Largest quick-service restaurant in Canada Tim Hortons Inc. (THI) has been recently drawing some attention as to its recent performance. With almost 3,600 units in Canada, and 850 units in the U.S., Tim Hortons generates revenue mainly through franchise royalties and rent payment, company-owned stores and distribution sales to franchisees. Indeed the company's brand is strong and has built some appealing intangible asset, along with a cohesive franchisee system and highly scalable business model. The franchisee model typically allows companies to perceive an annuity-like stream of rent and royalty payment, stabilizing the business against macroeconomic fluctuations and cyclicality.
Nevertheless, this industry is distinctive for its low entering barriers and its competitive pressures, and Tim Hortons is likely to be affected by the increased consolidation of the quick service restaurant industry in Canada. However, this restaurateur is stiff in its position, and with its big scale and strong brand perception holds some competitive advantages as to cope with immediate competition. Moreover, management has been developing an increased brand awareness strategy along with other improvements like the enhancing of guest experience in its restaurants, product innovations in take-home and single-serve coffee products, as well as improved use of technology.
Analysts’ recurrent position has been to disincentivize an investment in Tim Horton based in risks driven by strong competition, market saturation and the challenges presented in a U.S. expansion. Nevertheless, the firm has a long growth runway and is planning to continue doing so, as chief executive Marc Caira announced at Tim Horton's annual investor conference in February. Returns on invested capital have always been in the high teens for the company, and as it controls interest in 83% of its full-service system restaurants, it stands in a better position than its peers.
Improving unit-level productivity at Canadian locations, with a greater daypart penetration outside the breakfast and coffee categories, introducing product innovations, such as Dark Roast Coffee and Frozen Green Tea, along with re-imaging efforts and the development of mobile payment capabilities are part of the company’s effort towards achieving a more leveraged brand. Moreover, speed is being increased through double order stations and additional drive-thru capacity, while expanding through urban areas with “Tims Express” locations. The focus on increasing productivity levels is a key objective for Tim Hortons in the U.S., and management's plan centers on daypart expansion and increasing average check size, along with the pursuing of area development agreements and master licensing agreements in new markets, such as St. Louis, Youngstown, Fort Wayne and Fargo/Minot.
As a result of these efforts, analysts are anticipating approximately a 4% revenue growth in 2014 driven by system sales growth and franchise openings in Canada and the U.S. as well as an expansion of operating margins by 90 basis points in 2014.
Competition in the Market
Companies within the retail-restaurant industry are always susceptible to cyclical and competitive headwinds. The increased competition from larger players such as McDonald's (MCD) and Starbucks (SBUX) might affect Tim Horton’s same-restaurant traffic and same-store sales growth. The company’s position in Canada is strong, but Tim Horton could reach saturation sooner than expected while struggling to expand within the U.S. market, a much more competitive one. Moreover, the quick service restaurant chains will compete for market share on the basis of price and product differentiation, as the marketplace has low switching cost. Nevertheless, Tim Hortons is likely to defend market share over the medium term, and restaurant productivity increase in focus is expected to push up operating margins.
Tim Horton holds a strong business, with a spotless franchisees system and a strong brand perception, along with a great track record of rewarding shareholders, increasing its distribution at a 25% compounded annual clip over the past five years. Furthermore, since 2009 the company has repurchased $2 billion in outstanding shares. The firm controls 75% of traffic of Canada's QSR caffeinated beverage sales and accounts for 42% of QSR traffic. An increased average check with an enhanced menu and more complex beverages are likely to have a positive impact on same-store sales. Still, the industry is fiercely competitive and the macroeconomic instability might affect the company’s performance. Nevertheless, the coffee maker is well positioned to keep its business growing and further within the U.S.
Disclosure: Damian Illia holds no position in any of the stocks mentioned.