Los Angeles, 28 July, 2008 - Hot coffee sales at McDonald's Corp may be eating into results at Starbucks Corp, which is expected to report another period of lower profits when it posts quarterly results Wednesday.
Traffic to U.S. Starbucks stores also has softened as consumers pinched by the mortgage meltdown, job losses and higher costs for food and fuel cut back on everyday luxuries like coffee drinks that sell for $3 to $5.
"People aren't buying $5 coffee anymore. Starbucks made it through the last recession or two because it was a new concept. Now Starbucks is meeting up with reality," said Scott Rothbort, president and founder of LakeView Asset Management in Millburn, New Jersey.
Rothbort owns shares of McDonald's and watches, but has no intention of buying, shares in Starbucks.
"The consumer knows to stop buying the $5 cup of coffee at Starbucks and to buy the $1 cup or $2 cup of coffee at Dunkin Donuts," which like McDonald's is working to woo away Starbucks devotees, he said.
Analysts expect Starbucks's fiscal third-quarter profit excluding items to cool to 17 cents per share, compared with its year-earlier June quarter of profit of 21 cents per share, according to Reuters Estimates.
The chain, which has more than 18,000 owned and licensed U.S. locations, recently said it will close 600 underperforming outlets by early next year -- an admission that stores built in the last few years were either too close to already established cafes or in areas of questionable potential.
Starbucks, which like other restaurant operators is grappling with rising costs for milk and other ingredients, is starting to book closure-related charges in the third quarter so it will be difficult for investors to tease out the impact of competition.
McDonald's this week fueled speculation it was cutting into Starbucks' customer base, telling analysts Wednesday that it was pleased with the growth and momentum of its premium drip and specialty coffees.
"Total coffee sales continue to increase, led by iced coffee," McDonald's President and Chief Operating Officer Ralph Alvarez said on the company's earnings call.
McDonald's is expanding its beverage line to include specialty coffee drinks that will more directly compete with offerings from Starbucks. The fast-food chain is also planning to add smoothies, frappes, bottled beverages and energy drinks -- a lineup that is very similar to Starbucks'.
Respondents to an informal survey conducted by RBC Capital Markets said they bought more coffee at McDonald's in July compared with April and less at Starbucks, analyst Larry Miller said in a client note this week.
At some of its roughly 30,000 restaurants worldwide, McDonald's is also building separate areas dubbed McCafes, which offer specialty coffee and desserts.
The build-out has been more aggressive in international markets -- which Starbucks is eyeing for future growth.
At the end of last year, McDonald's had more than 1,500 McCafes in international markets and about three dozen in North America.
UBS Investment Research analyst David Palmer said McDonald's could capture up to 10 percent of U.S. specialty coffee market share in coming years -- and he doesn't think that it will necessarily be all bad for Starbucks.
"We believe (McDonald's) strategy is broader than simply taking share from (Starbucks), and may even grow the category -- benefiting competitors," Palmer said.