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Lower Grocery Prices: Good for Consumers, Bad for McDonald’s

McDonald's reported worse-than-expected quarterly sales at established U.S. restaurants on Tuesday, becoming the latest chain hurt by menu price increases that far outpaced supermarket food costs, leading more consumers to eat at home.

Shares in McDonald's tumbled 4.3 percent to $121.96 and pulled down most shares in the restaurant sector. The Dow Jones U.S. Restaurants & Bars Index was off 2 percent. The world's biggest fast-food chain gets roughly one-third of its revenue and 40 percent of profits from the United States.

A McDonald's restaurant is pictured in Encinitas, California
A McDonald's restaurant is pictured in Encinitas, California September 9, 2014. REUTERS/Mike Blake

The second-quarter report from McDonald's landed after chains such as Dunkin' Brands, Starbucks, and Wendy's also reported disappointing results for the latest quarter in large part due to weak customer traffic.

Bernstein analyst Sara Senatore said restaurant companies, which are grappling with profit-squeezing minimum wage increases, use more labor than grocery stores and have the extra burden of trying to convince franchisees to hold back on price increases aimed at offsetting higher labor costs.

"Food prices are coming down, but labor is not. That's doubly bad for restaurants," Senatore said. "It's hard to convince everybody to operate in lockstep."

When franchisees raise prices, she said, "it just makes their prices look even higher relative to grocery stores."

McDonald's sales at U.S. restaurants open at least 13 months were up 1.8 percent in the quarter, far less than the 3.2 percent rise that analysts expected, according to research firm Consensus Metrix.

Restaurant food inflation is outpacing the increases at supermarkets and the gap is widening, McDonald's Chief Financial Officer Kevin Ozan said on a conference call with analysts.

Food-at-home inflation is expected to be flat to up about 1 percent for this year, while food-away-from-home inflation is expected to be up 2.5 percent to 3.5 percent, he said.

The food service industry is harder hit by state and local minimum wage increases because it employs more minimum wage workers than any other occupation. Some planned minimum wage hikes will more than double the prevailing wage to $15 per hour over time.

McDonald's executives said they expected labor cost pressures to continue, but declined to elaborate. They did, however, note that the company generally needs same-restaurant sales to increase 2 percent to 3 percent to maintain profits.

Read More: McDonald's Workers Wage Protest Shuts Down Company Headquarters

Restaurant companies also pinned the industry's second-quarter softness on the fractious U.S. presidential election and uncertainty spawned by terrorist attacks around the world.

"I think generally there's just a broader level of uncertainty in consumers minds at the moment," Chief Executive Steve Easterbrook said on the company's earnings call.

McDonald's total revenue declined 3.5 percent to $6.27 billion, in line with the average analyst estimate.