Despite Tim Hortons (NYSE:THI) being the biggest quick-service restaurant in the country, it's possible that you have never heard of it before. That's because the country being referred to is Canada, where Tim Hortons is an iconic brand. And it's still looking to grow in new and existing markets, particularly Quebec, Western Canada, Ontario, and Canada's major urban markets. But that's just the tip of the iceberg. The real growth potential exists in the United States.
Of the 4,304 Tim Hortons restaurants in existence, 3,468 of them are situated in Canada, and just 807 are located in the United States.
If you're not familiar with Tim Hortons, it develops and franchises out quick-service restaurants in North America. It offers coffee, specialty drinks, cappuccino, fruit smoothies, soup, baked goods, grilled Paninis, traditional sandwiches, and more. Does that description sound familiar? It should -- Tim Hortons is a direct competitor with Dunkin' Brands (NASDAQ:DNKN), and to a lesser extent, Starbucks (NASDAQ:SBUX).
Some investors believe that Tim Hortons isn't capable of competing with these brands if restaurants are in the same geographic area. We can eliminate Starbucks as a major threat immediately, since Starbucks sells high-priced specialty coffee and caters to middle- to high-end consumers. Tim Hortons, on the other hand, is more of a value-oriented operation. For instance, one of its current promotions is $1 for iced coffee, frozen lemonade, or iced latte. Good luck finding anything for $1 at Starbucks.
Dunkin' Donuts presents more of a direct threat to Tim Hortons as it continues to expand in the United States. However, Tim Hortons' new CEO, Marc Cain, believes that Tim Hortons can compete by offering quality, value, convenience, innovative products, and customer service. Further U.S. expansion will no doubt be tricky in the face of competition from Dunkin', but Tim Hortons clearly knows what it's doing as it already has over 800 U.S. stores.
Recent results and expectations
Tim Hortons is a franchiser. It collects revenue from franchised restaurant sales. This keeps costs low, and a lot of the company's potential profitability is tied to its supply chain. With five distribution centers in operation, required capital is kept to a minimum.
In the second quarter, systemwide sales increased 5% year over year. The addition of 18 net new stores played a role, but comps also grew by 1.5% in Canada and 1.4% in the United States. Looking at the bigger picture, systemwide sales in the first half of 2013 increased 4.1%, with comps growing by 0.6% in Canada and 0.5% in the United States.
In addition to international expansion, Tim Hortons will attempt to grow by offering more single-serve products, enhancing its menu, adding drive-through locations, and innovation. As an example of the kind of innovation Tim Hortons is generating, it recently introduced an Orange Tangerine Real Fruit Smoothie and an Apple Cobbler doughnut in Canada, as well as a Jalapeno Flatbread Breakfast Sandwich in the United States.
On a valuation basis, Tim Hortons is currently trading at 20 times earnings, giving it a stronger valuation proposition than Dunkin' Brands (Dunkin' Donuts) at 37 times earnings and Starbucks at 35 times earnings. Tim Hortons also offers a dividend yield of 1.8%, which is slightly higher than Dunkin' Brands at 1.7% and Starbucks at 1.2%. With a debt-to-equity ratio of 0.4, Tim Hortons' dividend appears to be safe. Tim Hortons has also recently reiterated its full-year earnings-per-share guidance of $2.87-$2.97, which would be an improvement over the $2.54 number seen last year.
It should also be noted that Tim Hortons sports an impressive ROE of 35.25%, versus 28.74% and 22.97% for Starbucks and Dunkin' Brands, respectively. While all three companies are good at turning investor dollars into profits, Tim Hortons is the most efficient in this area, and that's saying a lot.
Another interesting note is that Tim Hortons' share price performance proved to be more resilient than Starbucks in 2008/2009, which was directly related to Tim Hortons being Canadian-focused, meaning it had limited exposure to the financial crisis in the United States. The chart below shows this, and a similar pattern could play out if the U.S. were to have a similar economic calamity.
Like most restaurants, Tim Hortons is dealing with some significant headwinds, including a weak consumer and attempting to establish its presence in a highly competitive American market. However, Tim Hortons has been a long-term winner, it's a shareholder-friendly company, and since it caters to the value consumer as well as the consumer on the go (which is always in demand), the stock is likely to be relatively resilient to any market downside. And if the market holds up, then you should have a sure winner on your hands as Tim Hortons heads south of the border.
Dan Moskowitz has no position in any stocks mentioned. The Motley Fool recommends Starbucks. The Motley Fool owns shares of Starbucks. 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.