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

DBRS has today confirmed the long-term rating of Tim Hortons Inc. (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. The rating also reflects the high level of competition in the restaurant industry as well as risks surrounding the Company’s U.S. expansion plans and volatile commodity prices.

THI’s earnings profile in 2011 was stable for the current rating category as the Company reinforced its position as the leading QSR in Canada, quickened the pace of its U.S. expansion and began its international growth strategy. Revenues in 2011 increased nearly 12.5% to $2.85 billion based on system-wide restaurant sales growth of 7.4% driven by healthy same-store sales growth of 4.0% in Canada and 6.3% in the United States and the opening of 264 net new stores. Operating margins remained relatively flat despite the accounting consolidation of lower-margin variable interest entities related to the U.S. expansion, as THI was able to pass on higher input costs to consumers through increased prices. As a result of the above factors, EBITDA in 2011 increased 4.2% to nearly $670 million from $642 million in 2010. Strong operating results continued in Q1 2012 as revenues increased nearly 12.1% year over year (yoy) which, combined with a modest decline in EBITDA margins (attributable to the consolidation of the variable interest entities), resulted in an increase in EBITDA of 9.4% yoy to $159.5 million.

In terms of financial profile, THI continues to benefit from its low relative debt levels and strong free cash generating capacity. In 2011 and Q1 2012, cash flow from operations continued to track operating income and dividend policy remained consistent; at the same time, capex increased significantly toward a new equilibrium as THI invested in refreshing and opening stores and a new distribution centre in Kingston, Ontario. As a result of the higher capital spending, THI’s free cash flow before changes in working capital declined to $225.6 million in 2011 versus $250.3 million a year earlier. THI completed approximately $572.5 million of share repurchases in 2011 as it continued to return free cash flow and cash generated by the sale of its interest in Maidstone Bakeries to shareholders.

Gross debt levels increased moderately in 2011 and Q1 2012; however, combined with the increased EBITDA, credit metrics nevertheless remained stable (i.e., lease adjusted debt-to-EBITDAR of 1.69x for the LTM ended Q1 2012).

Going forward, DBRS expects THI’s earnings profile to remain stable on the strength of its market position, continued product innovation and steady growth model. DBRS forecasts that system-wide sales will increase in the mid-to-high single digits in 2012 based on same-store sales growth of approximately 4% and net store openings of approximately 250 to 290. THI’s revenues should therefore grow in the mid-to-high single digits in 2012. Margins are expected to remain relatively stable in 2012 as input cost inflation moderates. As a result of the above factors, DBRS expects THI will generate EBITDA in the $700 million to $750 million range in 2012.

In terms of financial profile, DBRS expects THI will maintain a solid financial profile on the strength of its conservative financial leverage and free cash generating capacity. Cash flow from operations should track operating income and remain fairly steady. Capex requirements are expected to increase to the $220 million to $260 million range in 2012 and 2013 as the Company continues to invest in new stores and refreshes existing stores. Dividend policy is expected to remain consistent, growing in line with net income. As such, THI should continue to generate solid free cash flow before changes in working capital in the $150 million range in 2012. DBRS expects THI will continue to use free cash flow and possibly debt to complete share repurchases and invest in growth, while leverage is expected to remain relatively stable in a range commensurate with the current rating category. Deterioration in credit metrics (i.e., lease adjusted debt-to-EBITDAR toward the 2.0x level) 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 Companies in the Merchandising Industry, which can be found on our website under Methodologies.