320 Report

1

Investment Analysis ReportBUS320 Intermediate Accounting: Assets

Prepared forChief Executive OfficerMaureen Fizzell

Prepared byMichelle Nguyen301197387

Jacob Lee301162203

Elaine Lee 301138304

Submittedi

16

July 16, 201AbstractThe purpose of this report is to analyze Tim Hortons Inc.s financial health standing to determine whether or not it would be a worthwhile investment for investors. Several ratios were determined using Tim Hortons and its competitors Financial Statements. Quantified research shows that Tim Hortons may face financial difficulties in the long-run if it continues to borrow money in the future. They are not earning enough funds from operations to cover its borrowings. Expansion plans were also not as favourable as projected in the 2013 year. This will influence the amount of investments that the company is making, as well as its profits in the long-run. Further research is discussed in-depth leads to the conclusion that the company needs improvement in order for it to be considered a viable investment option.

ContentsAbstractiIntroduction1Company Profile: Tim Hortons Inc.1Risk Management2Brand and Marketing3Operations Management4Free Cash Flow5Competitor Profile: Starbucks Corporation5Ratio Analysis6Total Debt-Equity Ratio6Cash Flow-to-Debt Ratio7Receivables Turnover Ratio7Dividend Yield8Price to Earnings Ratio8Return on Assets9Return on Equity9Current Ratio10Conclusion10References12Appendices14

