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Falling out of love with Tim Hortons Add to ...

Could it be that the great Canadian love affair with Tim Hortons Inc. is starting to wane?

Certainly, investors are no longer quite as smitten with the stock these days. Consider that, if you purchased shares at the start of 2012, your capital gain for the year would be virtually nil. After peaking at all-time highs near $58 in May of last year, they have tumbled by more than 15 per cent. The stock that had been in a seemingly unstoppable upward trajectory since the start of 2010 is in bad need of a double shot of espresso.

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Tim Hortons, according to the company, sells eight of every 10 cups of coffee sold in this country. Its brand resonates so strongly and proudly within these borders that questioning its future prosperity may be considered sacrilege.

But I think anyone considering investing in the stock must look beyond its iconic cultural status and see the troubles that may be brewing.

Same-store sales growth is slowing rapidly. In the third quarter, they rose just 1.9 per cent in Canada, far below the 4.7 per cent growth of a year earlier and well below the company’s full-year target of 3 to 5 per cent. And you can’t just blame an over-saturation of Timbits and double-doubles in this country: U.S sales grew just 2.3 per cent from last year’s 6.3 per cent, also well below annual targets.

For a reason why, look no further than the Golden Arches. McDonald’s Corp. has poured on the competition of late, offering coffee giveaways in new stores remodelled to resemble a neighbourhood café, complete with a cozy fireplace. Tims is still growing its sales and profits as it expands into such premium offerings as lattes and panini sandwiches. But it also may be putting at risk its nostalgic grip on the national psyche, no longer quite the same “Canadian doughnut shop” many of us grew up with.

McDonald’s also saw a weak third quarter, but it wasn’t an industry-wide phenomenon that you can simply blame on soft consumer confidence; Starbucks posted surprisingly strong results in the same period, with same-store sales in the U.S. rising 6 per cent.

Taste is subjective, of course, but I personally have always been amazed that Tim’s coffee commands such a massive market share. It’s easy to sip and agreeable enough, but rather bland. Recent professional taste tests – including at Canadian Business magazine and here at The Globe and Mail easily ranks the javas from Wendy’s and McDonald’s higher. Tim’s growing food menu offers good value for money, but whether it’s soups, smoothies, sandwiches or muffins, it’s pretty ordinary and unmemorable cuisine.

Many Canadians must think differently, given how often I encounter jammed stores with long line-ups. This is a problem in itself, though; the company is struggling to retain “look and leave” customers during peak hours. Tim Hortons is adding new stores and doubling drive-through lanes at a dizzying pace, but as UBS analyst Phillip Huang recently noted in a recent research note, the company “still has significant room to ease capacity constraints” despite improvements over the years.

Then there’s the question of just how far the Tim Hortons brand name will resonate beyond these borders, and results have been inconclusive so far. The company has more than 700 locations in the United States and had planned to grow that number by about 100 full-service restaurants last year. It’s also dabbling in overseas markets, expecting to add about 120 locations in the Middle East within five years.

Management clearly has challenges ahead convincing consumers more familiar with the Starbucks, Dunkin Donuts or Panera Bread Co. to drop by. Note how it slaps on the “café and bake shop” label at its U.S. locations to clue-in customers who don’t know what it’s selling.

As a stock, Tim Horton’s is among the most expensive of Canadian retail and restaurant companies, trading at a forward price-to-earnings ratio of about 16 times. Its growth prospects, including international expansion, are key to maintaining that kind of lofty valuation.

Canadians may very well be going for their Timmies runs for decades to come. But investors shouldn’t take the brand’s profitability for granted.

READERS: What are your thoughts on Tim Hortons as an investment? Do you think their international expansion will be successful? Are their new paninis or classic double-doubles enough to keep the competition at bay?

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