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Why Tims is a top U.S. restaurant stock Add to ...

Wall Street is lukewarm on Tim Hortons , a quick-service restaurant chain that sells baked goods, coffee and sandwiches. Of analysts covering the company, 36 per cent rate its stock "buy" and the remaining 64 per cent rank it "hold." Yet, the TheStreet's stock model ranks it as the top U.S. restaurant stock based on risk-adjusted performance.

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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 per cent 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, Tim Hortons was spun off in March of 2006. Its stock has returned 26 per cent since then, while the S&P 500 Index has dropped 19 per cent. 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 per cent increase for the year, because of recent success. A pending $475-million sale of a 50 per cent stake in Maidstone Bakeries may mean more share buybacks.

As for the numbers, second-quarter net income increased 21 per cent to $94-million, and earnings per share climbed 26 per cent to 54 cents, boosted by a share repurchase program. The company's operating margin extended from 21 per cent to 23 per cent.

The operating margin exceeds those of restaurant peers McDonald's , Denny's , Chipotle , Panera and Starbucks . A net margin of 15 per cent is also lofty. Quarterly same-store sales rose 6.2 per cent in Canada and 5.4 per cent in the U.S., despite weaker consumer spending.

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Tim Hortons pays a 13-cent quarterly dividend, equaling a yield of 1.5 per cent with a modest payout ratio of 28 per cent. 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 per cent, 22 per cent and 9.4 per cent 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 per cent 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 per cent 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 per cent, Tim Hortons shares posted an eye-catching 3.8 per cent rise.

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