IntroductionThe goal of this report is to determine whether or not Tim Hortons Inc. (THI) is a viable investment option for current and potential shareholders. A brief company profile summarizing Tim Hortons operations is provided, followed by a competitor profile of its main competitor; Starbucks Corporation, a company deemed appropriate to compare Tim Hortons to. In order to provide an in-depth analysis of Tim Hortons, its annual financial statement for 2013 will be examined. The annual report is used, as opposed to the more recent 1st quarter report for 2014, because the annual report offers a more complete view of Tim Hortons operations throughout the year. Using various ratios derived from the annual report, predictions will be made regarding the future profitability of Tim Hortons. These ratios will be set against competitor and industry ratios to benchmark Tim Hortons performance compared to its comparable competitors. The industry ratio will be an average of 3 companies: Mcdonalds Corporation, Starbucks Corporation, and Tim Hortons Inc. In the North American region which Tim Hortons mainly operates, Mcdonalds Corporation and Starbucks Corporation are the two main competitors. After the analysis, recommendations will be made as to whether an investment in Tim Hortons is worthwhile.Company Profile: Tim Hortons Inc. Tim Hortons Inc. (THI) is a Canadian company traded on both the Toronto Stock Exchange (TSX) and the New York Stock Exchange (NYSE). It is one of the largest quick service restaurants (QSR) in North America with its markets highly concentrated in Canada. It is known for selling coffee, donuts, and other breakfast foods. Established in 1964 in Hamilton, Ontario, it has expanded into a multinational fast food restaurant (Tim Hortons Inc., 2014a). As of March 2013, Tim Hortons has 4,288 locations throughout Canada, the US, and the Middle East.The percentage and success of its Canadian locations has helped the company garner a large market share in the QSR industry. Strong brand loyalty has also fostered Tim Hortons success in Canada. Tim Hortons highest stock price on the TSX in the last 52-weeks was $64.18, with the lowest being $56.12. They currently own $2,433,823 in total assets, and $1,672,304 in total liabilities (Tim Hortons Inc., 2013). In the future, Tim Hortons plans to open 800 more stores across the US and Canada by 2018 (Tim Hortons, 2014). They also plan to increase their locations in the Middle East by 220 stores.Today, Tim Hortons offers a larger variety on its menus to cater to the ever changing and evolving economic trend. Nonetheless, the QSR is a highly saturated industry with multiple companies competing for the most customers. In order for Tim Hortons to remain relevant, it must seek ways to give itself a competitive advantage over its competitors such as McDonalds and Starbucks. This report will examine Tim Hortons and its competitors to determine its financial health in order to make a recommendation for potential shareholders deciding to invest in the company.Risk ManagementTim Hortons risk management will influence the potential profitability of an investment in the company. Its growth strategy and competitive advantage are listed as the primary factors that could affect its financial health in the future (Tim Hortons Inc., 2014). The QSR industry is highly competitive, which will affect Tim Hortons market share, as Tim Hortons will have to find innovative ways to attract new and current customers. In recent years, McDonald's has been expanding its coffee and morning food menu items similar to that of Tim Hortons menu. Starbucks is also expanding rapidly and has been able to find success in the Canadian and US market. Although Tim Hortons is expanding, its location success, store management, food prices and consumer demands are all elements that could impact its likelihood of being profitable. Company growth was below Tim Hortons listed target of 2-4% in Canada and 3-5% in the US (Tim Hortons Inc., 2013). Actual figures were 1.1% and 1.8% respectively. Such forecasts are only estimates and not actual figures.Brand and MarketingThe Tim Hortons brand is well known across Canada. The company spends a large amount on advertising each year to attract customers and gain reputation for being sustainable (Appendix I). In addition, customers exhibit a strong sense of brand loyalty to the company. Tim Hortons reputation comes from serving fresh products, which is one of the main reasons for its success (Tim Hortons Inc., 2013).Tim Hortons is also very active in the communities in which they are present. It hosts its own Minor Sports program and operate many fundraisers and summer programs for kids. During the Tim Hortons Camp Day, Tim Hortons managed to raise $11.8 million for the Tim Horton Childrens Foundation (Tim Hortons Inc., 2014b).Additional marketing ventures include the recently launched mobile payment option for customers who can use a free TimmyMe mobile application to pay for products (Tim Hortons Inc., 2014c). Once their customers register their prepaid Tim Card with the mobile application, they will be able to pay with the barcode on their mobile devices. This payment option was introduced to improve customer convenience in order to attract more people. Operations ManagementA majority of Tim Hortons locations are franchises, which operate under separate and individual owners (Tim Hortons Inc., 2013). Such franchises also play a large part in Tim Hortons revenue recognition as revenues from franchise fees, rents and royalties.Revenue is earned from the distribution of its food products from Tim Hortons warehouse. They also receive revenue from the sales made at company-operated restaurant locations. From franchise owners, revenue is earned through the rental of property and equipment, as well as franchise fees which are collected at the time of sale. The revenue earned from Tim Cards are considered restricted cash and cash equivalents. In 2013, Tim Hortons decided to terminate its branding agreement with Kahala Franchise Corp., the parent company of Cold Stone Creamery. Tim Hortons paid out $19 million to restaurant owners for renovation, depreciation, and other related costs. Tim Hortons also no longer produces its donuts in-house; instead, the company sold off Tim Hortons major line of business to a Swedish company that will produce the donuts instead (White, 2010). Tim Hortons aim was taken in efforts to reduce high costs and lack of skilled labour from finding qualified bakers.Free Cash FlowIn 2013, Free Cash Flow amounted to $355,765 million, the difference between the companys operating cash flow and capital expenditures (see Appendix I). The company has a negative investing cash flow, which reflects its current growth strategies of new store openings and more products. Tim Hortons has a healthy Free Cash Flow figure as it is positive; however, its cash flow is not able to meet its financing activities, which resulted in a decrease of $69,726 million in cash and cash equivalents in the 2013 year (see Appendix I). Appendix I also shows that Tim Hortons has taken out a large amount of debt to support its share repurchases and dividend payouts (see Appendix I). Nonetheless, Tim Hortons, through its debt financing, intends to create greater share value for its shareholders.Competitor Profile: Starbucks CorporationStarbucks Corporation (SBUX) is the worlds largest coffee company. It operates in 64 different countries, with 1,550 locations in Canada. Starbucks specializes in hot and cold beverages, and also sells snacks and pastries. It also sells instant coffee and other pre-packaged foods in retailers, such as Walmart and Target. Currently, Starbucks is planning to expand into the Indian coffee market and is hoping to expand its business to attract customers during lunch and dinner hours in the US (Peterson, 2014). We have chosen Starbucks as the main competitor for Tim Hortons because it operates during similar hours, in similar niches. Like Tim Hortons, they provide smaller snacks and beverages that are suitable for customers to consume when on-the-go. McDonalds is another major competitor identified as it has been aggressively expanding in the coffee and coffee-based beverage market, and has a large market share. Ratio AnalysisTo measure the performance of Tim Hortons, we have chosen seven ratios with which we can benchmark Tim Hortons against itself over time - its main competitor, Starbucks, and the industry.Total Debt-Equity RatioThe debt-to-equity ratio is a companys ability to use its equity and debt to finance its assets, which allow investors to compare the leverage of various companies (Investopedia, 2014c). Ideally, the debt to equity ratio should be low, but it depends what industry the company is in (Investopedia, 2014c). More debt may not necessarily be a bad thing because sometimes debt is used to generate more earnings (Investopedia, 2014c). Tim Hortons debt to equity ratio in 2013 is 142.1, increasing significantly by 93.6 since 2012 (see Appendix A). The ratio in 2013 was higher than Starbucks, McDonalds, and even the industry average, which were 30.1, 88.3, and 86.83, respectively (see