McDonald's Corp is muscling in on business from other fast-food chains and turning up the heat on coffee chain Starbucks Corp by expanding its lower-priced roster of competing drinks.

The world's biggest restaurant chain on Wednesday posted first-quarter earnings that outpaced analysts' forecasts after March sales at established restaurants picked up more than expected in the United States and Europe.

We saw consumers come out of hiding in March, Morningstar analyst R.J. Hottovy said.

U.S. results got support from McCafe coffee drinks, the breakfast Dollar Menu and new frappe drinks that take aim at the successful Frappuccino line from Starbucks, which is due to report results after the market's close on Wednesday.

Sales at U.S. restaurants open at least 13 months rose 4.2 percent in March -- compared with Wall Street's target for a 1.6 percent rise -- and 1.5 percent for the quarter.

Rival Yum Brands Inc , parent of the Taco Bell, KFC and Pizza Hut chains, last week reported a 1 percent drop in its first-quarter U.S. same-restaurant sales. Competing hamburger chains like Wendy's/Arby's and Burger King , which reports next week, also are lagging.

The competition seems to be floundering, said Edward Jones analyst Jack Russo. They're clearly picking up market share.

So far, same-store sales in April were trending at least as strong as first-quarter sales, McDonald's Chief Executive Jim Skinner said.

The consumer is starting to feel a little bit better, Skinner said on a conference call with analysts.

While high-margin beverage sales helped McDonald's widen its lead versus other fast-food chains, Bernstein Research analyst Sara Senatore and other analysts think that the industry got a lift from improving trends in March.

I think this should bode well for Starbucks, she said.

Shares in many restaurant chains have risen significantly this year, leaving little room for further gains, and expectations were high going into McDonald's quarterly report.

Shares in McDonald's, which are up about 12 percent so far this year, were off 0.2 percent at $70.21 in afternoon trade. Shares in Starbucks, which have gained almost 10 percent this year, were off 0.4 percent.

COFFEE IS KING

The McCafe business has been very good for McDonald's, largely because it gives operators the chance to increase sales of high-profit beverages.

Through McCafe, which debuted nationally a little over a year ago, McDonald's offers lattes, mochas, cappuccinos, frappes and fruit smoothies that cost up to $1 less than similar Starbucks products.

McDonald's franchisees resisted the McCafe beverage expansion. They were asked to invest around $90,000 in renovations amid a deep recession. That view changed as operators started reporting sales results.

Executives said frappes were available in 90 percent of U.S. restaurants and performing better than expected. Fruit smoothies are being sold in about 2,000 restaurants and that number will grow in coming months.

While McDonald's and Starbucks customers overlap a bit, Bernstein's Senatore said Starbucks consumers have proven surprisingly loyal.

We didn't see as much switching as we might have thought when McCafe came out, Senatore said.

PROFIT TOPS STREET

McDonald's global sales at established restaurants jumped 5.2 percent in March and were up 4.2 percent for the quarter.

On the back of that, first-quarter net income rose 11 percent to $1.09 billion, or $1 per share.

Excluding a tax charge related to restaurant closings in Japan, McDonald's earned $1.03 a share. That topped analysts' average forecast calling for a profit of 96 cents per share, according to Thomson Reuters I/B/E/S.

Revenue, which includes sales from company-owned restaurants plus royalties from franchisees and other fees, increased 10.5 percent to $5.61 billion.

While consumers are feeling a tad better, executives said big U.S. sales gains won't come until unemployment comes down significantly from the current level of almost 10 percent.

Until that time, the company is using low-priced food to lure diners away from their kitchen tables.

McDonald's said value pricing helped business from China to the United States, where the Breakfast Dollar Menu reinvigorated morning sales.

(Reporting by Lisa Baertlein in Los Angeles and Phil Wahba in New York. Editing by Gerald E. McCormick, Dave Zimmerman and Robert MacMillan)

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