Raising the minimum wage pay to a "living wage" for fast-food workers in the United States has become one of the nation's premier hot-button issues as of late. Whether or not you feel that fast-food workers should make more money than EMTs, bank tellers, taxi drivers, nursing aids, urban police officers, line cooks and many vocational apprentices is unimportant, and do not let the fact that minimum wage jobs are designed to be high turn-over positions for minimally skilled teenagers and retirees looking for spare change and not career jobs for a skilled workforce influence your opinion, these changes appear to be coming, whether it is socialist tyrants like Bill de Blasio forcing the issue through government regulation, or simply fast-food restaurants caving to heavy societal pressures.
How will these changes affect companies like McDonald's (NYSE:MCD), Burger King (NYSE:QSR), Wendy's (NYSE:WEN), KFC (NYSE:YUM) and their competitors? Probably not as much as you think. There seems to be this naive perception that raising the costs of labor can simply be offset by raising prices on products. This ignores one of the key principles of Capitalism - companies already price their products to perfection. If McDonald's could sell its burgers for more money, it would be doing so already. Clearly, it cannot, because after a certain point, the cost of the fast-food burger approaches the cost of a higher-quality burger from a more upscale restaurant. The cost of an item is not set by the cost it takes to manufacture the item, but rather by the supply and demand for that item. If the cost to manufacture the item is higher than the demand allows the price to be, the item is not economically viable to manufacture and any company designed around that business model is doomed to fail.
The most reasonable way for fast-food companies to accommodate a labor cost increase is a reduction in overall labor. For example, Glassdoor lists the average McDonald's crew member as earning roughly $8.50/hour. If McDonald's is forced to raise its labor costs 76.5% to give us an individual labor cost of $15/hr, we can then expect an overall employee reduction of 43.3%. That would mean nearly 1:2 crew members would lose their job in order to pay for the wage increases. And how would this most likely be achieved?
In 2011, McDonald's Europe experimented by purchasing 7,000 touch-screen kiosks to automate the ordering process. These automated kiosks are already ubiquitous at Wawa, a PA-based, privately-owned convenience store chain near and dear to my heart, and I can speak firsthand to their superiority versus a human cashier. They do not mishear my order, they never present me with a negative attitude, they never show up to work late, they never call in sick, they never show up with a hangover, they don't require any health benefits and they never try and sue the company for any reason. Still, many establishments prefer the potentially warm welcome that only human-to-human interaction can provide. When faced with huge wage increases, that may be a luxury these companies cannot afford.
But if you do not believe me, hear it from the horse's mouth. Todd A. Penegor, Chief Financial Officer & Senior Vice President of Wendy's had some choice words to say about this very issue on last week's Q2 2015 earnings call:
"So we continue to see pressure on wages two fronts, one is minimum wages at the state level continue to increase, and as there is a war on talent to make sure that we're competitive in certain markets. So we've made some adjustments to that starting wage in certain markets. The impact hasn't been material at the moment, but we continue to look at initiatives on how we do work to offset any impact to future wage inflation through technology initiatives, whether that's customer self-order kiosks, whether that's automating more in the back of the house in the restaurant, and you'll see a lot more coming on that front later this year from us."
Companies like McDonald's, Burger King, Wendy's and KFC rose to the top of the marketplace by being unabashed capitalists. These companies care not about providing "living wages" to their employees. Job creation is simply a benevolent side effect of a thriving business. It is this ruthless pursuit of profit for company shareholders that drive these businesses, and these businesses will do what they deem necessary to protect their bottom line. We have yet another case where government intervention and societal pressures from the economically ignorant will likely have truly detrimental consequences to the very people they claim they are trying to help. The true cost of these wage hikes will be the worker's job.
It has been a struggle for the fast-food industry in recent years. Its popularity has been dwindling when compared to trendier, more health-conscious rivals like Chipotle Mexican Grill (NYSE:CMG) and Panera Bread (NASDAQ:PNRA). Wendy's is responding by aggressively remodeling its restaurants to give them a fresher, hipper look, going as far to sue franchisees that would not comply with this shift. Burger King recently merged with Ontario-based Tim Hortons to form Restaurant Brands International, creating the third largest operator of fast-food restaurants worldwide and moving its headquarters to Canadian soil. McDonald's has continued to struggle with no definitive solution on the horizon, which the chart below clearly illustrates:
The fast-food industry is cyclical, going through periods of stagnation and rebirth. This situation is not unique from a historical perspective. I believe in McDonald's ability to rebrand itself and come out on top. While its direct competitors don't benefit from as strong of a brand image, they certainly can do it as well. However, I feel that now is not the time to establish or increase a position in any of these companies. The red-hot labor wage disputes, the overall negative public image of fast food and the current broader market correction we are in the middle of should unlock additional value for investors looking to establish long-term positions in these companies. Currently, there is just too much uncertainty on the horizon. Even worse, if the Federal government decides to step in and raise minimum wage across the nation, this could turn the restaurant industry itself into a metaphorical minefield and force sweeping changes across the board. I believe in this case the patient investor will be the most rewarded investor, and would be advised to keep a close eye on current events while not yet committing any capital. The end result of this chaos may be opportunity.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.