash flow helped the company generate over $160 million in free cash flow, which allowed the company to pay over $65 million in dividends. The company's 40.18% free cash flow payout ratio should give investors confidence that the company will continue increasing dividends in the future.
Tim Horton's Could Be The Best Of Both Worlds
As I said at first, Tim Horton's represents sort of a happy medium between McDonald's and Panera Bread. This is especially true when you look at the company's operating margin and growth rate. Tim Horton's finds itself in the middle ground between these two competitors. McDonald's is the much more established chain, and shows this with analysts expecting earnings growth of just over 9%; it boasts an impressive operating margin of over 30%. Panera Bread is still rapidly expanding, and analysts expect this to continue with earnings growth of almost 19% over the next few years. Panera shows an operating margin much lower than either McDonald's or Tim Horton's, but this should improve as the company matures.
Tim Horton's is expected to grow by about 12%, and their gross margin falls almost perfectly in between their two competitors at just over 20%. With McDonald's offering a roughly 3% yield and with Panera currently not paying a dividend, Tim Horton's dividend yield of 1.66% also falls right in the middle of these two figures. Naturally I have to wonder if Tim Horton's expanded their concept in the United States at a faster pace, could the company's faster growth rate make the stock the best of both worlds? In theory, the company might sport a growth rate closer to Panera, but with a dividend yield that Panera does not possess. There's just one problem standing in the way, and that is Tim Horton's management. The company needs to realize that it has the cash flow to expand more rapidly. While buying back shares is nice, a faster growth rate would be even better.
MHenage owns shares of McDonald's. The Motley Fool owns shares of McDonald's and Panera Bread. Motley Fool newsletter services recommend McDonald's, Panera Bread, and Tim Hortons. 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.If you have questions about this post or the Fool’s blog network, click here for information.