Over the past few months, thousands of fast food workers have been protesting across the U.S. to increase wages in order to support their families and have a better standard of living. The workers on pre-Labor Day across the U.S. went on strike demanding their employers pay them around $15 an hour, which is double the amount of the federal current minimum wage of $7.25 an hour.
The workers mainly targeted the famous fast food restaurants -- McDonald's (MCD), Yum! Brands (YUM), Burger King (BKW), and Wendy's (WEN). Looking at this issue, the state legislature recently approved a bill that states that the current wages in California will be raised from $8 an hour to $9 an hour in July 2014, and increase to $10 an hour by January 2016. This will make California the eighth-highest state in terms of minimum wages in the U.S. Currently Washington is the highest state with a minimum wage of $9.19, followed by Oregon, Vermont, Connecticut, and Illinois.
According to the National Employment Law Center, or NELP, 89.1% of workers earn low wages, and average workers work 35 hours a week for 52 weeks. McDonald's pays its employees the current federal minimum wage of $7.25. The company currently has around 859,978 employees in the U.S. Assuming that McDonald's 89.1% workers earn the minimum wage of $7.25 an hour and workers work for 35 hours a week for 52 weeks a year, we get $10.11 billion as company's total wage expense for this year. If a similar bill is approved across the U.S. by next year and assuming the same number of employees, McDonald's will be bound to pay its employees $9 per hour. Here, we are assuming a similar wage hike of $9 an hour for across the U.S. only for analysis purpose and to find out how many expenses will be incurred by these fast food companies. Thus, with this, the total wage expense is expected to reach $12.55 billion in 2014.
Wendy's and Yum! Brands are expected to face similar losses due to the increase in wages. Wendy's and Yum! Brands have 168,672 and 880,330 employees across the U.S. respectively. Both the companies pay minimum wages of $7.25 an hour. If we assume the same working hours and 89.1% of workers earning low wages for both the companies then we expect wage expenses of $1.98 billion for Wendy's and $10.34 billion for Yum! Brands this year. If the wages are raised to $9 an hour by next year, we expect the figures to reach $ 2.46 billion for Wendy's and $12.84 billion for Yum! Brands.
This will not significantly impact McDonald's, but franchisees would feel the sting. Around 90% of McDonald's locations or restaurants in the U.S. are owned by franchisees. Wendy's operates through around 6,500 franchisees. The franchise owners may face intense pressure, as they have to pay the workers, pay rent, buy supplies, and pay fees to the respective parent company for using the brand name.
The franchisees can overcome the increase in its wage expenses by replacing workers with less costly substitutes such as automated technology like online payment applications and self-service ordering machines. However, there are several jobs like making burgers and cleaning that cannot be replaced by machines. Companies have a few options such as stopping all the expansion going forward; raising menu prices, cutting down on the number of permanent staff, or hiring more part-time workers than full-time workers. All these measures can help the three companies' franchisees overcome a rise in wage expenses.
If we look in the past at the wage raise at McDonald's, the minimum wages were raised in July 2009, from $6.55 to $7.25. This rise did not affect McDonald's margins and its same-store sales were in line. In addition, the company did not raise its menu prices. By taking a glance at its past and the present scenario, the company is well positioned and strong enough to overcome the wage hike scenario. As stated above, the company's franchisees are likely to face a significant impact, but overall we expect only a minimal impact on the company's margin and other financial metrics.
Taking advantage of an evolving landscape of technology
McDonald's is currently testing a new mobile payment application in Texas, that will allow its customers to place their orders through mobile devices. This is the best option for customers that prefer to have their food at home rather than in restaurants. The mobile app will allow customers to order their favorite burger and later pick it up from the restaurant's drive-thru window. McDonald's is not the first fast food company to adopt this system; its rivals Chipotle Mexican Grill (CMG) and Starbucks (SBUX) already have a mobile ordering app and more than 10% of orders for both companies are placed through the mobile option.
Looking at the success of its rivals and the level of technology adoption by customers, we expect that if the new mobile app gets a nationwide approval in the U.S., then it is likely to attract more customers. It should add its new dollar menu, new Mighty Wings, Blitz Box, etc. along with its old menu to the ordering app, which should lead to an increase in sales. We expect this mobile app to increase the company's same-store sales in the U.S., which experienced constant growth of 1% in the second quarter.
Peer analysis on valuation metrics
McDonald's is one of the major players in the fast food industry followed by Yum! Brands and Wendy's. McDonald's is the largest company in terms of market capitalization and number of stores compared to its peers. Let's take a look at all three companies' valuation metrics to find if there's any future growth potential.
Trailing 12 months P/E
Forward 12 months P/E
Except for Wendy's, McDonald's and Yum! Brands trailing PE and forward PE are in line, which denotes positive and higher earnings in the future. McDonald's trailing EPS and lowest forward PE compared to its peers makes it the leader of the fast food industry. As of September 18, 2013, McDonald's stock has appreciated 12.79% year to date, or YTD. The stock's trailing PE is 17.93 and it has a forward PE of 16.03, which shows an upward trend in the company's earnings with an expected EPS of $6.11 for next year.
Being the largest fast food company, the hike in wages should minimally impact McDonald's financials, but its franchisees are expected to face a significant impact. In addition, looking at its past history, we assume that the company will manage to overcome the situation. Also, its mobile app should help it generate revenue in the coming years. Based on the valuation metrics, it stands as the leader in the fast food industry. With these factors, investors can count on McDonald's as an investment.
Additional disclosure: Fusion Research is a team of equity analysts. This article was written by Shweta Dubey, one of our research analysts. We did not receive compensation for this article (other than from Seeking Alpha), and we have no business relationship with any company whose stock is mentioned in this article.