After Dunkin’ And Starbucks, McDonald’s To Foray Into Packaged Coffee

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Following in the footsteps of Starbucks Corporation (NASDAQ:SBUX) and Dunkin’ Donuts, McDonald’s Corporation (NYSE:MCD) will soon introduce packaged coffee under its McCafe brand. The company has tied up with Kraft Food Groups, which will be responsible for distributing and marketing the packaged products. [1] It is a good time to start selling coffee since the arabica coffee prices are near a four year low. Moreover, the outlook for coffee remains bearish due to a bumper production in Brazil, the world’s largest producer of arabica.

We have a $97 price estimate for McDonald’s, in line with the current market price.

McDonald’s specialty line of drinks such as Frappés and Real Fruit Smoothies, introduced under the McCafe brand in 2009, have resonated well with the American public since their launch. To a certain extent, the company’s strong sales growth in 2010 and 2011 was attributable to the success of McCafe.

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Starbucks has already defied the conventional wisdom that would suggest that packaged products should cannibalize the restaurant sales (which tend to have higher gross profits). However, sales at its restaurants and those of its packaged goods continue to grow at an impressive rate.

Coffee Consumption On A Rise

While the overall restaurant industry might not be growing at a fast pace, coffee consumption is on a rise. An estimated 83% of American adults consume coffee presently, up from 78% in the previous year. [2] Coffee is viewed favorably as its consumption is associated with providing certain health benefits. This is in stark contrast to McDonald’s traditional reputation of promoting obesity through its main menu of fast food.

Consumers generally like to stick with their coffee brands, so the company hopes that the people who buy the McCafe packaged coffee would also be drawn towards the McCafe outlets. If the model becomes successful, McDonald’s can even foray into K-Cups and single serve coffee packs. Starbucks and Dunkin’ Donuts already have a line up of their respective K-Cups and single serves.

Appeasing Franchisees

At the same time, the move will also appease the franchisees who had long been complaining about narrowing margins. Selling coffee through retail outlets will also help improve the same-store sales, without any additional investment on the part of the franchisees. The incremental sales should help spread the fixed costs, such as labor and occupancy, over a bigger revenue base and help widen the margins.

It has been a tough year for McDonald’s as sales have refused to pick up. Through October, McDonald’s same-store sales are up a meager 0.5%. [3] The company has had to rely heavily on inexpensive value meals such as Dollar Meals in order to lure customers. However, sales haven’t grown at the rate the company would have liked, while excess reliance on value meals has eroded the margins. This has led to dissatisfaction among the franchisees. [4]. Therefore, McDonald’s is now testing the expanded version of the Dollar Menu known as Dollar Menu & More which will have products priced at $2 or $5, in addition to the regular $1 items.

Comparable sales, or same-store sales, is an important measure to gauge a restaurant’s performance since it only includes the restaurants open for more than a year and excludes the effect of currency fluctuation.

There are also reports that McDonald’s is in the process of simplifying its menu. The current menu is too big, which results in long queues especially at drive-thrus. With these changes incorporated, the year 2014 could throw in some surprises for the world’s largest fastfood chain.

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Notes:
  1. McDonald’s and Kraft to test grocery coffee sales in 2014, October 30, 2013, reuters.com []
  2. Coffee Consumption Increases in U.S., Association Survey Shows, March 23, 2013, bloomberg.com []
  3. MCD 8-k []
  4. McDonald’s ‘Much More Controlling’ Amid Slow Sales, Franchisees Complain: Report, August 7, 2013, huffingtonpost.com []