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- (Chris Young/The Canadian Press)
- (Chris Young/The Canadian Press)

YIELD HOG

Why I sold my Tim Hortons stock Add to ...

John Heinzl is the dividend investor for Globe Investor’s Strategy Lab. Follow his contributions here. You can see his model portfolio here.

I was never a big fan of Tim Hortons coffee, but for years I was a huge fan of the stock.

In fact, for a dividend growth investor like me, Tim Hortons Inc. had just about everything.

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For starters, there was the iconic brand name, the addictive nature of the product and the fact that I found myself drinking the coffee anyway – and ordering iced cappuccinos and frozen lemonades for my wife and kids – just because Tims was always the handiest place to stop on a road trip (and had the cleanest bathrooms).

The Canadian thing? Yeah, that was part of it, too. When my kids were learning to play hockey on our local outdoor rink, both proudly wore their blue-and-white Timbits jerseys. Several years ago, my son even got to play hockey at the Air Canada Centre between periods of a Leafs game.

But as an investor, it was something else entirely that won me over: Tims’s shareholder-friendly philosophy.

Although the stock never sported a massive yield – the highest it got was about 2.2 per cent – I liked the fact that the company carried modest levels of debt, generated copious amounts of cash and used the money to reward shareholders with hefty dividend increases (I looked at it as payback for all the money I spent there). Over the past five years the dividend grew at an annualized pace of more than 25 per cent – the highest, by far, of any stock I owned. (I never held Tims in my Strategy Lab model portfolio only because I was limited to 12 stocks.)

Tims’s dividend hikes every February became as predictable as the long lines at its stores. I would mark the date on my calendar and eagerly await the the increase, which was always well into the double digits.

And those dividend increases would have probably continued for many years to come – had Burger King Worldwide Inc. not entered the picture.

Tims can talk all it wants about how the $12.5-billion merger with the U.S. burger chain, owned by 3G Capital, will accelerate the Canadian company’s international expansion. But for income-oriented investors, the deal means the days of juicy dividend increases are almost certainly over.

Let’s call the deal what it is: a highly leveraged buyout. The merged company will be saddled with so much debt and diverting so much cash to interest and principal payments that dividend hikes will be well down the list of priorities.

Here are a few numbers to chew on.

Following the transaction, which is slated to close by early 2015, the merged company is expected to yield about 1 per cent, based on Burger King Worldwide’s current share price. That’s assuming the company maintains its current quarterly dividend of 8 cents (U.S.) a share.

But the combined company, which is being financed with borrowed money, will also initially carry net debt of about $11.8-billion (including preferred shares), a staggering amount compared to Tims’s current net debt of about $1.38-billion (Canadian). Clearly, this will not be your dad’s Tim Hortons.

“The issue for shareholders unfamiliar with this type of investment is that the company will be highly levered upon formation,” Perry Caicco, an analyst with CIBC World Markets, said in a report.

Specifically, the merged company’s net debt will be about 7.6 times trailing earnings before interest, taxes, depreciation and amortization (EBITDA), which will necessitate paying down debt aggressively. By comparison, Tims’s net debt/EBITDA multiple is a much more conservative 1.6.

The good news is that, even with interest payments of about $590-million (U.S.) annually, the company should generate about $850-million of cash flow after common and preferred dividends are paid. The bad news for dividend investors is that most of this excess cash – apart from a small amount for capital expenditures – will probably be funnelled toward debt repayment, Mr. Caicco said in his report.

In other words, don’t expect any juicy dividend increases from the Home of the Whopper. It will be too busy paying back creditors.

And what if Burger King’s business hits a pothole? Leveraged companies don’t have a lot of financial flexibility during tough times, and cutting the dividend is one way to conserve cash. With Tim Hortons, that was never a worry.

I’m not saying the combined company won’t be successful. I hope it takes the Tim Hortons brand around the world and makes a lot of money for shareholders and franchisees. For his part, Mr. Caicco said the company “has a chance to create material shareholder value.”

But as a dividend growth investor, I won’t be going along for the ride. Last week I sold my shares, and today – with no small amount of sadness given my personal and financial relationship with this great Canadian brand – I’ll receive my final dividend from the company.

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