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Should Investors Worry About Tim Hortons?

This week, both Tim Hortons (TSX: THI)(NYSE: THI) and Canadian Imperial Bank of Commerce made headlines when the two companies agreed to cooperate on a Tim-Hortons-themed Visa card. The card is completely flat, with two circles on it. One says “Visa”, while the other says “Tims”. Pressing one of the circles reveals either blue or white lights, and allows you to purchase goods with Visa or pay for food at Tim Hortons, depending on which one.

For the bank, the card is just another partnership with a another successful retail brand. The bank’s competitors have demonstrated that these types of partnerships work, teaming up with brands like Shoppers Drug Mart and Canadian Tire. For Tim Hortons, the card is an important loyalty tool, since customers can redeem their credit card rewards instantly for free coffee or donuts. It’s a win-win deal for both companies.

Tim Hortons has been one of the most successful fast service restaurant success stories in North America. Fifty years ago, the company had only one location in Hamilton, Ontario. Today, it has more than 3,500 locations in Canada, and an additional 800 in the United States, with plans to expand significantly in the next few years.

Despite the company’s terrific slate of assets, and the fact that it seems like the entire country is addicted to its coffee, I’m not sure I’d be buying shares at these levels. Here are three reasons why.

1. Competition

For a long time, Tim Hortons was practically unchallenged in the Canadian coffee market, which allowed the company to rise to its current level of dominance. Times have changed, however.

Both Starbucks (NASDAQ: SBUX) and McDonald’s (NYSE: MCD) have become formidable competitors. Starbucks has succeeded in getting consumers to pay a significant premium for its coffee compared to its rivals, while McDonald’s has taken a different approach, running promotions like giving away a free cup of joe after a certain number of purchases. McDonald’s has also upped its advertising budget dedicated to coffee quite a bit.

Sure, Tim Hortons has done a nice job diversifying, but coffee still makes up 40% of the company’s sales. An additional 60% of customers just buy one thing when in a restaurant. These metrics need to be improved, or the company is bound to lose additional coffee sales.

2. Anemic same-store sales growth

If it wasn’t for expansion, Tim Hortons would barely be growing.

The company’s most recent numbers pegged same-store sales growth at just 1.1% for Canada and 1.8% for the U.S. These numbers are hardly impressive, and are a far cry from the 4%-6% growth numbers posted just a few years ago.

There are a few reasons for this. The company has expanded its footprint significantly, taking away sales growth from existing franchisees and giving it to new stores. Additionally, wait times in restaurants continue to be an issue, especially as the company continues to introduce new items.

3. Temporary foreign workers

Back in April, the federal government announced it was shutting down Canada’s temporary foreign worker program, where the company gets about 5% of its front-line workforce. This number isn’t entirely accurate, since the company surely continues to employ people who have used the program to attain a more permanent status.

The feds have since re-instituted the program, but with restrictions. If a market has unemployment greater than 6%, employers can’t bring in any foreign workers. Since many franchisees depend on those workers, this could ultimately lead to weakness on the bottom line, and perhaps more tension between the company and its franchisees.

Ultimately, this could be the beginning of higher wage costs for franchisees, which is bad for the entire company.

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Fool contributor Nelson Smith has no position in any stock mentioned in this article. David Gardner owns shares of Starbucks. Tom Gardner owns shares of Starbucks. The Motley Fool owns shares of Starbucks.

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