Not any more

Buyback would put the sprinkles on Tim Hortons bakery deal

In Canada on August 12, 2010 at 20:32

It’s hard to get excited about anything the Swiss do. They make nice watches and chocolate. They produce innovative food and convenient tax laws. But generally they’re conservative plodders, as dry as their instant coffee. They make Canadians look thrilling. So let’s not get carried away in celebration over the Swiss giving Tim Hortons THI-T half a billion dollars for a bakery.

Don’t get me wrong: The deal looks luxurious at first blush. But scratch a little and it doesn’t quite look like you’re getting your money for nothing.

As reported, Tims is selling its half of joint venture Maidstone Bakeries for $475-million. Tims has a net investment of $75-million in the property, so it’s making a big profit. And the bakery only made $26-million in operating profit for Tims last year, so the price looks rich.

But is it? According to Desjardins Securities, the bakery runs at about half its capacity. So the Swiss group, which specializes in this kind of baking and knows the business well, is getting something with an awful lot of potential upside. Tim Hortons got $30-million in dividends from the bakery last year, meaning that, even at half capacity, the plant churns out $60-million in excess cash.

The Swiss are also getting a very captive major customer in the form of Tim Hortons, which will be tied up for several years.

The plant makes all of the par-baked doughnuts and Timbits and “substantially” all of the bread served in Tim Hortons restaurants. It also makes pastries. It’s not as if Tims can easily replace this supplier. The payment reflects that captivity.

So let’s say this is a fair deal for both parties. Tims gets cash up front but loses a nice (and growing) dividend stream. The Swiss write a big cheque but keep all the profits and have a chance to double them, more or less, plus they keep a very reliable anchor customer.

So why are investors so jubilant about this deal? The stock was up more than 6 per cent Thursday. Tims posted good quarterly numbers but that was at least in part thanks to selling heavily promoted ice coffees during a heat wave. The U.S. profit improved but is still negligible.

No, investors are excited because, in my opinion, they smell a special dividend.

After tax, the company could pay a couple of bucks a share or so. That would be nice because Tims investors haven’t made out particularly well. If you bought in at the IPO price, you’ve done okay – compound annual gain of 9 per cent, assuming you reinvested your dividends. But most investors bought at higher prices and aren’t up that much.

If I were one, I’d hope that the board would use every cent to accelerate its share buyback. Tims could buy back about 6 per cent of its outstanding shares by my math.

It’s more tax efficient than dividends and it might also help the company out, since Tims seems to be having a rough go of it. It’s a prudent, well-run company but same-store sales have been trending down and the business isn’t creating the economies of scale you’d expect from a powerful brand. Revenue is up 35 per cent since 2006 but earnings per share are only half that. They’d have risen even less if the company hadn’t wisely bought back a lot of stock.

Of course, Tims has been opening a lot of new restaurants, and these take a while to get going. But whether its careful U.S. expansion will succeed is anyone’s guess. Chief executive officer Don Schroeder acknowledges that “the playing field is littered with people who have moved too quickly.”

So putting excess money to work by thinning the share count seems like a good idea.


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