How a Higher Minimum Wage Could Affect These Investments
Reuben is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
President Obama called for a national minimum wage increase of almost 25% in his State of the Union address. He also said that the minimum wage should be tied to the rate of inflation. There are good and bad sides to these ideas, but one group will definitely feel a pinch from such changes—employers in services industries.
The minimum wage is a contentious issue. From one side, people are upset that they can work hard and still not make enough money to make what they believe is an acceptable living. On the other side, employers are concerned that paying more will crimp margins and, in the end, curb hiring. Each side of this argument has valid support.
Whichever side you take, this is a big issue for some companies and their investors. It becomes an even bigger issue if the minimum wage is indexed to inflation, making it a cost that constantly increases, regardless of the business environment. That would leave trimming employees as the only recourse to reduce salaries. That could make difficult business environments even more difficult for a struggling company.
The impact will be most notable in service industries. For example, grocery stores already live within an environment of thin margins and intense competition. A 25% increase in wages could be a huge hit to absorb. Take SUPERVALU (NYSE: SVU), which owns the Save-A-Lot brand and others, as an example. The company's performance in recent years has been poor at best. Imagine how much worse things will get if its salary costs notably increase.
In fact, after cutting the dividend, the company is now in the process of selling off parts of itself to Cerberus Capital in order to remain alive. Clearly, SUPERVALU's execution helped spur this drastic move, but intense competition in an industry with thin margins didn't help any. While these dispositions will be tough medicine, the company might need even more drastic moves to survive if the minimum wage goes up.
The competition that has made SUPERVALU's life, and that of many other grocers, so hard came from some pretty tough characters: Wal-Mart (NYSE: WMT) and Target (NYSE: TGT). Both companies have made aggressive moves to add grocery items to their stores in an attempt to increase the frequency of their customers' visits. In fact, in a very short period of time, Wal-Mart has taken material market share in the grocery space.
While Target and Wal-Mart may be able to make up for the industry's notoriously thin margins by selling more within their other retail operations, and benefiting from more frequent customer visits, grocery stores don't have that luxury. The traditional grocery chains just have to accept lower profits or, in some cases, larger losses.
Of course, Wal-Mart and Target will both have to deal with higher costs, too, if the minimum wage goes up by 25%. While that will impact both of these retail giants, it won't likely have as notable an impact as the grocery chains will feel.
That said, Wal-Mart is easily one of the largest employers in the United States, so it will be a big issue for the company. In fact, a 2007 study from UC Berkeley Labor Center estimated that increasing the minimum wage to $10 an hour would cost Wal-Mart nearly $2.4 billion. While that estimate is over five years old, the scale of the problem is obvious.
And these aren't the only businesses to monitor.
After the president made his call for a hike in the minimum wage, McDonald's (NYSE: MCD) shares traded lower. Was the president's speech the reason for the drop? Maybe, maybe not. However, McDonald's is a big employer either directly or indirectly.
About 20% of McDonald's restaurants are company-owned, meaning it has notable exposure to the issue. The remaining 80% of its restaurants are owned by others in some fashion, meaning those entities will face the increased costs. However, increased costs means lower profits, and that will eventually work its way back to McDonald's.
There are plenty of other companies in the space to monitor, too. Weaker players, like Wendy's, and smaller players, like Krispy Kreme Doughnuts, will likely feel the biggest pinch. It could result in a slowdown in expansion efforts or, in some cases, worse fates.
The Whole Bill
Darden (NYSE: DRI) could feel a particular pinch, because it owns and operates virtually all of its more than 2,000 restaurants. Across its well-known Red Lobster and Olive Garden brands, as well as its smaller brands, the company employes more than 185,000 people. With so many direct employees, it will have to foot the entire bill.
And that expense will snowball, too. Since most employees are very aware of what others earn, no matter how hard an employer tries to limit that knowledge, those not earning the minimum wage will also be calling for salary increases. So the entire cost structure of running a business will have to change.
Monitor this Issue
While mom-and-pop stores will probably feel the biggest brunt of an increase in the minimum wage, it will have a big impact on any company that hires at or around that pay level. While strong companies won't go out of business because of this, smaller and weaker competitors will clearly feel a bigger pinch.
ReubenGBrewer has no position in any stocks mentioned. The Motley Fool recommends McDonald's. The Motley Fool owns shares of Darden Restaurants and McDonald's. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!