Is Tim Hortons Inc.’s Dividend in Danger?

Can Tim Hortons Inc. (TSX:THI)(NYSE:THI) keep the dividend hikes coming?

The Motley Fool

I’m not the brightest guy in the world.

You’re probably smarter and more talented than I am. You’re almost certainly better looking. For all of those reasons, I like to keep my investments simple.

That’s why I have often touted Tim Hortons Inc (TSX: THI)(NYSE: THI). It’s an easy to understand business that lavishes shareholders with dividends. It doesn’t take an MBA to figure out that Timmies will likely reward investors for decades to come.

That was until Burger King Worldwide Inc. (NYSE: BKW) entered the picture. Now shareholders have to ask if this dividend is really safe.

Is danger lurking in Tim Hortons dividend?

Tim Hortons had just about everything I look for in an income investment.

For starters, there’s the iconic brand. Firms that can lock in a loyal customer base (myself included) generate strong cash flows and superior profit margins. That’s the hallmark of a wonderful business.

But as an investor, it was the company’s steady dividends that really won me over. No, the stock never sported the biggest yield. However, Tim Hortons used most of its profits to reward shareholders with hefty dividend hikes. Every February, you could always count on executives to announce another big increase.

And those dividend hikes would’ve likely continued for decades to come – until Burger King Worldwide came onto the scene.

In August, Tim Hortons announced a US$12.5 billion merger with the American burger chain, funded by big helpings of debt. Executives can talk all they like about the benefits of this merger. But let’s just call it what it is: a leveraged buyout.

After the deal is closed, the combined company will be saddled with more debt than a shopping addict after a spending spree. Today, Tim Hortons debt load is modest at US$1.4 billion. However, after the deal is closed, the combined firms will carry a staggering net debt load of about US$11.8 billion, including preferred shares.

Right now, Tim Hortons has about $1.60 of net debt for every dollar it earns before interest, taxes, depreciation, and amortization, or EBITDA. Once the merger is completed, the new company will sport $7.60 in net debt on this same metric.

Those numbers are worrying. Like any household with a high debt load, a business that has overextended itself on credit has little financial flexibility. If margins tighten or interest rates rise, then Timmies could have to resort to a dividend cut.

There’re other problems here, too. Tim Hortons has already been saddled to a slow growing company once before in Wendy’s. Now it has hooked its ship to another poorly performing anchor with Burger King.

Even in the best-case scenario, this deal is still bad news for income investors. 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.

Is it time to bail on Timmies?

I don’t know how a Tim Hortons/Burger King merger will play out. You should have a lot of confidence in the ability of 3G Capital, the quarterback behind this deal. This might also just be what management needs to take the Timmies brand global.

But for income investors, this is no longer the reliable dividend stock we once loved. And when an investment no longer meets your original thesis, then it’s time to move on.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor Robert Baillieul has no position in any stocks mentioned.

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