With Canadian Retail Sales on the Rise, Time to Buy Tim Hortons?

Tim Hortons ended the week on a high note. The Canadian coffee shop saw its share price jump 2.76% on Friday after a report from Statistics Canada showed strength in retail sales and limited inflation. Specifically, June sales showed a 1.1% rise from the previous month and an impressive 5.9% year-over-year gain. Food and beverage stores specifically showed a 1.3% gain from the prior month, above the overall average, with a lower year-over-year gain of 3.6%. According to Reuters, this beat expectations as analysts had expected an 0.3% jump over the prior month.

Analysts had also expected 1.9% inflation but it came in at 1.7%. With better-than-expected economic results in Canada and expansion underway in the United States, is it time to buy Tim Hortons?

Tim Hortons has 3,630 restaurants in Canada but it has limited space for more restaurants there, so it has been adding stores in the United States where it had 866 at the end of the second quarter. Its Canadian segment can serve as a cash cow to help provide the funds its United States segment needs to expand, so it needs to show stable results in Canada with more growth-oriented numbers abroad.

The second quarter earnings call shows that pricing power has been driving sales growth for Tim Hortons recently. The coffee shop chain posted 2.6% comps growth in its main market, although it also said that fewer transactions occurred in Canada. While the drop in traffic is somewhat concerning, the recent strength in Canadian retail sales and subdued inflation may indicate that some Canadian customers can handle a price hike. The Canadian market didn't show huge growth either, but Tim Hortons did better on this metric in its main expansion market.

Tim Hortons posted a much stronger same-store sales growth figure of 5.9% in the United States. Once again, pricing drove the growth here as CFO Cynthia Devine said that same-store traffic remained the same versus the comparable period after a question from an analyst. However, this response also indicates that the coffee shop chain has pricing power in the United States as well, which is important because it faces tough competition from McDonald's and other restaurants there. However, Tim Hortons also seems like it has learned an important competitive lesson from the burger seller.

McDonald's has seen sales slide recently and executives have pointed to its menu as a possible source of the problem. Specifically, they think that McDonald's added too many new items to its menu and this slowed down its service speed. Tim Hortons has taken steps to avoid this issue and it explained this on its earnings call. While the chain has experimented with special menu items and limited time offers, it specifically noted that if it decides to keep one of these special items on its menu permanently because customers really like it, the coffee shop will stop selling something else. This could help Tim Hortons maintain an up-to-date menu that remains streamlined at the same time.

Right now, it looks like Tim Hortons' strategy is on track, although its traffic could be better. However, the chain does have pricing power and strength in the Canadian economy should help it maintain its prices. Tim Hortons has a forward P/E of 17, which looks reasonable since it has pricing power to support this valuation along with share buybacks. This Canadian coffee shop seems like it deserves further consideration from investors.

By Eric Novinson

Copyrighted 2016. Content published with author's permission.

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