Tim Hortons Investors Awaiting U.S. Market

To its most devoted fans, grabbing a Tim Hortons double-double on the way to work is almost a religious experience. The Church of Tim's, as it's only-somewhat-jokingly called, has such a firm grip on the Canadian psyche even the clergy are prone to bouts of envy.

To its most devoted fans, grabbing a Tim Hortons double-double on the way to work is almost a religious experience. The Church of Tim's, as it's only-somewhat-jokingly called, has such a firm grip on the Canadian psyche even the clergy are prone to bouts of envy. This coming June the United Church of Canada will host a workshop in Toronto on growing its base entitled "More Franchises than Tim Hortons?" And last year, Rev. Ross Lockhart, a minister in Belleville Ont., lamented to his flock that "many folks in our community today turn to Tim's for a sense of belonging beyond home and work instead of the church." But if a church's ultimate success lies in its ability to attract new converts, investors' faith in the company may be put to the test as it tries to expand into the United States.

Tim Hortons' conquest of Canada is virtually complete. Sure, there are a few city blocks in Vancouver where the familiar red lettering of the company's logo remains elusive. But there is now a Tim Hortons restaurant for every 12,500 Canadians, nearly double its closest competitor, McDonald's. Through 2,750 Canadian stores, the chain controls 80 per cent of the coffee, doughnut and tea market - 90 per cent if you only count the coffee. When Don Schroeder took over as Tim Hortons' new chief executive officer last week, replacing Paul House who became executive chairman, he inherited what has become the fourth-largest fast-food chain in North America when measured by market capitalization, largely on the back of Canadians' insatiable demand for its beloved coffee.

Yet south of the border things haven't gone so well. Tim Hortons' huge U.S. rollout has been foretold by analysts and journalists for nearly 15 years. And each time the chain fell short of the mark. During the last round of stories about its U.S. expansion in 2005, executives boldly predicted there would be 500 Tim Hortons in the U.S. by 2007. Today, there are 398. Now as excitement builds once again around the plans to convert America's Timbit-less masses, the company faces not only a dramatically slowing economy, but a mighty competitor in Dunkin' Donuts with ambitious plans of its own to conquer the nation.

You could hardly call Tim Hortons' move into the U.S. a failure. Not when you consider the fate of so many other chains. The American retail and restaurant landscape is littered with the remains of disastrous incursions by Canadian companies. Canadian Tire tried and failed twice, while Kelsey's Restaurants barely put up a fight before meekly withdrawing. "In Canada companies have tended to exist side by side with their competitors, whereas in the United States companies are out to annihilate each other," says Wendy Evans, a Toronto retail consultant who specializes in cross-border expansion. "There's just no room for nice guys down there."

Tim Hortons took its first step into the U.S. market in 1985 with a restaurant near Buffalo, N.Y. Those were early days for the company, which got its start in 1964 when star NHL defenceman Tim Horton and former cop Ron Joyce opened a handful of doughnut joints in Hamilton. Horton died in a car crash in 1974, leaving Joyce to build the empire. By the mid-'80s there were more than 200 restaurants, and it was already building a devout following, especially among rural Canadians and those in smaller cities. So when, horror of horrors, burger giant Wendy's International snapped up the chain in 1995, weeks of national soul-searching ensued. For patriots, the only silver lining in the deal was that with Wendy's clout, the chain was expected to spread far and wide. Canadians who travelled to the States would finally be able to find a decent cup of coffee. But the U.S. invasion never really panned out.

During the time Wendy's owned it, Tim Hortons' U.S. store count grew from about a dozen to 270. But 45 of those restaurants, which were added when Tim Hortons bought a small doughnut chain in New England in 2004, were duds. As House told investors in 2006: "We got our ass kicked in New England - that's plain English." (The company declined to make anyone available to comment for this story.) While the company's staunch supporters argue 398 U.S. stores is not a shabby start, thank you very much, others have proven far more effective at conquering new markets. Quiznos Subs, for instance, set up shop in Canada in 1996 and today operates nearly 440 restaurants, in a market one-tenth the size of the U.S.

When Wendy's spun off the Tims chain in 2006, it was celebrated as the repatriation of a Canadian business icon. It wasn't hard to find Canadians stuffing their faces with Boston creams, while lusting after the company's initial public offering. And the stock has not disappointed, thanks mainly to growth in Western Canada and continued innovations in the kitchen - this month it will roll out hot lunch sandwiches in some stores.

