Tim Hortons financial engineering

I noted with some amusement that some shareholders of Tim Hortons have been clamoring for the company to financially leverage itself (via the Globe and Mail). I am not an investor in Tim Hortons and will likely never be, but I took a brief look at the financial metrics driving the company.

One can assume the company in Canada is relatively mature. There seemingly is a per capita rate of Tim Hortons of one per ten people. This has been the case in almost any region in the country I have been in.

So the push southward is a logical strategic focus for the company, except for the fact that they can’t gain any traction in the USA. I find this to be a curious phenomena since this is one of the few cultural differentiators between Canada and the USA that I can think of – intuitively there shouldn’t be any reason Tim Horton’s can’t be as successful in the USA, but there is seemingly something wrong with their product mix.

As such, when looking at the financial state of the situation, the company is trading at approximately 20 times earnings and they have succumbed to the vocal shareholders calling for a share buyback. Right now, Tim Horton’s debt level is $530 million, which is a relatively safe level given their cash flow generation (for the first half of the year, operational cash flow is at $258 million and free cash flow at $171 million). Also note that the company does give out a 26 cent quarterly dividend, which took out another $79 million in cash for the first half of the year. The proposal to lever the company another $900 million to do a buyback will not accomplish much other than destroying shareholder value and making the company as a whole more financially brittle.

I do not think $1.4 billion in debt is an unsafe amount of money for the company (although it is at the upper end of the threshold I would accept if I was on the board of directors), but it does seem unnecessary to exercise this buyback at existing valuations.

Although it can be assured that Tim Hortons will exist in some form in the indefinite future, will it always be as profitable as it is currently? I would steer clear of the shares.