McDonald's Sales Jolt Higher

The fast food giant is poised to boost sales thanks to higher-margin products like specialty coffees at discount prices

McDonald's (MCD) has been getting a nice jolt from the high-margin potential in upscale coffee products such as lattes and expressos that have been drawing early-morning commuters to cafes like Starbucks (SBUX) for years. News of robust sales in August pushed shares of McDonald's up 3.2% to $51.76 on Sept. 11, after touching a new 52-week high of $53.55 during trading.

On Sept. 11, the Oak Brook, Ill., restaurant chain reported a 7.4% gain in U.S. sales at stores open at least one year for August (up from 4.3% growth in July) and pointed to continued growth in the breakfast business, beverages and new food products.

Global comparable-store sales rose 8.1% in August, driven by a 12.4% increase in the Asia-Pacific, Middle East and Africa region and aided by extended hours and targeted menu promotions.

Among the products responsible for the improving sales are a new line of specialty coffee drinks that puts the restaurant chain in direct competition with Starbucks and Dunkin Donuts.

McDonald's premium coffee costs less (BusinessWeek, 8/1/07) than a cup at Starbucks, and also won a Consumer Reports' taste test.

Since McDonald’s introduced its premium drip coffee last year, coffee sales in the U.S. have risen 19% through August, while total coffee sales – including specialty coffees like lattes and cappuccinos - were up 37% through July 2007, says McDonald's spokesperson Heidi Barker. Coffee represents about 3% of the company’s total U.S. sales, she says.

The specialty coffees are offered at McCafes, which are separate sections of McDonald’s restaurants. Ten of the 21 McCafes in the U.S. have opened this year. There are 1,300 McCafes worldwide.

In a Sept. 8 research note, Standard & Poor’s said it expects “the further rollout of new salad offerings, snack wraps, breakfast items and coffee to help sustain same-store sales momentum through out 2007.” S&P expects total sales to rise by 5.2% in the U.S., 14.0% in Europe, and 12.5% in Asia-Pacific/Middle East/Africa this year. (Standard & Poor’s, like BusinessWeek, is a division of McGraw-Hill Companies (MHP).)

Broader introductions of other innovative products such as the Angus burger, Southern-style chicken sandwiches and chicken biscuits should continue to bolster same-store sales into the future, J.P. Morgan Securities said in an Aug. 8 research report. (J.P. Morgan, which has an overweight rating on the stock, does investment banking with the company and has acted as a lead or co-manager of a public offering of its stock and/or debt within the past 12 months.)

The growing strain that higher fuel and food prices are putting on consumers’ budgets could also be working to McDonald’s advantage as people migrate to quick-service venues from higher-cost casual dining restaurants, said Ann Northrop, a restaurant industry analyst at Zacks Investment Research, in a recent report.

But consumer spending pressures aren’t the only reason for the switch to quick-service eateries, Northrop said. McDonald’s is among a handful of these restaurant chains that “have done a great job in upgrading their offerings,” especially by upgrading its coffee in response to pressure from coffee chains and by expanding its menu to include healthier and more current foods, she said.

The “trade down” from casual dining should be a continued trend, and over the longer term same-store sales is likely to at least track food purchases outside the home amid ongoing increases in food prices, the J.P. Morgan report said.

McDonald’s sale of its Boston Market eateries is also positive, as it will allow the company to better focus on its core brand, J.P. Morgan said.

Higher sales of high-margin products in the U.S. bodes well for better earnings in the third-quarter, UBS Investment Research said in a Sept. 11 research note. Large increases in store traffic, which accounted for over half the same-store sales growth in August, suggests the company will have the ability to raise prices and generate trials for new product platforms such as the Angus burger, UBS said. (UBS has received compensation for non-investment banking services to McDonald’s within the past 12 months and makes a market in the company’s stock.)

UBS, which has a buy rating on the stock, boosted its global same-store sales estimate to 4.4% from 3.4% for September and to 6.3% from 4.4% for the third quarter. It also raised its third-quarter profit forecast by a penny to 78 cents a share and upped its 2007 earnings outlook to $2.81 a share.

While comparable-store sales in the U.S. have been rising for the past four years, margins in McDonald’s European restaurants are entering only their second year of expansion, said Northrop at Zacks. The U.S. and Europe each represent 35% of the company’s total revenues. She predicted that widening margins in Europe could drive earnings growth in 2008 and said profits could increase by 10% to 12% annually over the next five years due to overseas expansion and the repurchase of shares.

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