DBRS Confirms Tim Hortons at A (low), Stable Trend

DBRS has today confirmed the long-term rating of Tim Hortons (THI or the Company) at A (low), with a Stable trend. THI continues to benefit from its position as the leading quick service restaurant (QSR) in Canada, while exploring and refining its U.S. and international expansion strategies.

In 2010, THI revenues increased by 4% from the previous year to approximately $2.54 billion as system-wide restaurant sales rose 6.2% to over $5 billion. System-wide restaurant sales growth was based on same-store sales growth of 4.9% in Canada and 3.9% in the United States, in addition to 172 net new restaurant openings. Operating margins remained fairly stable as rising input costs were offset by price increases and improved product mix. THI disposed of its 50% interest in Maidstone Bakeries (the Bakery) in 2010 for cash proceeds of $475 million. The Bakery remains obligated to supply THI at agreed-upon pricing through 2016, after which THI has an option to extend the obligation for an additional year. THI incurred one-time asset impairment and closure-related costs of $28.3 million in 2010, as the Company exited a number of underperforming markets in New England.

Q1 2011 revenue increased by 10.4% year-over-year (yoy) as a result of an increase in system-wide restaurant sales, as well as changes in supply chain accounting resulting from the disposition of the Bakery. Q1 same-store sales growth continued to be positive (+2.0% in Canada and +4.9% in the United States) and THI opened 32 net new restaurants in the quarter as the pace of store openings in Canada and the United States remained strong. Operating income in Q1 declined, however, primarily as a result of the disposition of the Bakery. In terms of financial profile, cash flow from operations continued to track operating income and increased moderately from 2009 levels. Capex declined substantially to $132.9 million in 2010 (from $160.5 million in 2009), despite the opening of 172 net new stores, as the mix of new stores included a high proportion of non-standard stores requiring lower capital investment.

Dividends increased approximately 25% from the previous year, as THI continues to return value to shareholders. Share repurchases of $245 million in 2010 and an additional $200 million in Q1 2011 resulted in a reduction of cash-on-hand from $574 million at year-end 2010 to $313 million at the end of Q1 2011. Gross debt levels remained largely unchanged, resulting in relatively stable lease-adjusted debt-to-EBITDAR.

Going forward, DBRS expects that the Company’s earnings profile should remain stable in the near to medium term on the strength of its market position in Canada and its U.S. and international growth strategies. DBRS forecasts mid-to-high single-digit growth in system-wide restaurant sales in 2011, based on same-store sales growth of 4% and 250 net new restaurant openings. International growth in the form of licence agreements will continue as five stores are expected to be opened in the Gulf Cooperation Council area in 2011. Such growth in number of restaurants, along with organizational and accounting changes after the disposition of the Bakery, should result in approximately 10% corporate revenue growth. DBRS believes margins should come under pressure in 2011 as a result of rising input costs, which are likely to offset price increases. As such, DBRS expects THI to generate EBITDA in the range of $640 million to $660 million in 2011, growing at a slower pace than top-line revenue.

THI’s financial profile should remain stable in the near to medium term as DBRS forecasts cash flow from operations should continue to track operating income and remain steady in the range of $450 million to $475 million range in 2011. Capex requirements should be within the $175 million to $200 million range in the near term as THI continues to invest and open new locations in North America. Free cash flow should nevertheless be in the range of $145 million to $175 million in 2011 and 2012. In the medium term, DBRS expects THI will continue to use free cash flow to invest in growth and return value to shareholders via dividends and share repurchases, while leverage is expected to remain stable and within the range for the current rating category. Deterioration in credit metrics (i.e., lease-adjusted debt-to-EBITDAR above 2.0x) as a result of weaker-than-expected operating performance or more aggressive-than-expected financial management could result in pressure on the current rating.

Notes:
All figures are in Canadian dollars unless otherwise noted.

The applicable methodology is Rating Food Retailers, which can be found on our website under Methodologies.