Still, it's Tim Hortons' U.S. expansion that is driving investor interest these days. At two investor conferences in New York last week, Schroeder and other executives repeated the company's pledge of opening up to 110 new restaurants this year in the U.S. northeast. (The company is also rolling out self-serve kiosks in Ireland and the U.K.) The U.S. stores currently account for roughly 10 per cent of Tim Hortons sales, but don't generate any real profit. David Hartley, an analyst with BMO Capital Markets, says once the magic number of 500 U.S. stores is reached, the company should have the brand awareness and distribution clout to "start making money in a meaningful way."

There are signs that optimism is well-founded. Slowly but surely, the chain is developing a following south of the border. They congregate on the Internet, if not over the company's coffee, and through word of mouth they're helping to pave the way for Tim Hortons' eventual growth.

But if the U.S. market was a tough nut for Tim Hortons to crack in the past, it could be more so now. For one thing, the American economy is on increasingly shaky ground, forcing people to cut back on their spending. Tims execs figure that's more of a concern for Starbucks, which charges premium prices for its gourmet coffees and snacks. "We're not recession-proof, but we're as close to it as you can get," Schroeder told investors last week. He said when the economy has cratered in the past, Tim Hortons was able to snatch up real estate on the cheap, while luring qualified franchisees who'd been laid off from their jobs. Yet analysts say Tim Hortons is at a disadvantage due to its size and relative lack of brand recognition. With gasoline prices soaring, some analysts believe consumers are sticking closer to home. And since Tim Hortons has far fewer stores (one to every 210,000 people, versus 56,000 for Dunkin' Donuts and 21,000 for McDonald's) Micky-D's is that much more convenient.

Meanwhile, the coffee wars have heated up in the U.S., with three giants gunning for top spot. Starbucks controls 21 per cent of the quick service restaurant coffee segment, followed by Dunkin' Donuts and McDonald's at 18 and 11 per cent respectively. Dunkin' Donuts in particular poses the biggest threat to Tim Hortons' plans. When the Canadian chain stepped up its expansion in the U.S. northeast, Dunkin' Donuts responded with price cuts and a marketing blitz. Now the Massachusetts-based company is owned by private equity investors with plans to roll it out across the rest of the country. Last month, for instance, Dunkin' Donuts said it will open 100 new stores in St. Louis, Mo. alone over the next few years. "Dunkin' is aggressively pursuing [the U.S. northeast] and into the rest of the country," says Jeff Davis, president of Sandelman & Associates, a U.S. restaurant research firm. "There are a lot of similarities between the two brands. Who gets there first is going to be the issue." If size means anything, Dunkin' Donuts has the edge. At US$5.3 billion in sales, the U.S. chain is roughly three times larger than its Canadian rival.

There is something to be said for slow and steady, of course. Just look at the boom-and-bust cycle Krispy Kreme went through a few years ago when it tried to blanket North America overnight with its gooey, warm doughnuts. Investors are obviously wary of a repeat performance at Tim Hortons. "You're building a brand, highway ramp by highway ramp, small town by small town," says BMO's Hartley. "It just takes time to get acceptance. This is not Krispy Kreme here. It's not a fad, it's a slow build."

In some ways the very things that have made Tim Hortons such a phenomenal force in Canada are what have made its push into the U.S. so difficult. The company rose to dominance here by forging close ties to hockey and wrapping itself in the maple leaf. Dunkin' Donuts, in contrast, uses slogans like "America Runs on Dunkin" and fills its ads with baseball, football and basketball imagery. In other words, the kind of sports that appeal to the vast majority of red-blooded Americans - people who think a puck is something you put in your swimming pool to kill algae. That's left Tim Hortons to market itself as the restaurant where you can always get fresh coffee and food at a good price, which is hardly the most original or memorable marketing campaign around.

For now Tim Hortons has gone further in its U.S. expansion than any Canadian retailer or restaurant chain before it. And if it keeps growing at its current pace, eventually, some day, Americans may come to appreciate the undeniable value of a steaming bowl of Tim Hortons' chili. But the chain will never elicit the same level of devotion and reverence as it does in Canada - one nation, under Tim.

Maclean's March 24, 2008


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