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Incoming Tim Hortons Inc. CEO Marc Caira faces a noisy welcome: two U.S. activist hedge funds which between them own almost 10 per cent of the stock and are pushing for a slew of changes. Longer term shareholders should be wary, since their ideas amount to little more than financial engineering and don't address the real challenge: Tim Hortons' long-term growth plans.
Public disclosures from Highfields Capital Management in early May and now Scout Capital suggest the activists think some immediate fiddling can boost the stock price: namely, by packaging Tims locations into a real estate investment trust and levering up its balance sheet to fund a major stock buyback.
Let's address those points first. Tims owns so little of its real estate that any bump to its stock price by selling its owned properties into a tax-efficient trust would be marginal, perhaps adding a buck to the share price. The company is open to taking on debt and funding a buyback, but levering up comes with other costs: it weakens flexibility, particularly if the tepid economy worsens, and could crimp capital spending, and therefore growth, plans. Highfields is also skeptical about Tims' thus-far underwhelming expansion into the U.S. Returns there, it said in a recent letter to management, "do not justify further material investments in this business." These suggestions are one-time events that might boost the share price in the short term, but investors should ask if they are worth the longer-term tradeoffs.
The central question about Tims boils down to this: should the company stick to its growth strategy, and if so, is it a sustainable plan? Or should the Canadian icon throw in the towel and position itself to become a low-growth, income trust-like annuity for investors?
Tims has an incredible franchise network in Canada, but it also has 3,453 outlets and should be up to around 3,600 by year-end. Company leaders have said the country can support at least 4,000 Tims outlets, which at the current rate of expansion will be reached in 2016. Perhaps there's a lot more growth to be had here: the company has said there's plenty of room in western Canada and major cities for more Tims. Long lineups in many locations suggest that's justified, and that Quebec alone could support 500 more outlets. Perhaps the threshold in Canada isn't 4,000 stores, but 5,000 or even 6,000.
But nobody should sell short the U.S. strategy just yet. The 800-plus stores in the U.S. are undoubtedly weaker performers: Operating income is still marginal, at $16.5-million last year compared to $637.3-million in Canada, but both sales per square foot and operating income are growing at a faster rate than than they are at home. Some mature stores in the U.S. are performing as well as Canadian outlets. Tims hasn't found the unqualified winning formula south of the border yet, and it is trying to compete in a far more competitive market with a much-less-known brand than in Canada. A tough, multi-year slog lays ahead. But the U.S. business represents such a small share of the company's value today – and represents such little downside risk overall – that investors should hold out for a new plan. Give the new guy, who doesn't even take over as CEO for two weeks, a chance. Tims' best chance for sustained growth is its business south of the border, not playing balance sheet Twister to satisfy the fast money crowd.
Sean Silcoff is a contributor to ROB Insight, the business commentary service available to Globe Unlimited subscribers. Click here for more of his Insights , and follow Sean on Twitter at @seansilcoff .
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Sean Silcoff