Facing stumbling sales at venerable coffee-and-donuts chain Tim Hortons, Restaurant Brands International (RBI) (QSR 0.33%) hopes to bring its troubled subsidiary back into positive territory with a rewards-program makeover. During the company's recent earnings conference call, RBI's CEO made Tim Hortons the first item on the docket, laying out the brand's negative growth impact and what RBI intends to do about it. Before any recovery plan succeeds, however, the company has to address the ire of Tim Hortons' customers and franchisees alike.

RBI's Canadian subsidiary chills profits

Tim Hortons is one of the three main restaurant brands owned by RBI, along with Popeyes Louisiana Kitchen and Burger King. During the company's recent Q4 2019 earnings call, CEO Jose Cil painted a generally rosy picture of RBI's overall performance. Company data largely supports this narrative, with 9.9% systemwide sales growth during the quarter. Burger King's sales climbed 8.4% in Q4, while those of Popeyes popped an outstanding 42%, driven by its success in the "chicken sandwich wars."

The one sour note in the swelling chorus of success came from Tim Hortons. The brand generated a year over year 2.9% sales decline. Comparable sales fell even faster, dropping 4.3% for the quarter. More than a temporary anomaly, the decline affected Tim Hortons' whole-year performance. Sales in 2019 fell by 0.3%, and comparable sales shrank 1.5% for the year. Even in the previous year, Tim Hortons was weak overall, generating only 0.6% comparable sales growth, less than a third of Burger King's.

To understand Tim Hortons' effect on RBI overall, consider the company's year in terms of adjusted earnings before interest, taxes, depreciation, and amortization, or EBITDA:

  • Without Tim Hortons, the EBITDA of Burger King and Popeyes grew by 8.94% year over year.
  • With Tim Hortons, the total company's EBITDA grew only 4.16%.

The fact that Tim Hortons reduced RBI's EBITDA growth by more than half indicates how much its troubles are putting the brakes on the company's profitability as a whole.

A Tim Horton's restaurant with an SUV parked outside.

Image source: Tim Hortons

Jose Cil spoke at length about the Tim Hortons situation, identifying Canadian sales as the problem area. With only approximately 205 restaurants out of 4,932 outlets located outside North America, according to RBI's 2019 Investor Day presentation, and  with more than 3,800 franchises still operating in Canada, sales difficulties there are highly significant. In Cil's own words, "There is clearly a sizable gap between what this brand is capable of and the performance we've delivered."

The CEO's proposed solution, already being implemented, consists of an enhanced loyalty and rewards program. Some of the incentives, either already offered or soon to be rolled out, include:

  • A free coffee or baked good after seven purchases (one per visit) at Tim Hortons.

  • Tailored offers.

  • Most menu items eligible for redemption.

  • Changeover from a visits-based system to a points-based system indexed to purchases (likely to reward people who make bigger individual purchases). Visits will seemingly convert to points at a rate of 1 visit equaling 10 points.

Cil went on to note that RBI had "strayed" from Tim Hortons' "core values" such as quality, freshness of foods and ingredients, and value for money. He stated that to improve quality, the company had already installed fresh coffee brewer machines at 2,000 restaurants, and that other initiatives included focusing on skimmed milk that most Canadians prefer, offering almond milk, and improving the texture and flavor of breakfast sandwich ingredients like bacon and bread.

Tim Hortons trouble comes not in single spies, but battalions

RBI's detailed plans seem intended to address problems at Tim Hortons from multiple directions. Actual execution has proven rocky so far. Tim Hortons offers an app allowing people to preload money for purchases in-store, used by approximately 2 million people. However, following botched updates starting in December 2019, the app erased the balances of at least 20,000 users, causing their money to disappear. As of late February, many had not received a refund or credit for the lost money, despite company apologies. The error also erased reward program visits and points from user accounts. 

Since Tim Hortons' acquisition by Burger King in 2014 and the companies' merger to create RBI in December of that year, the Canadian restaurant's reputation plunged among Canadians. Surveys by Leger ranking Canadian companies showed Tim Hortons tumbling from 4th place in 2016 to 50th place by 2017. According to a somewhat informal February 2020 survey on Facebook by Yahoo Canada, 90% of respondents said they were unhappy with Tim Hortons. More tha a quarter, 26%, said they wanted better baked products in the restaurants, 21% thought it should be a private Canadian company, and 19% wanted fewer menu items.

Adding to RBI's difficulties, a group of franchisees who dubbed themselves "The Great White North Franchisee Association-USA, Inc." are suing the parent company for price gouging. The lawsuit document points out RBI forces its franchisees to purchase all supplies either from its affiliates or from companies with rebate agreements with RBI, all of whom charge Tim Hortons franchisees prices far above current market value.

The brief points out the discrepancy between RBI's franchise revenue of $286 million and its $586 million supply chain sales, and accuses RBI of falsely billing itself as a franchisor when it is in fact a supply chain company. The document goes on to cite suppliers selling identical supplies at much higher prices to Tim Hortons than to Wendy's (WEN -0.49%), allegedly owing solely to the leverage provided by the RBI contract. It also describes dropping same-store sales and numerous restaurant closures since the acquisition, blaming this on allegedly predatory practices by RBI.

Tim Hortons raises uncertainty about RBI's future course

Restaurant Brands International is aware of the problems at Tim Hortons and has developed a detailed set of initiatives to attempt correcting them. However, these will have to overcome multiple obstacles to put the brand securely back in the black for the long term. Loyalty programs have an uphill fight against the company's current rock-bottom reputation, a situation not made any easier by problems like the money-erasing Tim Hortons app. A franchisee lawsuit and company-acknowledged "straying" from quality could also prove costly to set right.

It's still too early to say if RBI's Tim Hortons turnaround plan will succeed. It might work, or the subsidiary could continue to be a ball and chain on growth, or RBI might spin the brand off as an independent entity or sell it to another company. Until the situation is resolved, Fools investing in restaurant stocks may want to consider the possible outcomes carefully before adding the stock to their portfolio.