While Dunkin Donuts fights for business with other U.S. chains, it's also hearing the heavy footsteps of Canada's Tim Horton.
NEW YORK (Fortune) -- Most accounts of Dunkin' Donuts' aspirations to blanket the nation with its pink-and-orange logo focus on its battle with established powerhouses like Starbucks and McDonald's.
(For more about Dunkin Donuts' move West, see this story from the Sept. 18 issue of Fortune.)
But as he moves westward, Dunkin' CEO Jon Luther better not lose sight of a growing threat in his own backyard - Canadian coffee-and-doughnuts purveyor Tim Hortons (Charts), flush with cash from its recent IPO and itching to do battle with Dunkin' in the Lower 48.
Founded by a pro hockey legend 42 years ago, Toronto-based Tim Hortons currently dominates the fast-food scene in Canada with more than $1.3 billion in sales from over 2,600 locations and a 23 percent share of the $14 billion Canadian quick-service market, more than McDonald's (Charts), according to the Canadian Restaurant and Foodservices Association.
Tim Hortons' vibe is decidedly blue-collar, just like Dunkin's, and its menu also resembles Dunkin's, with coffee and donuts at its core. But Hortons also offers soups and sandwiches to generate lunchtime sales - a weak spot in Dunkin's business right now, as two-thirds of its $4 billion-plus in sales come before noon.
Fast-food chains are notorious for their ups and downs - McDonald's suffered through several lean years before turning the corner two years ago. The jury is still out on Burger King (Charts), which was a dysfunctional mess before private equity firms cleaned it up and took it public earlier this year. No. 3 player Wendy's, meanwhile, is having a tough time of its own lately. (Wendy's CEO Jack Schuessler retired earlier this year.) Even Starbucks (Charts) has shown a glimmer of vulnerability, as its stock plunged in early August on news of weaker-than-expected July sales.
Amid all that volatility, Hortons just continues to grow. Since the end of 1995, the year it merged with Wendy's, Hortons' system-wide sales have grown at a compound annual rate of 18.5 percent. Same-store sales, the lifeblood of any restaurant, have grown for 13 straight years in Canada at a 7 percent annual clip, which is roughly double the industry average.
But with just under 300 stores in the United States - concentrated in the Northeast, Michigan, and Ohio - this growth has gone largely unnoticed. "We don't mind flying under the radar," says Tim Hortons senior VP Christos Laganos, who's spearheading Hortons' expansion.
Laganos wants to have 500 locations in this country by 2008, mainly in border regions where Hortons already has a footprint, like central Ohio, southern Michigan, upstate New York, and Maine.
"We could easily double our size in those markets," he says. If that goes well, Laganos will look to new markets like Lansing, Mich., Syracuse, and Youngstown, Ohio. Noticeably absent in his strategy - Massachusetts, Dunkin's home state, where it has over 1,000 stores and Hortons has but three.
Hortons' execs feel that two things separate it from Dunkin' Donuts - a dine-in atmosphere and a broader menu. According to Hortons' registration statement with the SEC, the company generates 16 percent of sales from soups and sandwiches in its U.S. stores.
Dunkin', meanwhile, doesn't offer soup, and while it does strong business in breakfast sandwiches, is just beginning to roll out lunchtime items like ham-and-cheese flatbread melts. Hortons also encourages diners to stay and eat, versus Dunkin', where the emphasis is to grab-and-go. (Most Dunkin' locations have a drive-thru.)
In a recent interview, Dunkin's Luther acknowledged that Hortons is a tough competitor. "We struggle in Canada," he says. "We have to be careful there because Tim Hortons is very strong."
But Luther relishes the challenge. He notes that when Krispy Kreme tried to enter New England a few years back, it left bruised and bloodied. And he's already making things tough on Tim Hortons in the States - in 2004 Luther submitted a competing bid for Rhode Island donut chain Bess Eaton, in order to complicate Hortons' ultimately successful attempt to buy the company.
"The entrepreneurial world wakes up when someone comes into their land," Luther says ominously, noting that the former Bess Eaton stores have struggled since joining Hortons. Wendy's, which still owns 83 percent of Tim Hortons until it completes the spin-off later this year, took a $25 million charge to write down goodwill related to the $41 million Bess Eaton acquisition.
Horton's Laganos admits that the acquisition has not been "as great as we would have liked." (The company also pushed back its time frame for reaching 500 stores to 2008, from 2007.)
While investors cannot bet on both horses in this race - Dunkin' is owned by a private equity consortium - there are plenty who think that Hortons will do just fine supplying our national caffeine fix.
Its NYSE-traded shares surged 22 percent on the first day of trading back in March. After dipping from $29 to $24 over the summer, the stock has rebounded of late. Most analysts are lukewarm on the stock, as it's quite expensive, trading at 27 times trailing earnings.
Can the hottest Canadian export since Mike Myers woo Dunkin's loyal customers while also dealing with a U.S. restaurant industry slowdown? It won't be easy, but never underestimate our nation's appetite for fried dough and caffeine.
Matt Boyle writes about the popularity of Dunkin Donuts coffee and its effort to expand and take on Starbucks and McDonalds in the Sept. 18. Fortune. Read that story here.