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By Jonathan Chen

As the global economy slowly starts to move into a recession (if it isn't there already), consumers have been noticeably trading down, or getting squeezed out of some of their favorite stores. Coffee is one luxury that consumers do not seem willing to give up on.

One potential name that could prosper is a neighbor to the north, Tim Hortons Inc. (NYSE:THI).

At almost 17 times 2012 earnings and sporting a 1.5% dividend, shares are not cheap , but Scotia Capital notes that Tim Hortons could benefit as the economy goes into a downturn.

In a note to clients, Scotia writes,

With fears of recession rocking markets, it is worth noting that Tim's does well in downturns and is using this one to build loyalty in particularly hard hit markets, taking advantage of a strong BS to exploit real estate opportunities. THI also conveyed optimism on the U.S., with confidence derived from strong leadership, franchise belief in the brand, and an aggressive marketing effort, underpinned by strong operations. The U.S. experience mimics the path to growth in Quebec, adding to that optimism. THI opened its first unit in Dubai. Key to International, says House, is a strong financial partner with good access to real estate. THI should be able to take advantage of the fact that, while the Mideast is a mature coffee market, no one as yet is doing a good job with food.

The company is in a defensive space (fast food space) and is growing exceptionally fast. According to Capital IQ, the Canadian-based company reported five year EPS growth of 22.9% and grew revenues by 11.1% year-over-year over the same time frame. The company has also been able to generate strong returns on its invested capital, generating ROIC (return on invested capital) between 16.3% and 20.7% during the session.

Bank of America is particularly positive on the name, rating shares at Buy. In a note to clients, it wrote,

Tim Hortons is the market-leading Canadian QSR with an approximate 20 year track record of positive same store sales. The brand still has significant growth opportunities both in Canada, with a 4,000+ unit potential, and internationally. THI generates significant FCF and has been active in returning cash to shareholders through share repurchases and dividends.

As the company expands into the U.S. market, it could see earnings estimates be taken up as it tries to take away market share from companies like Dunkin' Brands (NASDAQ:DNKN), Starbucks (NASDAQ:SBUX), and McDonald's (NYSE:MCD).

For the current quarter, analysts are expecting earnings of 64 cents per share on $723.08 million in revenues. That would be a huge jump from last year, when the company reported earnings of 54 cents per share on $670.52 million in revenues.

There is the potential for Tim Hortons to expand into the single space coffee market, like Starbucks and Green Mountain Coffee Roasters (NASDAQ:GMCR) have done. This is an extremely strong growing market, and something no doubt the executives at Tim Hortons have discussed. In a recent research note, Piper Jaffray was very positive on the serve space. It wrote,

Double-digit growth opportunities within the fast-growing single serve coffee market leave us encouraged about the future of the coffee beverage space; which we have begun to profile in this report. In particular, we believe the recent K-Cup collaboration between Green Mountain and Starbucks (among other traditional coffee retailers) is compelling. We believe the majority of growth for the segment lies ahead as consumers continue to adopt the single serve form factor and product innovation and evolution continues. In our opinion, industry fundamentals are strong and current valuations remain conservative.

As the global economy moves closer and closer to a recession, there are some things that people will not give up. Good coffee is one. Tim Hortons may very well benefit.

ACTION ITEMS:

Bullish:

Traders who believe that the coffee markets will continue to grow at healthy rates might want to consider the following trades:

  • Tim Hortons, Starbucks, Green Mountain and other names will all benefit as consumers purchase coffee for themselves in place of other luxuries.

Bearish:

Traders who believe that the global economy will get worse than anyone expects may consider alternate positions:

  • If things get so bad that the consumer trades down for coffee, then you know things are really bad. All of these names would be a short if that happened.
Source: Tim Hortons Will Remain A Strong Pick Even In An Economic Slowdown