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Why Tims' stale stock could be a sweet deal

People still line up for their daily Tim Hortons fix. But lately, you don't see anyone queuing up to buy the stock.

Nearly four years after the much-hyped initial public offering of Canada's beloved doughnut chain, something strange has happened: In the middle of a raging stock market rally, Tims' shares have gone staler than a day-old Dutchie.

They finished yesterday at $30.30, 8 per cent below the closing price of $33.10 on March 24, 2006, the day of Tims' IPO. For investors who like buying great companies at attractive prices, Tims is a sweet deal, some analysts say.

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Even as its shares have lost ground, Tims' revenue and profits have marched steadily higher. Its same-store sales, a key measure that strips out the effect of new store openings, have posted solid gains while other fast-food chains have struggled to hang on to customers.

"Tim Hortons remains a solid long-term growth story," Desjardins Securities analyst Keith Howlett said in a recent note. It is a "prolific generator of free cash" and is "posting the best same-store sales growth of North American restaurants."

If business is so good, why is the stock being left behind?

One factor is the nature of the rally. Investors are flocking to risky assets, leaving so-called defensive plays such as Tims in the dust. There are also concerns that in a few years the chain may near the saturation point in Canada, while the jury is still out on whether its U.S. operations - which only recently broke into the black on an operating basis - will gain sufficient traction, which is seen as critical to the company's long-term growth.

"The way in which the stock is being valued now is that you're not really paying anything for the U.S. business," said Dave Jiles, Canadian equity analyst with Vancouver-based Leith Wheeler Investment Counsel, which owns Tim Hortons shares. "Success in the U.S. would translate into, I think, significant upside for the stock price. I think most investors realize that."

Tims trades at a multiple of 15.3 times estimated 2010 earnings, which is reasonable for a company whose profits are projected to grow at double-digit rates for at least the next few years and which enjoys a wide competitive "moat" in Canada by virtue of its strong brand name, loyal customers and ubiquitous stores.

What's more, the company has conservative debt levels and throws off ample free cash, allowing it to finance expansion and return money to shareholders via stock buybacks and dividends.

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Even as other companies are cutting or holding their dividends steady, Tims announced an 11-per-cent increase in February and is expected to hike its dividend again in the new year, according to Bloomberg estimates. (The company's policy is to pay out 20 to 25 per cent of the previous year's earnings as dividends.) As for concerns that Tims may be running out of room to grow in Canada, the company says it still has plenty of expansion potential. With nearly 3,000 outlets in Canada, it aims to open another 1,000 units, president and chief executive officer Don Schroeder told a conference sponsored by Morgan Stanley last month in New York.

"We still have significant growth opportunities in the province of Quebec, where we believe we can double the size of our chain," he said. "We also continue to have growth opportunities in western Canada, which was the last area of Canada for us to develop. Finally, we still have good growth opportunities in a lot of the large urban markets, including Vancouver and Toronto."

The company is also exploring growth options abroad, having planted the Tim Hortons flag in about 300 convenience stores in Ireland and Britain. In North America, it has teamed up with the Cold Stone Creamery, securing the Canadian rights to the ice cream brand, which it is selling in about a dozen Canadian stores and 65 co-branded U.S. sites.

Longer term, however, the company's success may well hinge on the performance of the Tim Hortons brand south of the border, where it operates 560 stores, largely in the U.S. northeast. Although the U.S. operations are moving in the right direction, it will be a battle, analysts say.

"While we believe Tim Hortons is a high-quality restaurant concept, the U.S. is a highly competitive market with many entrenched players such as McDonald's, Panera Bread, Dunkin' Donuts, Wendy's, Burger King and Sonic, which we believe will make Tim Hortons' expansion more challenging," Brian Yarbrough, an analyst with Edward Jones in St. Louis, said in a research note.

Mr. Yarbrough rates the stock a "hold," but some analysts are more bullish. National Bank Financial's Jim Durran rates Tims "outperform" with a price target of $36.

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Tims "is an extremely high-quality name with dominant Canadian market share, a low capital-intensive U.S. expansion strategy, a rock-solid balance sheet, excellent cash-flow generation, solid unit growth and [Cold Stone Creamery]growth opportunities," he said in a note.

The company has a "terrific business model," added Leith Wheeler's Mr. Jiles. Notwithstanding questions about the U.S., "for long-term, income-oriented investors, this is an attractive stock to own."


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