Appendix A). Tim Hortons has a higher degree of leverage, lower degree of financial flexibility, and more of tim hortons' assets are financed by equity and debt in comparison with its competitors. Debt was increased a significant amount since 2012, due to its share repurchase program. At first glance, Tim Hortons high ratio shows that Tim Hortons is a fairly risky company. Tim Hortons justifies its debt usage as part of its intentions to increase value for its shareholders and to maintain financial flexibility with its share repurchase program (Tim Hortons Inc., 2013).Cash Flow-to-Debt RatioThe cash flow-to-debt ratio (coverage ratio) shows a companys ability to pay its debts with its operating cash flow (Investopedia, 2014a). With a higher ratio, a company is able to take on more debt, since it would be able to pay off its debt with its cash flow (Investopedia, 2014a). Tim Hortons 2013 cash flow-to-debt ratio is 0.59, a decrease of 0.46 since 2012 (see Appendix B). Compared with Starbucks, Tim Hortons ratio is very low, but Tim Hortons 2013 ratio is very close to McDonalds ratio in the past couple of years (see Appendix B). Again, debt in 2012 was high in order to fund their share repurchase program. Tim Hortons is offering unsecured 10-year notes to fund their share repurchase program, which were both announced in 2013 (Reuters, 2013). It seems that there may be some difficulties paying off its debt due to its fairly low ratio and high debt, especially because Tim Hortons is facing intense competition both in Canada and in the US. As mentioned before, Tim Hortons plans to actively expand its stores in the future. However, there will be difficulties, especially in the US, because McDonalds and Starbucks already has a large presence there. Receivables Turnover RatioThe receivables turnover ratio determines a firms effectiveness in extending credit as well as collecting debts (Investopedia, 2014g). The higher the ratio, the more frequent the debts are collected. Tim Hortons receivables ratio was 16.5 in 2013, slightly higher than 15.1 in 2012. Its competitors Starbucks and McDonalds both had higher ratios in 2012 and 2013 (see Appendix C). Even the industry average ratio was almost 2 times Tim Hortons in 2013 (see Appendix C). This indicates that Tim Hortons is not as efficient as its competitors, and even the industry as a whole, in collecting its accounts receivables, and may need to stricken its credit policies.Dividend YieldA companys dividend yield can be calculated by dividing its annual dividends per share by the price per share (Investopedia, 2014d). This ratio indicates the return on investment for each share, or the amount of dividends you receive for each share.Tim Hortons' dividend yield for 2013 was 1.67%. There has been a decline of .03% from the end of the 2012 fiscal period (see Appendix D). However, it is above the 5-year average of 1.4%. It is also above Starbucks dividend yield of 1.15%, meaning investors who require a steady cash-flow from dividends will desire Tim Hortons stocks more. On the other hand, the industry average for 2013 was 2.03%, significantly higher than Tim Hortons.Price to Earnings RatioThe price to earnings ratio is derived by dividing the price per share by the earnings per share (Investopedia, 2014f). This ratio gives us a prospective outlook of a companys stock performance. A higher price to earnings ratio means that investors are currently willing to pay more for lower earnings. This can be the result of a positive outlook on the companys performance in the subsequent fiscal periods. A low earnings ratio indicates that investors are not willing to pay low prices even for relatively higher earnings. There is a negative outlook and investors expect the companys performance to drop. In the short-term, it is good to invest in companies with a low price-to-earnings ratio since the earnings you receive are higher than the price you pay for the shares. However, it is better to purchase shares with a high price-to-earnings ratio because it is likely that the company will perform better in future fiscal periods.Tim Hortons' price to earnings (P/E) ratio for this fiscal period was 22.0 (see Appendix E). This is an increase from last years figure of 18.7. However, both the competitor ratio and industry average was higher. Starbucks price to earnings ratio for 2013 was 35.84 and the industry average, 25.11. This means that potential investors are more confident in the future performances of other companies in the industry compared to Tim Hortons Inc.Return on AssetsReturn on Assets (ROA) measures the success of a companies ability to use its assets to generate a profit (Investopedia, 2014h). A high ROA indicates a profitable return with little investment. In 2013, Tim Hortons ROA was 19.29% which is considerably higher compared to its main competitors, Starbucks and McDonalds (see Appendix F). In addition, Tim Hortons ROA has been increasing over the past five years with a surge in 2010 after selling part of its donut manufacturing company, Maidstone (White, 2010). This has allowed the company to focus on profit optimization in its food retail services. The increase in ROA can also be attributed to the companys current share buyback, as assets have decreased (Investopedia, 2014h). The same is true for Return on Equity.Return on EquityReturn on Equity (ROE) is a profitability measure used to evaluate the amount of earnings received for every dollar invested by common shareholders (Investopedia, 2014i). Similar to Tim Hortons ROA, its ROE has also been rising over the past five years with the exception of a spike in 2010 as mentioned in ROA (see Appendix G). Its ROE is also consistently higher than its ROA, which is a good indicator of its leverage, which can increase profitability for a company as there is more flexibility in a companys operational activities (see Appendix G). McDonalds ROE is also good; however, its ROE has been declining over the past three years, whereas Tim Hortons has been increasing for the past five consecutive years, although the rise is limited to the same conditions that affect the ROA. Current RatioCurrent Ratio compares a companys ability to meet its short-term liabilities with its current assets to assess a companys liquidity capacity (Investopedia, 2014b). Tim Hortons is limited in this aspect as its current ratio has been declining over the past five years and was 1.0 in 2013 (see Appendix H). Tim Hortons plan to buy back $1 million of its outstanding shares, which again, is a likely factor contributing to the low current ratio as the company is financing the share repurchase with debt (Tim Hortons Inc., 2013). The low ratio is also emphasized when compared to its Cash Flow which shows limited cash reserves that would be needed in order to pay off debt. Conclusion The analysis and reviews conducted on Tim Hortons and its competitors have provided a clearer picture of Tim Hortons financial standing in the relative quick service-restaurant industry. Tim Hortons strengths and weaknesses are highlighted, aiding in determining its potential as a long-term investment for shareholders and potential shareholders alike.Comparisons of the company over time show positive returns on its assets and equity at first glance. However, because of Tim Hortons sale of its donut production operations and its share repurchase program, it is very likely that the figures have been distorted. Moreover, the companys operating cash flow, an important initial indicator of a companys financial health, is not sufficient enough to cover Tim Hortons investing and financing activities.At this time, there is a prevalent risk in investing in Tim Hortons. Its dividend and share repurchase program is mostly financed by debt. This may be unsustainable if the company enters a free cash flow deficit because the company would not be able to pay out dividends. Looking at its cash-flow-to-debt ratio, Tim Hortons is currently not receiving enough cash from operations to fund their debt. This poses a serious risk, especially as share prices rise, because the repurchasing process will become more expensive. As a result, a large amount of debt will be accumulated, making it very risky for investors if the company is not able to pay back the debt after the repurchase program. Furthermore, its goal to expand its store in the next few years does not seem attainable due to its high debt.From the current performance of its shares, it is evident that shareholders are wary of investing in Tim Hortons (Mcdermid, 2013). Its relatively low price-to-earnings ratio shows that investors do not expect their performance to increase significantly in the near future.To summarize, there is risk involved in investing in Tim Hortons. They have accumulated a large amount of debt due to its share repurchase program. However, management will be able to exercise more control over the company, giving them more financial flexibility. By investing in Tim Hortons, high returns are not as likely. However, a better return for shareholders is possible only if Tim Hortons is able to generate higher cash flows in the future, which in turn, will help cover its large debt.

