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Burger King may need to pay up for a Canadian conquest

It's never felt so good waking up to Tim Hortons. Should investors take the profits and run, or stick around for another helping?

Shares of the leading Canadian fast-food chain jumped 23 percent in mid-session trading Monday after announcing it was in talks to merge with Burger King Worldwide. The move was a pleasant change of pace for Tim Hortons investors, who had seen the stock essentially drift sideways for the past two years.

It may pay to be a little bit greedy. Indeed, while the transaction has drawn attention for the potential to create a so-called tax inversion, Tim Hortons has many strengths as a standalone company that should help it earn a healthy takeout price.

A Tim Hortons restaurant in Toronto.
Brent Lewin | Bloomberg | Getty Images
A Tim Hortons restaurant in Toronto.

First, Tim Hortons is far and away the category leader in the Canadian fast-casual coffee market with a roughly 80 percent share. Even as foreign competitors such as McDonalds and Starbucks have entered Canada, Tim Hortons has maintained positive same-store sales growth over the last several years, including the darkest days of the financial crisis.

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That strength should allow Tim Hortons to expand further across Canada with confidence. The company had 3,630 Canadian locations at the end of the second quarter, and management has said there's runway for more than 600 units in Canada.

Tim Hortons also has new ways to take advantage of its cult-like following in Canada. During the second quarter, Tim Hortons began to sell its single-serve coffee products through grocery stores. Others have shown that the single-serve category can grow quickly into a very significant business. At Starbucks, for instance, packaged and single-serve coffee accounted for 16 percent of companywide sales during the last fiscal year.

Tim Hortons has also begun to generate more revenue per customer visit in its Canadian stores by offering meals during more parts of the day. Traditionally a breakfast and coffee destination, Tim Hortons has bulked up on lunch offerings this year, which has driven positive same-store sales growth even while traffic has softened.

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Burger King has even more opportunity if it brings Tim Hortons further beyond Canadian borders. Christopher O'Cull, an analyst with KeyBanc Capital Markets, points out that Tim Hortons has about 80 percent of its store base in Canada and generates nearly all of its profits there. Burger King, meanwhile, has about 40 percent of its store base outside the U.S. and also earns about 40 percent of its profits abroad.

Burger King and Tim Hortons haven't commented on a potential transaction price, but Tim Hortons now trades just shy of 24 times consensus 12-month forward earnings. While that's near the richest level the stock has ever commanded, it's now comparable to the multiple for U.S. counterpart Dunkin' Brands. With a deal possible in the next few days, Tim Hortons investors may have another big morning in short order.

—By CNBC.com's John Jannarone

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