Coffee Wars: McDonald's vs. Starbucks

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Includes: MCD, SBUX
by: FP Trading Desk

It appears McDonald's Corp. (NYSE:MCD) has pulled ahead of Starbucks Corp. (NASDAQ:SBUX) in the cutthroat U.S. coffee war by offering similar "luxury" products at a 20% discount, attractive to consumers looking for places to save.

Recent price checks by Deutsche Bank show the Golden Arches sells a medium iced mocha for $2.89, compared with $3.65 at Starbucks.

In Canada, McDonald's tried to put a dent in Tim Hortons' (THI) market share by offering free coffee in the morning for two weeks back in April.

The bank said in a consumer report Thursday:

Call it a crazy guess, but we think the ability to get this good-tasting product at close to 11,000 outlets, many of them with drive-thru, is having negative impact.

Buying a drink that is close to $4 once a week works out to some $200 a year, not exactly "chump change" in a recession. Buying McDonald's instead saves about $40 a year. That's worth at least a few Big Macs.

There are risks to the McDonald's gambit, including diluting pricing for the entire market over the long term.

In any case, the short-term benefits of the aggressive McDonald's campaign has Deutsche Bank giving the company a Buy rating with a target price of $65, and a prediction of same-store sales to go up 4% in the second quarter.

Starbucks, on the other hand, remains bearish in the bank's eyes.

The note said:

Although we note the company's progress recognizing the need to reduce the store base and improve value for consumers, we continue to believe measures taken are not enough to contain erosion of comps or meet impending competitive pressure from McDonald's.

The company gets a Sell rating with a target price of $9.

There is also a much more practical perspective on the whole coffee war: does anybody actually need to buy a premium drink, even at a discount?

The note said:

If you do not drink coffee (at Starbucks), what will happen? Nothing. We compare this to what happens when one goes without food basics like water and bread needed to live. There’s a value gap there too.

No kidding.