TH International Limited (NASDAQ:Thchn) is a company that operates Tim Hortons coffee shops in mainland China, Hong Kong and Macau. The company is a subsidiary of Tim Hortons Inc. and is located in Shanghai, China. It was founded in 2018.
I believe it is a good play for increasing coffee consumption in China. I wouldn’t take a huge position on it, but for those people who are looking for a clean play and aren’t willing to gamble with Luckin Coffee (more on that later), I think THCH is worth a shot .
The company is led by Yongchen Lu, who serves as CEO. Other key leads include Dong Li (CFO), and Bin He (Chief Customer Officer).
Commonly known as Tims China, THCH is the main franchisee of Tim Hortons coffee shops in China. It was founded as a partnership between Cartesian Capital Group and Restaurant Brands International Inc.
Tims China has been expanding rapidly since the opening of the first cafe in China in February 2019. The growth of Tims China is a result of the growth of coffee consumption in China, which is growing at an annual rate of 30%, significantly higher than the global average of 2%.
TH International Limited was formed as a master franchisee as opposed to a direct spin-off from Tim Hortons. The decision to form it this way was to allow Tim Hortons to expand its brand presence in the Chinese market through a local entity that understands and can effectively navigate the unique aspects of the Chinese market.
THCH has ambitious plans to open over 2,750 coffee shops by 2026, taking advantage of China’s underpenetrated coffee market and significant growth potential in China.
This expansion strategy mirrors the aggressive growth tactics of other major coffee chains in the region, aiming to capitalize on the growing popularity of coffee in China, including coffee giant Starbucks (SEX).
Overall, the formation and growth strategy of TH International Limited represents an important move in the global coffee shop market, especially in the rapidly developing and expanding Chinese market.
Any discussion of China should begin with your general appetite for investing in a communist country and then your comfort with the company’s corporate governance. It’s easy to see the growth potential of coffee in China, which we’ll talk about a little later, but if you don’t have good corporate governance and you’re willing to invest in a communist country, then it’s definitely not investment for you.
Yongchen Lu has been CEO of THCH since May 2018. Prior to this role, he served as CFO of Burger King China from November 2012 to April 2018 and worked as the China Representative at Cartesian from January 2008 to January 2016. Lu holds a undergraduate degree from Shanghai Jiao Tong University and an MBA from the Tuck School of Business at Dartmouth. His tenure at Tim Hortons China marks an important period in the company’s expansion and development in the Chinese market.
It is difficult to determine how Burger King China did during his tenure because there are no publicly disclosed financial records. Burger King, as a global brand, is part of Restaurant Brands International Inc.QSR), which is a company that includes other big brands like Popeye’s and Tim Horton’s.
Cartesian Capital Group is a global private equity firm focused on transnational investments. They are known for creating and managing innovative, cross-border, private equity and structured investments in multiple regions, including the Americas, Asia and Europe.
The firm often engages in large-scale investment projects and partnerships, particularly in markets undergoing significant economic transformation. Here are some of Cartesian’s key investments:
- Burger King: Cartesian played a key role in Burger King’s global expansion, particularly in China.
- Tim Hortons China: They partnered with Restaurant Brands International to expand the Tim Hortons brand in China.
- PetroRio: Cartesian invested in PetroRio, one of the largest independent oil and gas companies in Brazil.
- support: They invested in Uphold, a digital money platform that offers a wide range of financial services.
They seem to be a reputable private equity firm. However, more due diligence is required. You can read about Cartesian Capital’s investment in Tim Horton’s China here.
A cautionary tale: Luckin Coffee
Investors in Luckin Coffee (LKCNY) are well aware of the issues with corporate governance in China. Luckin was a growth investor’s dream, enjoying the growth of coffee consumption in China.
However, in 2020, Luckin was embroiled in a major accounting scandal. An internal investigation found that its chief operating officer had fabricated the company’s 2019 sales by about $310 million. This led to Luckin’s stock being suspended from trading on the US stock market and its CEO and COO being fired. After that, the US Senate passed legislation that could potentially bar many Chinese companies from listing shares on US exchanges or raising money from US investors without adhering to strict regulatory and auditing rules.
However, it is interesting that Luckin is now the largest coffee brand in China. Their return is surreal. Just 2 years after being delisted, they passed Starbucks as the largest coffee chain in China by number of stores.
