DBRS Downgrades Tim Hortons to BBB after Announced Change to Capital Structure

DBRS has today downgraded the Issuer Rating and Senior Unsecured Debt rating of Tim Hortons Inc. (THI or the Company) to BBB from A (low). The trend is now Stable. This action removes the ratings from Under Review with Negative Implications and follows the Company’s announcement that it intends to increase its balance-sheet debt levels by approximately $900 million. THI is expected to return the proceeds of the debt issuance to shareholders in the form of share repurchases.

On May 8, 2013, DBRS placed THI’s ratings Under Review with Negative Implications when the Company announced that it was actively evaluating possible changes to its capital structure (i.e., optimal debt level within the context of maintaining an investment grade credit rating).

In its review, DBRS’s analysis focused on the effects of the increase in balance-sheet debt on leverage and the Company’s financial profile, as well as capital management going forward.

DBRS estimates that balance-sheet debt, including capital leases, will increase to approximately $1.4 billion versus $532 million at Q1 F2013. Credit metrics are expected to deteriorate materially (i.e., pro forma lease-adjusted debt-to-EBITDAR of 3.06 times (x) and EBITDA-to-interest of 6.40x versus 1.69x and 9.85x, respectively, for the last twelve months (LTM) ended Q1 F2013), to levels consistent with the lower end of the BBB rating category.

THI’s ratings continue to benefit from the Company’s strong market position as the leading quick service restaurant in Canada, balanced by the competitive nature of the restaurant industry and risks surrounding the Company’s U.S. expansion plan.

DBRS expects THI’s earnings profile to remain relatively stable, based on its strong market position and steady growth model. DBRS forecasts system-wide sales will increase in the mid-single-digit range through the end of 2013 and into 2014, based on low- to mid-single-digit same-store sales growth and approximately 250 net new store openings in 2013. THI’s revenues are therefore expected to grow in the mid-single-digit range through the end of 2013 and into 2014. EBITDA margins should remain relatively stable as the Company focuses on increasing efficiency and controlling general and administrative costs. As a result of the above factors, DBRS believes that EBITDA should increase toward the $800 million level in the medium term versus approximately $740 million for the LTM ended Q1 2013.

DBRS believes that THI’s financial profile should remain relatively stable in the near to medium term. The Company should continue to generate adequate levels of free cash flow after dividends and before changes in working capital (nearing the $100 million level, or 8% of balance-sheet debt) despite rising capex toward $300 million in the near term. Free cash flow is expected to be used to invest in growth and/or increase returns to shareholders. As such, DBRS believes that any improvement in THI’s credit metrics will be based on growth in earnings rather than repayment of debt. Should credit metrics deteriorate further as a result of weaker-than-expected operating performance or more aggressive-than-expected financial management, a negative rating action could result.

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

The related regulatory disclosures pursuant to the National Instrument 25-101 Designated Rating Organizations are hereby incorporated by reference and can be found by clicking on the link to the right under Related Research or by contacting us at info@dbrs.com.

This rating is endorsed by DBRS Ratings Limited for use in the European Union.

The applicable methodology is Rating Companies in the Merchandising Industry, which can be found on our website under Methodologies.