McDonald's challenging Starbucks with cheaper coffee drinks

When Charles Ruppert has a yen for a white-chocolate latte, he doesn't head to a Starbucks shop. He goes to a McCafe located in a McDonald's restaurant and pays 26 percent less.

"McDonald's got a real winner," said Ruppert, 55, a car-repair shop owner in Greensboro, N.C. Analysts think so, too: McDonald's shares will rise 18 percent in the coming year, UBS Securities estimates.

McDonald's, the world's biggest restaurant chain, has added the frothy drinks at two-thirds of its 13,794 U.S. stores since introducing a stronger brew in 2006.

Shares of Starbucks are down 24 percent in 2007, on track for their worst annual performance amid the slowest sales growth in more than five years at stores open at least 13 months.

McDonald's is "being extremely aggressive," said Peter Kwiatkowski, who helps manage $21.9 billion, including 1.3 million McDonald's shares, at Fifth Third Asset Management in Cincinnati.

"They're a lot cheaper than Starbucks coffee in general, and they have the high quality to go with it."

Ruppert paid $3.31 for a 20- ounce cup of latte at the McDonald's in Oak Ridge, N.C., compared with the $4.48 cost for the same size at Starbucks

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McDonald's coffee is drawing new customers and spurring food sales, especially at breakfast, President Ralph Alvarez said.

"Coffee, by itself, is a very high-margin business," said Alvarez, 52. "But it doesn't compare to what we get selling a full meal."

McDonald's said Tuesday that August same-store sales climbed 8.1 percent, helped by coffee and breakfast items. Sales on that basis have advanced 7 percent in the first eight months of the year. Alvarez declined to disclose breakfast results.

The chain offers lattes, cappuccinos and iced brews in 9,000 U.S. restaurants where consumers order coffee primarily at drive-through windows, Alvarez said.

U.S. coffee sales through restaurants, cafes and other outlets may reach $29 billion by 2011, 50 percent more than last year, according to New York-based National Coffee Association. About six in 10 adults drink coffee, making it the second most popular beverage after water.

Starbucks controls 52 percent of the global specialty coffee market, Euromonitor International Plc said. McCafe is the fifth-largest, with 1.7 percent.

Word is getting out about McDonald's coffee. In March, Consumer Reports magazine reported a taste test of basic black coffee found McDonald's stronger blend beat brew from Starbucks, Burger King and Dunkin' Donuts.

Consumer Reports' "trained tasters" visited two stores of each company. McDonald's coffee was "decent and moderately strong," whereas Starbucks was "strong, but burnt and bitter enough to make your eyes water," the magazine said.

In the U.S., McDonald's coffee sales climbed 20 percent through June from the February 2006 debut of the stronger blend. Sales that include hot, iced and specialty blends are up 34 percent this year, it said.

Sales at Starbucks stores open at least 13 months rose 4 percent in both the second and third quarters this year, the slowest growth rates since 2002. Total revenue jumped 20 percent to $4.61 billion from January through June of this year.

Rising sales of McDonald's coffee prompted Marc Greenberg, a Deutsche Bank Securities Inc. analyst in New York, in June to reduce his Starbucks stock-target price by 14 percent to $32.

"The golden arches are doing coffee better," Greenberg wrote in an investors' note. He rates Starbucks as "hold."

Starbucks has set a goal of 40,000 locations. The company had 14,396 outlets as of July 1. In the U.S., it has 10,295, compared with almost 13,800 for McDonald's.

Starbucks Chairman Howard Schultz has acknowledged the threat of fast-food chains, even though his company has 87 percent of the U.S. specialty coffee-shop market, whereas McCafe has less than 1 percent, according to Euromonitor.

Fast expansion and similar designs made Starbucks cafes lose the "warm feeling of a neighborhood store," Schultz wrote in a memorandum to top executives in February.
Starbucks now sells warm breakfast sandwiches such as eggs Florentine with spinach and Havarti cheese. It offers gourmet salads, including Asian sesame-noodle that cost $6.
Alvarez said McDonald's has no plans to offer the breadth of Starbucks beverages such as raspberry latte with soy milk and half the caffeine.

"If your only business is coffee, you better have all those options," Alvarez said.
"But we don't need 31 flavors, just enough variety to be considered a destination for coffee."