Luckin now has over 6,000 stores compared to 5,600 for Starbucks. It actually went from an operating loss to $136 million in operating profit in the third quarter of 2023. Luckin is now valued at over $8 billion in the non-sold market and is preparing plans to list in Hong Kong or even re-list in Nasdaq. Luckin denies this, however, and says he is “committed to US capital markets.”
However, most investors are not so eager to get back on the Luckin train given its dark history, nor are they willing to invest in the stock off the shelf. As a result, the purest play way to invest in growing Chinese coffee consumption is through Tim Horton’s China.
First, let’s talk about coffee consumption trends in China before diving into Tim Horton’s financials and strategy.
Coffee consumption trends in China
Coffee consumption in China has grown rapidly, driven by urbanization, rising middle-class incomes and changing consumer preferences.
This growth is particularly evident among the younger population, who are increasingly embracing Western lifestyles and beverage choices. The expansion of international and local coffee chains has also contributed to this trend.
As a result, coffee is becoming a popular alternative to traditional Chinese teas, especially in urban areas, signaling a significant cultural shift and presenting a growing market opportunity for coffee businesses.
Some interesting statistics:
Long Term Growth: In the last 14 years, the total consumption of coffee in China has increased by more than 1000%.
Coffee production: In 2020, 60% of China’s coffee was produced in Yunnan province. Despite this, most of the coffee consumed in China was still imported.
Preference for instant coffee: Instant coffee accounts for a significant portion of coffee consumption in China, about 63%. In 2021, Nestle led the instant coffee sector with 50% of sales.
Despite the traditional dominance of tea, coffee is steadily gaining ground, driven by the expansion of international coffee chains such as Starbucks and the growing preference of the middle class for modern and urban lifestyles. The preference for instant coffee is particularly evident, reflecting the convenience and affordability that matches the lifestyle of many Chinese consumers.
Tim Horton’s China Finance
THCH made $8.2 million in revenue in 2019. Just 4 years later, trailing twelve month revenue is $209 million.
In the third quarter of 2023, sales increased from $43 million to $59 million year over year. However, the company continues to operate at a loss. Operating income was -$18.5 million in the third quarter of 2023, from -$21 million a year ago. With only $63 million in cash, you’d like to see the company reach GAAP profitability fairly quickly.
However, free cash flow has improved from -$90M in 2022 to just -$30M in the trailing twelve months and has fallen to just -$4.5M in Q3 2023.
With a market cap of $320 million, THCH is trading at just 1.6 times trailing earnings. With a 30%+ growth rate, that’s not expensive. The discount definitely comes from being in China.
A key pillar of THCH’s growth strategy is expanding its product offerings and expanding its stores. In the third quarter of 2023, they launched 21 new beverages and 11 new food products in the third quarter of 2023. Several “hero” products have emerged from their recent product launches including buffalo milk latte, which sold 528,000 cups during the quarter.
The company is seeing a higher order total from grocery items.
And their digital customer base is expanding nicely.
The overall growth of the company has been mainly driven by the increase in the number of stores. Last year alone, they increased the number of stores from 486 to 763, an increase of 57%.
If you can invest in China and you can deal with issues related to corporate governance in China, then I think THCH is an interesting company.
As the company expands, their expense management must improve. Look for store profitability to improve and the company to show leverage in general and administrative expenses as it is spread across a wider store base.
Right now, many of their stores are still in their infancy, so as they mature, they should theoretically see an improvement in sales. And again, corporate overhead and admin expenses won’t need to double for each new store, meaning more operating leverage as the company grows its store count.
As I mentioned before, THCH is a market cap of ~$320M and is trading at just 1.6x trailing earnings. With a 30%+ growth rate, that’s not expensive. By comparison, the battered Luckin is trading at 4X trailing earnings. I don’t think that discount is warranted given Luckin’s history. I think it is reasonable to expect THCH to trade up to a similar price to sales. However, being in China, a discount is generally guaranteed for peers like Starbucks.
Luckin’s is also a risk for the company because it appears to have rebounded strongly and is growing faster than Tim Horton’s (Luckin’s grew sales about 85% last quarter). Plus, it’s a local brand that can win over local consumers more than a foreign brand.
I don’t currently own any stock, but I may take a small position. I would say a max position size for me would be around 3 to 5% (I tend not to have more than 15 positions at a time).