ReferencesInvestopedia. (2014a). Cash-flow to debt ratio. Retrieved from http://www.investopedia.com/terms/c/cash-flowtodebt-ratio.aspInvestopedia. (2014b). Current ratio definition. Retrieved from http://www.investopedia.com/terms/c/currentratio.aspInvestopedia. (2014c). Debt-to-equity ratio. Retrieved from http://www.investopedia.com/terms/d/debtequityratio.aspInvestopedia. (2014d). Dividend yield. Retrieved from http://www.investopedia.com/terms/d/dividendyield.aspInvestopedia. (2014e). Impact of share repurchases. Retrieved from http://www.investopedia.com/articles/investing/112013/impact-share-repurchases.aspInvestopedia. (2014f). Price-to-earnings ratio. Retrieved from http://www.investopedia.com/terms/p/price-earningsratio.aspInvestopedia. (2014g). Receivable turnover ratio. Retrieved from http://www.investopedia.com/terms/r/receivableturnoverratio.aspInvestopedia. (2014h). Return on assets. Retrieved from http://www.investopedia.com/terms/r/returnonassets.aspInvestopedia. (2014i). Return on equity. Retrieved from http://www.investopedia.com/terms/r/returnonequity.aspMcdermid, B. (2013 November 27). Tim Hortons sets debt offering to fund share buyback. Reuters. Retrieved from http://www.reuters.comPeterson, K. (2014 April 28). Starbucks growth strategy? Open more Starbucks. CBS Money Watch. Retrieved from http://www.cbsnews.comThomsonOne. (2014a). Mcdonalds Corporation. Retrieved from http://www.thomsonone.comThomsonOne. (2014b). Starbucks Corporation. Retrieved from http://www.thomsonone.comThomsonOne. (2014c). Tim Hortons Inc. Retrieved from http://www.thomsonone.comTim Hortons. (2014, February 25). Tim Hortons plans 800 more restaurants. CBC News. Retrieved from http://www.cbc.caTim Hortons Inc. (2014a). Corporate Profile. Tim Hortons. Retrieved from http://www.timhortons.com.Tim Hortons Inc. (2014b June 10). Tim Hortons Camp Day raises $11.8 million. Tim Hortons. Retrieved from http://www.timhortons.comTim Hortons Inc. (2014c May 22). Tim Hortons launches mobile payments. Tim Hortons. Retrieved from http://www.timhortons.comTim Hortons Inc. (2013). 2013 Annual Report on Form 10-K. Retrieved from http://files.shareholder.com/downloads/ABEA-333FKS/3319688106x0x744056/69f45dc9-7832-4c8a-b180-33863567b623/Tim_Hortons_2013_AR_full.pdfWhite, S., Stevenson, C., Harris, A. (2010 September 7). Tim Hortons extra-large trouble trouble. Mcleans. Retrieved from http://www.mcleans.ca.

