It has been like pulling teeth.
That is how I would characterize an effort to get publicly traded restaurant companies to share what they pay workers in the high-cost labor zones such as New York City and California. Some companies have sent back responses stating their love for employees, but not sharing an hourly wage figure. Others have deflected the question completely by saying franchisees handle wages, not corporate number-crunchers. A few replied with a nice-sounding average hourly wage rate that was above the federal minimum wage of $7.25 an hour, obviously to put themselves in the best light possible. Frankly, I am honked off about the lack of clarity in response to a simple, but admittedly hot-button, request -- so much so that I am going to be bluntly honest here.
Every publicly traded restaurant company is going to be hammered by the minimum wage hikes that were approved in New York City and California, where they often have the highest concentration of locations. From cheap fried chicken seller Popeyes (PLKI) to expensive burrito seller Chipotle (CMG), we will start to see their earnings power erode over the next five years.
Franchisees I have talked with are rightfully concerned. One in New York City flat out called the increase "devastating" and said franchisees couldn't afford it. These companies will be unable to jack up prices enough to offset minimum wages that will be $15 an hour in about five years. Those that do try and hike a standard burger by $5 or a small iced coffee $2 will be met with consumers visiting their locations less frequently. Indeed, the inevitable fast food price hikes may send people back to eating at home, which could be great news for Walmart (WMT) and many of the big food makers.
Ultimately, lower traffic at franchisee-owned fast food restaurants will mean weaker profits paid to corporate.
Oddly enough, investors have seemed to fall asleep on the minimum wage debate. Shares of most restaurant companies haven't priced in risk to future profits from materially higher labor costs. They only are factoring in a currently choppy traffic environment for the second quarter, which could lead to more than a few earnings misses starting in July. As a result, it's hard to get overly excited about the sector long term.
If you do want to play in the space, it should be with a name such as Shake Shack (SHAK). The company has shown an ability to raise prices of its food with no detriment to sales and profit. It has limited exposure to California. And, the company already pays its workers very well. According to Shake Shack, the hourly pay range for its employees is $10.50 to $15.00 across all markets, depending on experience, skills and performance. The average hourly wage at Shake Shack is nearly $12 per hour.
Background On Fast-Food Minimum Wage Debate
Last September, the state of New York approved a measure to increase the minimum wage for employees of fast-food chain restaurants to $15 an hour over the next few years. The law gradually raises the minimum wage to $15 in New York City by the end of 2018. On Long Island and in Westchester County, the wage would rise to $15 by the end of 2021. The minimum wage only would rise to $12.50 in the rest of the state by 2020, with further increases tied to inflation and other economic indicators.
Earlier this year, California Gov. Jerry Brown signed a law raising the state's minimum wage to $15 by 2022. The statewide minimum wage will increase from $10 an hour to $10.50 an hour on Jan. 1, 2017, then up to $11 an hour on Jan. 1, 2018. From there it will increase by $1 annually until reaching $15 an hour on Jan. 1, 2022.
Fast-food companies already are bracing for the impact.
"We believe the minimum wage should go up on a state-by-state basis, we've always said that -- but we don't want it to accelerate at a rate that is unsustainable for the people who are really important to us, which is our franchisees and building their businesses," said Dunkin Brands (DNKN) CEO Nigel Travis during an April 28 call with analysts. To try and get out in front of the headwind, Dunkin' is working with franchisees on simplifying operations, finding supply-chain and energy-management cost savings and lowering capital investments for remodels.
Dunkin' has seen mixed traffic since the New York City law was announced as scared franchisees hiked prices in advance of the wage increases. It may be a dynamic playing out at Popeyes, too.
"It is true that the two levers are pricing and labor productivity and we are seeing that in our franchise operations that selective pricing and selective reduction in labor is occurring, particularly in those markets feeling the pressures of labor increases that are too fast," Popeyes CEO Cheryl Bachelder said during a May 28 call.
Meanwhile, Chipotle's San Francisco locations reportedly have raised prices by as much as 14% due to the city's 14% minimum wage hike that went into effect on May 1 and boosted the minimum wage to $12.25 an hour from $10.74. The company has not disclosed its sales performance in San Francisco following the reported price hikes. My gut tells me traffic weakened before the E. coli issue popped up months later.
The Hillary Effect
While the new minimum wage laws take hold in New York and California and place real pressure on the bottom lines of restaurants, there is also a headline risk to investors in the sector. Her name is Democratic presidential contender Hillary Clinton.
At an event in April, Clinton said she would sign a $15 minimum wage bill if a Democratic Congress were to place it on her desk as president.
"Well, of course I would," Clinton responded to a question on the wage topic. She added that she has "supported the Fight for $15" -- the union-backed campaign that has held rowdy protests demanding higher worker wages outside of fast food restaurants. Clinton originally supported a $12-an-hour minimum wage. Either way, a Clinton presidency could be bad news for restaurants given her penchant for a materially higher minimum wage.
Political uncertainty could lead some restaurant companies to take overly cautious stances with their 2017 guidance when it's eventually shared. Acknowledged Dunkin CEO Travis, "I think a lot's going to happen politically and through the election process, so I think this year we will probably decide on our guidance for 2017 later than we normally do as a result of that."
