The consumer discretionary sector is sensitive to economic cycles. As a result, it is expected to be one of the hardest hit in a protracted recession, which explains much of the sell-off we’ve seen in leisure, consumer and restaurant stocks.
At the same time, some of the companies that fall into this category are far from discretionary when it comes to the habits of consumers. Tim Hortons Inc. (THI) is a perfect example since few Canadians would likely go without their C$1.25 jolt of caffeine in the morning or be unwilling to spend some spare change on a few timbits, even if we were in the midst of a sharp recession.
In Canada, it could also benefit from consumers who trade down from chains like Starbucks (SBUX). However, Tim's has lower brand recognition in the U.S., which poses a challenge in this respect as it battles against Dunkin' Donuts and McDonald's (MCD).
Of the 23 consumer discretionary names in the S&P/TSX composite index, only two had a dividend yield above 0.5%, a price-to-earnings multiple of less than 20, and have seen their shares rise in the past 13 weeks. As of Wednesday’s close, they were Tim Hortons and Shaw Communications Inc. (SJR). But only Tim's has positive earnings momentum, something investors may be keying in on given that it is set to report third quarter results on Friday.
Many didn’t get a chance to buy the stock at its IPO price of C$27 per share back in March, 2006, when it soared on massive volumes in the first day of trading to nearly C$38, making Tim's more valuable than Air Canada (AIDIF.PK) or Bombardier Inc. (BDRAF.PK). The lowest they’ve gotten since was C$26.88 in August that year, not that far from where they are trading today.
RBC Capital Markets analyst Irene Nattel expects the results will reflect a more cautious consumer spending environment and slower traffic trends that are impacting almost all retailers and quick-service restaurants in North America.
She said in a recent report:
However, Tim's strong value positioning should help the network maintain better relative traffic trends, and overall, we expect Tim's to deliver solid financial results, reflecting its strong consumer franchise and attractive business model.
While her operating income growth estimate is below the Street and same-store sales expectations are at the low end of management's target range, Ms. Nattel's new 2009 valuation multiples for Tim's (18x P/E and 10x EBITDA) are in line with where its peers are trading.
Despite the forecast for slower earnings growth and this more conservative valuation that led to a price target reduction, RBC still sees upside for Tim's with a target of C$33 per share.