Scout Capital Management, a hedge fund managed by James Crichton and Adam Weiss, has reported a position of 8.4 million shares in Tim Hortons Inc. (USA) (NYSE:THI) in a 13D filed with the SEC. The fund had initiated a position of 2.3 million shares in the first quarter of the year, according to our database of 13F filings (we track these filings as part of our work researching investment strategies; we have found, for example, that the most popular small cap stocks among hedge funds earn an average excess return of 18 percentage points per year). So most of Scout’s shares have been purchased in the last two and a half months (see more of Scout’s stock picks). Tim Hortons Inc. (USA) (NYSE:THI) is a (primarily Canadian) quick service restaurant with a market capitalization of $8.3 billion; Scout’s stake gives it 5.5% ownership of the company.
In the first quarter of 2013, revenue was about flat versus a year earlier, with an increase in the number of locations being offset by small declines in same-store sales in both Canada and the United States. With the company’s costs rising as well- in part due to the larger number of restaurants- Tim Hortons Inc. (USA) (NYSE:THI) recorded a 3% decrease in earnings. In earnings per share terms this was offset by a decrease in share count, but certainly it was not a positive report from the company. Cash flow from operations was down as well.
Tim Hortons Inc. (USA) (NYSE:THI) currently trades at 21 times trailing earnings; while the company is not doing well, as we’ve discussed, quick service restaurants are generally seeing high valuations in the market. Still, we’d say that the valuation looks high compared to the business’s recent performance. In addition to Scout, we can see from our database that Jonathon Jacobson’s hedge fund Highfields Capital Management more than doubled its stake in Tim Hortons during Q1, to a total of 6.1 million shares (find Jacobson’s favorite stocks). Highfields has pushed the company to return more cash to shareholders, and it’s possible that Scout will join that fund in its activist campaign. Still, we generally prefer to see a company growing its net income in order to consider it a potential value play especially at a trailing P/E of 20 or more. Luxor Capital Group was another major shareholder, having bought 2.8 million shares between January and March (check out more stocks Luxor was buying).
Peers for Tim Hortons Inc. (USA) (NYSE:THI) include Dunkin Brands Group Inc (NASDAQ:DNKN), Starbucks Corporation (NASDAQ:SBUX), Panera Bread Co (NASDAQ:PNRA), and McDonald’s Corporation (NYSE:MCD). We’ve mentioned that the market is generally assigning high multiples to quick service restaurants, and we can see that the forward earnings multiple for McDonalds is 16 with the other three companies valued at 23 to 25 times consensus earnings for the forward fiscal year. This places Dunkin, Starbucks, and Panera at a premium to Tim Hortons Inc. (USA) (NYSE:THI) on that basis but those companies have generally been experiencing better results. Starbucks and Panera, for example, each delivered double-digit growth rates on both top and bottom lines in their most recent quarter compared to a year ago (Dunkin’s performance has been more questionable, however). As such those two restaurants may well deserve that valuation premium. Growth at McDonalds has been more modest, making it not too appealing from a value perspective at current pricing, but it could easily be a defensive play with a beta of 0.3 and a dividend yield of 3.1%.
Investors interested in quick service restaurants may want to watch Tim Hortons to see what Scout is up to, but we don’t recommend buying at this time. With same store sales down, and with the addition of new locations apparently negative for earnings, the company would seem to have a tough path towards growth in net income and the current valuation is assuming good performance over the next several years. QSRs generally trade at high multiples, though with a couple of Tim Hortons’ peers in better shape it’s possible that those businesses can end up justifying their current valuations.
Disclosure: I own no shares of any stocks mentioned in this article.
