As a caffeine addict, I was always a big fan of Tim Hortons Inc.’s (TSX: THI)(NYSE: THI) coffee. And as an income investor, I was an even bigger fan of the stock.
Tim Hortons shares never sported a huge dividend yield. However, the company generated an enormous amount of cash, carried a modest debt load, and lavished shareholders with generous dividend hikes. It was for these reasons that I frequently touted the stock here on The Motley Fool Canada.
That was until Burger King Worldwide Inc. (NYSE: BKW) entered the picture. Last month, Tim Hortons investors celebrated the announcement of a US$12.5 billion merger with the American burger chain. Now shareholders face a choice: hold on to the new company or take their money and run.
Here’s my take: I don’t know how the Burger King/Tim Hortons merger will play out. But for conservative investors, this is no longer a stock to buy and hold.
If the good times are all gone, then I’m bound for moving on
Tim’s management team can talk all they want about how this deal will ramp up the company’s international expansion. However, for income investors, it means any dividend hikes are off the table for the foreseeable future.
Even calling this deal a merger is absurd. It’s a leveraged buyout. After the deal is closed, the combined companies will be saddled with so much debt that any dividend hikes will be on the bottom of management’s priority list.
I’m not the only one skeptical of this merger. My colleague Nelson Smith pointed out the weaknesses in Burger King’s business shortly after the deal was announced. Fool contributor Cameron Conway highlighted his concerns yesterday that shortsighted cost cuts could potentially hurt the Tim Hortons brand.
My chief worry is the debt needed to finance this deal. The combined company will initially carry a net debt load of about US$11.8 billion including preferred shares. That’s a staggering sum given that Tim Hortons current debt load is a modest US$1.4 billion. Today, Tim Hortons has about $1.60 of net debt for every dollar it earns before interest, taxes, depreciation and amortization, or EBITDA. However, after the deal is closed, the merged company will sport $7.60 in net debt on this same metric.
The bad news for dividend investors is that any excess profits will likely be funneled toward paying off creditors. As is typical in a leveraged buyout, almost all cash flow is directed toward debt repayment. In other words, the days of double-digit dividend hikes at Tim Hortons are over.
It’s not hard to imagine other potential problems with this picture, either. Like any household that has overextended itself on credit, a high debt load leaves the new company little wiggle room. If interest rates rise or the economy sours, management may have to quickly resort to a dividend cut to conserve cash.
I’ll look for you if I’m ever back this way
Let me be clear: I’m not saying that the merger will be a flop. I hope the Tim’s brand goes global. I also have a lot of confidence that 3G Capital will be able to unlock value for shareholders.
But the bottom line is, the Tim Hortons investment thesis has radically changed. This is no longer the conservative dividend stock I once loved. And when an investment no longer meets your original criteria, it’s best to move on.
