Time to 'Double Double' Down on Tim Hortons?

By Chad Langager | March 24, 2006 AAA

Tim Hortons (THI), the Canadian coffee and donut chain, made their debut today as a publicly traded company, trading on both the NYSE (NYX) and the Toronto Stock Exchange (C.X). Shares traded up as much as 42% above the IPO price in the opening hour of trading. The company, which was has been a part of the Wendy's International (WEN) brand for the last 11 years, is using the $672M it raised to pay off debts it owes Wendy's.

The IPO market this year will likely be remembered by the numerous restaurant companies that went public. So far this year, not including Tim Hortons, there have been two other restaurant IPOs, Chipolte Mexican Grill (CMG) and Morton's Restaurant Group (MRT). And to top it off, Burger King will likely IPO in the first half of the year, potentially becoming the largest restaurant public offering ever.

Chipolte Mexican Grill, which was spun off from McDonald's (MCD), has been the best performing IPO of 2006, having risen nearly 150% since Jan. 25. Morton's Restaurant, on the other hand, has not seen similar success, only trading 2.3% above its initial offer price of $17. Looking ahead, will Tim Hortons follow in the footsteps of Chipolte or Morton's?

Tim Horton's has had strong financial performance over the last five years, seeing annualized revenue growth of nearly 10%, with total sales jumping from $926M in 2001 to $1.48B in 2005. The company has also seen solid bottom-line numbers, posting an average profit margin of 14% over the last five years.

Tim Hortons is also seeing strong same-store sales growth within their restaurants -- an increase of 6.0% in 2005, however this rate has been falling over the last five years (9.2% in 2001). The greatest area for future growth at Tim Hortons will come from continued store expansion in Canada and the U.S. instead of same store sales growth.

Even though the company is already the largest quick-serve chain in Canada, with over 2500 stores, they still have aggressive expansion plans. Tim Hortons has a long-term goal of 3500 to 4000 stores in Canada, which represents a 40% to 60% increase in franchises.

The potential increase does raise concerns about over-saturation of the Canadian market place. But with the company's leading presence in the Canadian market, its strong brand name and the continued long lines that form every morning for Double Doubles (a coffee with two cream and two sugar), the Canadian market might prove to easily digest these increases.

The greater growth potential for the company lies in the U.S., which has over ten times the population of Canada while harboring only 10% of total Tim Horton's locations. The company is looking to aggressively pursue expansion into the U.S. market beyond the ten states it currently operates in.

By 2008, the company plans to increase their U.S. store count to 500 from the 288 it currently has, which is almost a 100% increase. Another positive within the U.S. market is that U.S. same-store sales growth currently exceeds that which is found at Canadian stores -- U.S. store counts have grown by 7% per year compared to 5.2% in Canada.

The average Canadian operation generates $1.6M in annual revenue while U.S. operations average $1M, so there should be a significant amount of growth left at the same-store level for U.S. operations. However, while the Canadian operations have generated significant profit for the company, its U.S. operations have lost money in each of the last three years.

An investment in Tim Hortons is essentially a bet on the company's ability to profitably expand into the U.S. and maintain its success in Canada. The former of those two factors is the one that creates significantly more risk, as the U.S. market is full of competition at the quick service level.

With competitors such as Starbucks (SBUX) and Krispy Kreme (KKD) in the mix, the transition into the U.S. is made more difficult by the fact that the Tim Horton's brand name carries little consumer awareness outside of the ten states it currently operates in. But even with this challenge, there remains a lot of potential for Tim Hortons in the U.S. market and the company deserves a second look.

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