McDonald's ready to bean Starbucks

No. 1 fast-food chain says gourmet coffee growth - along with new breakfast items and 24-hour locations - fueling same-store sales increase.

By Parija B. Kavilanz, senior writer

NEW YORK ( -- Watch out Starbucks. McDonald's is eager to steal customers of your pricey frothy lattes.

McDonald's (Charts, Fortune 500), eager to find new growth categories to fuel its sales in areas other than burgers and fries, has aggressively dived into the market for gourmet coffee.

And despite Starbucks' dominance in that market, the move is working for McDonald's, according to CEO James Skinner.

The company, which reported its second-quarter results Tuesday, said its gourmet coffee drinks contributed to its robust 7.4 percent sales gain at its stores open at a year in the quarter, which is also a key measure of retail performance known as same-store sales.

New breakfast items, salads and chicken wraps, extended hours of operation and its Happy Meals movie tie-ins to "Shrek 3" contributed to its overall sales gains.

During a conference call with analysts to discuss the company's results, Skinner said McDonald's was "going after the $60 billion global coffee industry," which potentially threatens Starbucks (Charts, Fortune 500)' dominance in the space.

Starbucks, the leading seller of gourmet coffee beverages in the world, is set to raise U.S. prices for its coffee drinks next week as it struggles to offset rising costs for labor, milk and other commodities.

It will be Starbucks' second price increase in less than a year. But as many consumers shell out more for gas at the pump, they're also left with less disposable income to spend on $4 Starbucks latte.

This spells opportunity for McDonald's to steal some customers away from Starbucks as it expands its lower-priced coffee offerings.

"Our premium coffee sales were up 20 percent [in the quarter], and we're testing both hot and cold drip coffee and hot and iced espresso beverages," Skinner said.

McDonald's profits golden

McDonald's logged a second-quarter profit, excluding a one-time charge, that matched Wall Street's estimates

The Oak Brook, Ill.-based No. 1 fast-food chain in the world, posted a profit of 71 cents a share in the quarter, excluding a charge related to the sale of its restaurants in Latin America, up from 67 cents a share for the same period a year ago.

In April, McDonald's said it would sell about 1,600 restaurants in Latin America and the Caribbean to a franchisee.

That was in-line with analysts' consensus forecast for a profit of 71 cents a share, according to Thomson Financial. Including the charge, the company posted a loss of $711.7 million, or 60 cents a share.

Revenue for the quarter rose 12 percent to $6.01 billion, beating analysts' estimates of $5.8 billion.

Global sales at McDonald's restaurants open at least a year jumped 7.4 percent in the quarter.

Higher chicken, dairy costs pressure margins

McDonald's chief financial officer Matthew Paull said during the call that the company raised menu items by 3 percent in the quarter to offset a 9 percent increase in chicken costs and a double-digit percentage increase in cheese prices.

"This hurt [our margins] a bit otherwise our margins could go higher," Paull said.

For the year, McDonald's estimates chicken costs to be up between 4 to 5 percent.

"This year's 3 percent increase is consistent with our pricing model," said Skinner. "Some of that is reflected in the higher commodity costs but we're most [focused] on maintaining our relationship with our customers, adding that traffic at McDonald's store were up during the quarter.

Separately, Paull announced that he would retire from his position at the company by the end of the year.

"This is not about wanting to go to a bigger job. It is all about what I want in my life. I've always dreamed about going back to a college campus to teach," Paull said.

He added that McDonald's was considering both internal and external candidates to replace him. Top of page