There has been a lot of talk about minimum wage in the United States recently. Some groups have called for an increase in the wage to a more livable level. Some businesses argue that if they were forced to pay a higher wage, they would have to reduce the amount of hours worked by their employees. One industry this may affect greatly is the fast food industry.
The fast food industry is primarily made up of minimum wage employees. So, if there were any changes to the minimum wage, these companies would be hit the hardest and the quickest. Employees are already voicing a demand for an increase in wages. A group called Fast Food Forward recently organized a protest in New York City targeting major fast food chains. Protesters want to increase minimum wage in the city from $7.25 per hour to $15 per hour.
The changing demands will greatly affect major fast food chains. What do investors need to know?
Yum! Brands, Inc. (NYSE:YUM)
The company has seen changes in its overall cost of labor from 2011 to 2012. These figures are in relation to total revenue for the year.
| Labor Cost in 2012 | Labor Cost in 2011 | |
|---|---|---|
| USA | 29.45% | 30.40% |
| China | 18.52% | 16.22% |
| Other International | 24.94% | 25.97% |
The cost of labor is the highest expense the company has. On average, the cost of labor is greater than the cost of goods in relation to total revenue. The company is at risk for losses if changes in wages are required. Any increase in mandatory wages will have a greater impact on the bottom line than any other expense.
Another major issue Yum Brands has been facing is a decline in same-store sales in China. It has 5,000 stores in China, but because there has been an outbreak of contaminated chicken in some of its stores, it reported a decline of 6% in the Chinese market.
For the first quarter, management expects same-store sales to decline by 25% in Chinese stores. Also, full year earnings per share are expected to drop by 4%-6%. This is a huge change from the double-digit growth the company has been seeing.
Yum! Brands, Inc. (NYSE:YUM) is seeing challenges on two ends right now. First, there are very real and very strong sales issues in China. Second, there is a risk of wage instability in the United States that could very well bring profits down in the future.
Other fast food chains
The Fast Food Forward protest didn’t just target Yum! Brands, Inc. (NYSE:YUM). It also targeted McDonald’s Corporation (NYSE:MCD) and Burger King Worldwide Inc (NYSE:BKW). While the protest was only focused on New York City, the issue could just as easily spread across the county. New York has one of the highest costs of living, with no additional adjustment in the minimum wage. This is a prime location for the beginning of a widespread protest.
In McDonald’s Corporation (NYSE:MCD) most recent quarterly report, it stated that one of the factors adversely affecting profitability is the “long-term trend towards higher wages…in both mature and developing markets.” Across all company-operated stores, the payroll and employee benefits costs were 25.32%. This is an increase from the previous year’s 25.18% expense.
McDonald’s Corporation (NYSE:MCD) is also seeing challenges in the Chinese market. It recently dropped the price for some of its chicken-based products in stores in China. The McNugget originally cost $5.80 in Shanghai, now it’s only $3.22. McDonald’s is trying to offload the rest of its chicken inventory in the wake of the contaminated food scandal. The company will likely see a reduction in same-store sales in China this year, as well.
Burger King Worldwide Inc (NYSE:BKW) operates over 13,500 locations worldwide. The majority of these are franchise locations. Only 418 are company-operated. Burger King announced in its most recent quarterly report that it has suffered from worldwide increases in wages and benefit expenses. In 2012, total wages and benefits expenses were 29.52% of company-owned store revenue. In 2011, the total expense was only 29.36% of revenue.
Wages and profitability
Because total wages make up such a large portion of operating costs, it’s very important for investors to pay attention to risks associated with minimum wage. Because these companies also franchise stores, it eliminates some of the risks. When a store is franchised, the parent company isn’t responsible for paying employee wages. Instead, the parent company earns franchise fees from the franchisees.
| Franchise Revenue % in 2012 | |
|---|---|
| Yum Brands | 32.53% |
| McDonald’s | 13.20% |
| Burger King | 40.55% |
Burger King is in the best place to reduce the risk of higher wages because of its higher percentage of franchise fees. However, there’s still risk of lower profitability from each individual franchise store.
Final thoughts
This news is not necessarily bad for investors, it just presents a risk moving forward. As minimum wage changes over time, these companies, in particular, will have to adjust their operations. It could mean reduced profitability. New York has already based a budget that would raise minimum wage to $9 per hour by 2015. If this trend moves nationwide and continues to spread worldwide, investors will have to reconsider the valuation they place on these companies.
The issues in China look to be a short-term dilemma. As the chicken contamination is corrected and normal operations resume, same-store growth and revenue will return to normal levels. It’s a worry for now, but it shouldn’t be worrisome for too long.
Austin Higgins has no position in any stocks mentioned. He is the Principal Consultant for Avant Venture Group and focuses on building businesses through innovation, growth and investment. Read his company’s blog at BuildInvestGrow.com and follow him on Twitter @Austin_Higgins.
The Motley Fool recommends Burger King Worldwide Inc (NYSE:BKW) Worldwide and McDonald’s. The Motley Fool owns shares of McDonald’s.
