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Tim Hortons bakes its doughnuts in a factory in Brantford, Ont., flash freezes them and ships them to its 3,600 restaurants, which finish the baking process using in-store ovens.MARY ALTAFFER/The Associated Press

It's at the heart of Tim Hortons' pledge to be Always Fresh, and sparks strong emotions among the chain's diehards. Now the future of the iconic chain's baking operations is unclear.

At stake is Tim Hortons' "par-bake" system for making its doughnuts, Timbits, pastries and breads. To the resentment of some of its devotees, in 2003 the chain switched from baking the products from scratch at the store. Instead, it "par-bakes" them: bakes them in a factory in Brantford, Ont., then flash freezes them and ships them to Tim's 3,600 restaurants, which finish the baking process using in-store ovens.

This week, Tim Hortons Inc. 's Swiss-owned par-bake partner said it's bowing out of the marriage. That triggers a provision that gives Tim's the option to sell its interest or acquire IAWS Group Ltd's 50 per cent stake in the joint venture.

Already analysts have flagged potential snags.

"We consider the uncertainties surrounding this announcement to be a negative development," Peter Sklar, an analyst at BMO Capital Markets, said in a report Friday.

The bakery is the cornerstone of Tim Hortons' operations. It's so important to the Oakville, Ont.-based chain that it will be "highly motivated" to snap up the interest of its partner, he said. As a result, IAWS could demand a steep price.

Tim's stake in the joint venture along with 270 consolidated restaurants has a book value of $225-million, the company has indicated. Tim Hortons generated a first-quarter profit of $6.5-million from the combined venture and 270 restaurants, mostly from the joint venture.

The bakery "is a key component of the Always Fresh baking system which has been an important competitive advantage for Tim Hortons," Keith Howlett, retail analyst at Desjardins Securities, said. "The system permits stores to meet ever-changing consumer demand for baked goods on a current and timely basis, with less product waste, lower labour and transportation costs and a fresh-from-the-oven product."

Don Schroeder, chief executive officer of Tim Hortons, told analysts that the joint venture allows it enough wiggle room to land alternative baking arrangements if it needed to do so. The venture includes supply rights for seven years after either party exits from the venture; it provides for sourcing commitments until early 2016 for doughnuts and Timbits.

"We are in the very early stages of this negotiation process and the resolution of these matters may change as the ultimate ownership structure is determined," he said. He expects to reach an agreement with IAWS by year's end.

Still, Mr. Slkar doesn't think that Tim Hortons would be able to rely on the joint venture's provisions for supply rights for seven years and pre-determined pricing if it has to sell its interest in the partnership.

As well, he is concerned about a franchisee outcry if the acquisition price is high. In that case, the price would underscore the joint venture's profitability and spark resentment among franchisees who are the sole customers of the partnership, funding the underlying economics of it.

"Of course, a larger concern would be if IAWS were to acquire Tim Hortons' JV [joint venture]interest, but we consider such a scenario to be unlikely," he added.

Despite his concerns, Mr. Sklar raised his one-year stock price target to $37 from $35.

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