DBRS Assigns a Provisional Rating of A (low) to Tim Hortons

DBRS has today assigned a provisional rating of A (low), with a Stable trend, to Tim Hortons Inc.’s (THI or the Company) proposed private placement of senior unsecured debt. The rating is supported by a number of factors. (THI announced that the Maidstone bakery ownership structure will be renegotiated and is discussed below). Firstly, THI is the largest quick-service restaurant (QSR) chain in Canada (40% QSR market share based on traffic) and the fourth largest in North America (based on market capitalization). Its iconic brand is one of the most recognizable in Canada, which helps drive very high weekly repeat traffic through its restaurants.

Next, THI operates one of the most franchised restaurant systems in North America. It is this franchise network that is fundamental to the overall success of the system, along with a supply chain that relies on the following: (1) coffee buying for its two major roasting plants; (2) a very large centralized bakery (a joint venture), which partially bakes and then flash-freezes all the donuts and pastries sold in the restaurants; (3) the fondant and fills manufacturing facility; and (4) the purchase of most other related restaurant needs. This ensures product quality and consistency across the system. The franchisees operate the restaurants, hire staff, prepare products and ensure quality.

The main concerns include competition in Canada and the expansion in the United States. THI faces formidable competitors in Canada with access to substantial marketing, personnel and other resources. In addition, THI is growing its franchise network in the northeastern and midwestern United States (567 restaurants). The rollout faces several challenges, such as the fact that the Tim Hortons brand is not well known in the United States and that it is competing against well-established brands. Furthermore, the Company wants its future expansion to be profitable, which will be a challenge in difficult economic times.

In 2010, THI is targeting 3% to 5% same-store sales growth in Canada. THI intends to use marketing initiatives and expanded menus to improve its market shares. Despite the fact that some input costs such as coffee have been higher, the Company should continue with 20% margins and operating income growth. As a result, operating income and net free cash flow are expected to improve in 2010 over 2009. Balance sheet debt levels are reasonable and liquidity is good, with gross debt (adjusted for operating leases)-to-EBITDAR expected to remain below 2.0 times.

On May 13, 2010, THI announced that its partner in the Maidstone Bakeries 50-50 joint venture, IAWS Group Ltd., exercised the buy/sell provision under the terms of the joint-venture agreement. The Maidstone Bakeries facility (the Bakery) manufactures donuts, Timbits and other par-baked breads that are supplied to system restaurants in Canada and the United States. While this is a meaningful development, the Company has a reasonable time period to decide on whether to sell its 50% interest or acquire the 50% interest of the joint venture. If THI decides to sell its interest, there is a seven-year period wherein the Bakery must continue to supply THI as before. During that period, the Company has sufficient flexibility to secure an alternative means of supply. Should THI decide to acquire the other 50%, DBRS will review at that time the method of financing and the impact on the credit profile, if any.

While this development is meaningful, our comfort with the rating reflects the expectation that THI will maintain the gross debt(adjusted for operating leases)-to-EBITDAR below 2.0 times under any scenario. In the event that THI does not acquire the additional 50% interest, it appears that the seven years during which product would still be provided by the Bakery under the agreement provide more than sufficient time for THI to develop another satisfactory option.

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

This is a Corporate (Consumers) rating.