AppendicesAppendix A: Calculation of Total Debt-to-Equity Ratio20132012

Tim Hortons142.148.5

SBUX30.110.8

MCD88.389.1

Industry Average86.8349.47

Note: Reprinted from Tim Hortons Inc.: Ratios, ThomsonOne, retrieved from http://www.thomsonone.com Copyright 2014 by Thomson Reuters.Appendix B: Calculation of Cash Flow-to-Debt Ratio20132012

Tim Hortons.591.05

SBUX2.243.48

MCD.50.51


Note: Reprinted from Tim Hortons Inc.: Ratios, ThomsonOne, retrieved from http://www.thomsonone.com Copyright 2014 by Thomson Reuters.

Appendix C: Calculation of Receivables Turnover Ratio20132012

Tim Hortons16.515.1

SBUX28.430.5

MCD20.920.3



Appendix D: Calculation of Dividend Yield20132012

Tim Hortons1.67%1.7%

SBUX1.15%30.5%

MCD3.22%3.25%

Industry Average2.01%11.82%


Appendix E: Calculation of Price-to-Earnings Ratio20132012

Tim Hortons2218.7

SBUX35.8428.3

MCD17.516.5



Appendix F: Calculation of Return on Assets20132012201120102009

Tim Hortons19.29%19.13%17.36%28.07%15.49%

SBUX.28%18.34%18.92%16.62%7.57%

MCD16.46%17.12%18.26%17.16%16.84%



Appendix G: Calculation of Return on Equity20132012201120102009

Tim Hortons43.56%34.44%29.57%47.88%25.67%

SBUX.17%29.15%30.91%28.14%14.12%

MCD35.69%36.82%37.92%34.51%33.20%



Appendix H Calculation of Current Ratio20132012201120102009

Tim Hortons1.01.31.32.21.5

SBUX1.01.91.81.51.3

MCD1.61.41.81.51.3



Appendix I Cash-flow statement for Tim Hortons Inc.

Note: Reprinted from Downloadable Financial Documents, Tim Hortons Inc., retrieved from http://annualreport.timhortons.com/.com Copyright 2014 by Thomson Reuters.