Tim Hortons Grows While Market Slows

Canada coffee-and-doughnut franchise Tim Hortons is pushing further into the U.S., a catalyst for the stock.
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BOSTON (TheStreet) -- Wall Street is lukewarm on Tim Hortons (THI) , a quick-service restaurant chain that sells baked goods, coffee and sandwiches. Of analysts covering the company, 36% rate its stock "buy" and the remaining 64% rank it "hold." Yet, the TheStreet's stock model ranks it as the top U.S. restaurant stock based on risk-adjusted performance.

Although Tim Hortons isn't a household name in the U.S., it is in Canada, the country with the highest tally of per-capita doughnut shops. Tim Hortons is the largest food-service company in Canada, with over 2,800 stores, 95% of which are franchises. It boasts leading market share in the Canadian baked-goods and coffee market. It has 500 locations in the U.S. Once a subsidiary of

Wendy's

(WEN) - Get Report

, Tim Hortons was spun off in March of 2006. Its stock has returned 26% since then, while the

S&P 500 Index

has dropped 19%. Management is expanding in 10 U.S. core markets, which include Maine and New York.

Tim Hortons still runs joint locations with Wendy's, though the franchises are no longer under the same umbrella. It has also aggressively added dual venues with privately held

Cold Stone Creamery

, a "super premium" ice cream parlor that sells store-made, high-butterfat ice cream mixed with toppings on a frozen granite stone. There are now 70 co-branded locations. Management recently boosted its 2010 target for co-branded locations by 20 to 25 restaurants, a potential 42% increase for the year, because of operating success. A pending $475 million CAD sale of a 50% stake in Maidstone Bakeries may bring a special dividend or buyback extension.

As for the numbers, second-quarter net income increased 21% to $94 million, and earnings per share climbed 26% to 54 cents, boosted by a lower share count. The operating margin extended from 21% to 23%. It exceeds those of restaurant peers

McDonald's

(MCD) - Get Report

,

Denny's

(DENN) - Get Report

,

Chipotle

(CMG) - Get Report

,

Panera

(PNRA)

and

Starbucks

(SBUX) - Get Report

. A net margin of 15% is also quite lofty. Quarterly same-store sales rose 6.2% in Canada and 5.4% in the U.S. despite weaker consumer spending.

Tim Hortons pays a 13-cent quarterly dividend, equaling a yield of 1.5% with a modest payout ratio of 28%. The stock trades at a trailing earnings multiple of 19, a forward earnings multiple of 18 and a book value multiple of 5.1, 29%, 22% and 9.4% discounts to restaurant-peer averages. The stock trades at parity with its industry based on sales and cash flow per share. Although sell-side analysts are cautious about Tim Hortons, it's a reasonably priced and comparatively safe restaurant investment. In the past four weeks, eight researchers have increased their full-year 2011 earnings targets as two decreased their estimates.

An expected tally of $2.29 translates to a 2011 earnings multiple of 16. Although economic uncertainty is an ongoing concern, recent same-store sales gains, the ramping up of Cold Stone dual-venue locations and proceeds from the pending sale of Maidstone could be catalysts for the stock, which has rallied 16% in 2010, outperforming the S&P 500 by 22 percentage points. Tim Hortons carries $212 million of cash and $415 million of debt, equal to a quick ratio of 0.9 and a debt-to-equity ratio of 0.3.

The stock's largest owner,

Fidelity Investments

, which owns 8% of shares outstanding, boosted its stake in the latest quarter. Six of the 10 largest investors increased their holdings and 17 of the 30 largest investors amplified their bets, indicating modestly bullish sentiment from the stock's major owners. During the rapid correction of the past four weeks, with the S&P 500 falling 4.8%, Tim Hortons shares posted an eye-catching 3.8% rise.

-- Written by Jake Lynch in Boston.

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