BUSINESS

Tim Hortons CEO responds to unhappy investors by beefing up share buybacks

08/08/2013 09:51 EDT | Updated 10/08/2013 05:12 EDT
Tim Hortons' new chief executive has made a play to satisfy restless investors by increasing the restaurant chain's debt to repurchase shares and changing its U.S. growth strategy.

"This company and brand is woven into the fabric of Canada and I believe Tim Hortons has many opportunities ahead of it in Canada, the US, and internationally," Marc Caira said Thursday during a conference call with analysts.

The coffee and doughnut chain is going to borrow up to an additional $900 million to fund the repurchase of its shares. That's on top of $100 million already earmarked for repurchases for the coming year. Over the next few weeks, it will decide whether to fund the added leverage through bank debt or a bond issuance.

The company said it's not certain how much it will actually spend on the revised stock buyback program, but the additional borrowing will preserve its flexibility to invest the business while creating value for its shareholders.

Tim Hortons (TSX:THI) has received regulatory approval to buy back up to 10 per cent of its publicly traded shares, raising a previous spending limit set at $250 million.

In June, Tim Hortons came under pressure from shareholder Scout Capital Management, which called on it to revamp its U.S. expansion plans and borrow money to buy back shares. The push followed an reports earlier this year that U.S. investment firm Highfields Capital Management also wanted changes at Tim Hortons.

Caira, who took over as chief executive last month, said the move Thursday will also allow the company to take advantage of low interest rates.

"We will also be placing our debt ratios more in line with both our Canadian retail peer group and many of our U.S. restaurant peers with similar capital intensity."

By maintaining an investment grade rating, Tim Hortons will preserve its financial flexibility for its next stage of development.

Chief financial officer Cynthia Devine said the added leverage and buying back shares will increase earnings per share and create shareholder value.

Since it went public in 2006, Tim Hortons has repurchased about $1.7 billion in common shares while increasing its dividend by an average of 20.6 per year. Its market capitalization has increased to more than $9 billion from about $6 billion.

Caira said the company remains committed to expanding its U.S. presence, but is looking at altering how it funds that growth. It has accelerated efforts to attract partners which would carry more of the financial burden, presumably in exchange for lowering Tim Hortons franchise royalties. He said the change should reduce capital deployed in the U.S. beginning next year.

"I very much see the U.S. as being a must-win market for us. Based on the dynamics of the market, and the footprint we already have created, I believe the U.S. represents an opportunity for significant long-term earnings growth for us," he told analysts.

Tim Hortons said Thursday it earned $123.7 million or 81 cents per share, up from $108.1 million or 69 cents per share year ago.

The increase was due to an increase in its Canadian operations, which offset a decline in its much smaller U.S. division.

Total revenue for the company was $800.1 million, up 1.9 per cent from $785.6 million. Same-store sales, including corporate and franchised locations, grew 1.5 per cent in Canada and 1.4 per cent in the United States. Tim Hortons trimmed its full-year same-store sales guidance but maintained its profit forecast for the year at between $2.87 and $2.97 per share.

The company was expected to earn 75 cents per share on $818.2 million of revenues, according to analysts polled by Thomson Reuters.

Analyst Derek Dley of Canaccord Genuity said while the results were ahead of expectations, they still demonstrated challenges in Canada with lower same-store transactions although same-store sales rose on higher pricing and product mix.

He said Caira seems to be a lot more aggressive in implementing shareholder friendly initiatives and taking a new approach to the United States that should satisfy some investors.

"Overall, I think it was definitely an interesting quarter, a solid quarter and a quarter where we really saw this company through the new direction of the new CEO. We could be seeing more shareholder friendly initiatives out of Tims than what we've seen in the past," he said.

Dley said the plans may not go far enough for some U.S. investors who want the company to take on even more debt. But he said the levels appear "reasonable" for a company with a conservative investor base.

Unlike some restaurant companies that carry more debt, Tim Hortons' business model requires investments to maintain and grow its business, said Devine. She added that substantially increasing the debt further could significantly increase Canadian withholding taxes due to its cross-border structure or added nondeductible interest expenses.

Meanwhile, Caira said Tim Hortons needs to speed up how long customers wait in restaurants and drive-thrus as it operates in a competitive environment. It is doubling some drive-thru lanes and will consider simplifying its menu to remove products or sizes. The chain is also considering adding healthy choices and will soon sell its coffee for at-home brewing in Keurig machines.