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Is Tim Hortons’ dominance in Canada unshakeable?

Source: Yahoo Finance
Written By: Tom Fennell

Is it possible for a single brand to be so dominant in its market that it can’t grow any larger?

That’s a question Tim Hortons’ management and shareholders will soon have to consider, at least as far as Canada is concerned. That’s because the company, with a franchise on seemingly every corner, now controls 80 per cent of the coffee market in Canada.

Or, if translated into coffee cups, for every 10 cups of java consumed outside of the home, eight will be poured at a Tim Hortons.

By comparison, Tim Horton’s most high-profile competitor, Starbucks, (gingerbread and pumpkin-spiced lattes), controls just three per cent of the Canadian market, and has barely put a dent in the company’s dominance.

McDonald’s has also taken note of the fact tens of thousands of Canadians begin each day at Tim Hortons with a coffee, bagel, breakfast sandwich, or one of the chain’s large selection of sugar bombs like a double-chocolate donut.

To compete against Tim Hortons, McDonald’s has at times even offered free coffee to go with its breakfast sandwiches. But Tim Hortons, by constantly updating its breakfast offering, like its new breakfast wraps, has been able to hold even McDonald’s at bay.

To stay ahead of the competition and increase earnings, the company has expanded aggressively, opening 149 new outlets in 2010, with another 180 planned for this year.

But here’s the problem investors have to crunch.

With 3,148 outlets now in Canada, the company wants to expand to 4,000 as quickly as possible. And with Ontario saturated, it’s targeting Quebec, and Western Canada where it has a smaller footprint. The trouble, says Derek Dley, a consumer products analyst at Canaccord Genuity, at that point Tim Hortons will have so saturated the Canadian market it will be difficult for it to rapidly grow earnings as expansion opportunities dry up.

“They want to get 4,000 stores and with 80 per cent share of the coffee market, it’s hard to see where a lot of that growth lies,” says Dley.

As Tim Hortons continues its push to corral every possible remaining location in Canada to reach its 4,000-store goal, the competition, sometimes in futility, is chipping at away at its dominance.

McDonald’s, notes Dley, has been particularly aggressive by promoting its premium brand of coffee and offering a greater selection.

But he says it’s going to be a challenge for all quick-service restaurants in the breakfast market as consumers, under pressure from rising gasoline prices and mortgage debt, reign in spending. “Potentially you could see all these guys fighting over a share of the market while consumer spending is still shaky,” says Dley.

Once it reaches a point where it can’t expand any further, Dley says investors can expect Tim Hortons to transition from a growth company to a mature retailer spinning off cash. “At that point as opposed to network expansion,” says Dley, “the company can return cash to shareholders through dividends and share buybacks.”

Even if it reaches a market-saturating 4,000 stores in Canada, Tim Hortons can always look south to the United States, where it already has a 602-store bridgehead and plans to open 300 more restaurants, many in border areas, between 2010 and 2013 while investing additional resources in advertising and marketing.

And the company appears to be gathering some traction in the American market after closing 36 stores in unprofitable locations. In fact, Chris O’Cull, a restaurant analyst at Atlanta-based SunTrust Robinson Humphrey Inc., says he expects to see Tim Hortons stock rise from here, in part because the company is increasing same-store sales through product innovation while building brand awareness.

Tim Hortons’ strategy in the U.S., according to Dley, is to avoid head-to-head combat in markets already dominated by competitors like Dunkin’ Donuts in Massachusetts. “As part of their growth strategy, they want to build brand presence in selected markets that would be conducive for their growth as opposed to being spread out,” says Dley.

But whether or not they can ever dominate the U.S. market the way they do Canada’s remains open to question. “The problem in the U.S. is that the brand power isn’t there like it is in Canada,” explains Dley. “It’s just a more challenging environment in the U.S. There is just a lot of competition.”

Tim Hortons also surprised many analysts earlier this year when it announced that as part of an international expansion strategy it was opening 120 locations in the United Arab Emirates, Qatar, Bahrain, Kuwait and Oman.

Tim Hortons’ president and CEO Don Schroeder said at that time that while the company’s top priority was growing its Canadian and U.S. businesses, the primary drivers of shareholder value, he was also laying the ground work to expand abroad.

“We also believe there is an opportunity over the long term to explore international opportunities and seed the Tim Hortons’ brand in various markets outside of North America,” said Schroeder. “Our approach is prudent, targeted and will minimize capital requirements while still allowing us to pursue international growth opportunities.”

But Dley points out Tim Hortons’ investors don’t have to worry about the company being overly aggressive in the Gulf countries. He notes they are only opening about five stores over the next few years to gain a toehold in that market.

In the end, to be successful in the U.S. and beyond, Tim Hortons will have to recreate something that is intangible but accounts for so much of its success in Canada.

“A lot of people associate team Tim Hortons with a social aspect, as opposed to just grabbing a coffee,” says Dley. “It’s a place where you can sit down with your friends and catch up with the day’s chatter.”

And you’ll soon be able to do just that in 4,000 outlets across Canada.

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