McDonald’s Frozen Lemonade Boosts Profit as Food Costs Increase

McDonald's Frozen Lemonade Boosts Profit As Costs Increase
Customers walk out of a McDonald's Corp. restaurant with cold drinks and food in San Francisco. Photographer: David Paul Morris/Bloomberg

McDonald’s Corp. may report its eighth straight quarter of profit growth, the longest streak in 13 years, as beverages such as frozen strawberry lemonade combat rising costs that are making hamburgers less profitable.

The world’s largest restaurant chain is expected to say tomorrow that profit rose to $1.28 a share and revenue climbed to $6.65 billion, the average of analysts’ estimates compiled by Bloomberg.

McDonald’s is the most successful of fast-food restaurants trying to replicate the high-margin beverage sales of Starbucks Corp., said Steve West, a Stifel Nicolaus & Co. analyst. As meat costs rise, McDonald’s has advertised its McCafe drinks, which contribute as much as 80 percent of their price to profit, compared with about 60 percent from hamburgers, he said.

“No one has been able to do it until McDonald’s,” said West, who’s based in St. Louis and recommends buying the shares. “They promote the frozen beverages for warmer months and they’ll go back to the McCafe during the winter months.”

The Big Mac seller, which introduced McCafe specialty drinks in the U.S. in May 2009, has added mango-pineapple smoothies and ads urging customers to “Drinkcessorize.” Beverages make up about 20 percent of sales at McDonald’s stores. The company has boosted earnings-per-share excluding items in every quarter starting with the third quarter of 2009.

McDonald’s, based in Oak Brook, Illinois, rose 6 cents to $86.27 yesterday in New York Stock Exchange composite trading. The shares gained 12 percent this year before today.

Arby’s, Popeyes

Other fast-food chains have tried to match McDonald’s success. The Arby’s roast-beef chain, acquired by Roark Capital Group from Wendy’s Co. this month, has been advertising a limited-time jamocha Oreo milkshake as a part of its “Good Mood Food” campaign. Popeyes Louisiana Kitchen, owned by AFC Enterprises Inc., is hyping a beverage made with lemonade and Fanta strawberry soda.

The more profitable beverages are taking the sting out of commodities costs that are rising faster than McDonald’s can boost prices. The company said in April that commodity prices may rise as much as 4.5 percent in the U.S. and Europe in 2011.

“We’ll have to take some price increases along the way, but it won’t equal the total inflationary increase of the commodity cost,” Chief Executive Officer James Skinner said during a conference in June. The fast-food chain raised food prices 1 percent in March because of ingredient costs.

McDonald’s may raise its estimate for commodity costs again tomorrow, said Mark Kalinowski, a New York-based analyst at Janney Montgomery Scott LLC. He advises buying the stock.

Commodity Costs

Yum! Brands Inc., operator of the Taco Bell and KFC chains, said last week that U.S. commodity costs may gain as much as 7 percent this year. The Department of Agriculture last month forecast U.S. food costs may rise as much as 4 percent in 2011.

The profit margin at McDonald’s company-operated stores narrowed to 17.7 percent in the first quarter from 18.2 percent a year earlier. The decline was primarily due to higher commodity and labor costs, the company said in a filing with the U.S. Securities & Exchange Commission.

In the second quarter, the margin at company stores may contract 0.8 percent from last year, according to Matthew DiFrisco, an analyst at Lazard Capital Markets in New York, who has a “buy” rating on the shares. Margin expectations for McDonald’s have “cooled a little bit” because of mounting meat, dairy and wheat prices, he said.

Biggest Beef User

McDonald’s is the biggest beef user of all U.S. restaurants, according to Kevin Good, a senior analyst at CattleFax in Centennial, Colorado. U.S. ground beef prices jumped to $2.77 a pound in June, a 16 percent increase from a year earlier, according to the Bureau of Labor Statistics.

First-quarter net income advanced 11 percent from a year earlier to $1.21 billion, or $1.15 a share. The average estimate of 11 analysts is for second-quarter net income to rise to $1.34 billion.

The eight quarters of profit growth would be the longest since a streak of at least 29 quarters that ended in 1998.

McDonald’s has almost 33,000 stores worldwide, 80 percent of which are franchised.

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