McDonald’s Corp. (NYSE: MCD) finally has delivered on higher wages. The move came with instant criticism as not being enough and not covering enough workers from those who are seeking a $15 per hour minimum wage. It was also interesting to see that the fast-food king’s wage hike effort was also met with instant criticism from Wall Street analysts.
24/7 Wall St. has seen multiple analyst reports on the McDonald’s wage effort. Credit Suisse and Merrill Lynch both discussed how this will lower McDonald’s earnings ahead. Also, Standard & Poor’s put McDonald’s corporate credit ratings on negative watch after the move.
Credit Suisse maintained a Neutral rating with a $99 price target, implying upside of 4% from current prices. The firm noted that the earnings sensitivity of McDonald’s to a U.S. wage increase is mitigated by its low mix of U.S. company-operated stores, 23% of global company-owned and 4% of global system stores.
At the same time, the wage lift could create a roughly a 1% earnings per share (EPS) headwind in 2016. Credit Suisse estimates that labor costs represent about 28% of U.S. company sales, implying a 10 percentage point increase in U.S. wage costs, adding roughly $120 million in labor expense. Approximately $30 million of that increase would have come organically, implying $90 million of unexpected cost growth. These sensitivities assume no variance in pricing and no incremental customer spend.
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What analysts are asking at now is if U.S. franchisees also increase wages. McDonald’s operates 10% of its U.S. store base. So, ultimately, it will be up to franchisees to determine if the step-up in wages costs is implemented for the remaining 90% of McDonald’s U.S. employees.
Despite all the worries about who gets paid what, Credit Suisse sees declining customer traffic and foreign exchange headwinds as presenting a far more material concern for McDonald’s earnings.
Merrill Lynch maintained a Buy rating for McDonald’s with a price objective of $112, implying an upside of 17.6%. However, the firm lowered its EPS estimates for 2015 to $4.74 from $4.80 and for 2016 to $5.13 from $5.25. These lower estimates reflect higher wage rates in the roughly 1,500 company-operated McDonald’s in the United States.
Company-operated U.S. restaurant margins, which are currently in the high-teen percentage area, will be affected by about 400 basis points, starting in the second half of the year, according to Merrill Lynch. At the base level, this is the driver of the firm’s lower estimates.
In terms of a broader view on wages, Merrill Lynch had this to say:
McDonald’s took a pre-emptive move with respect to wage rates. But we had previously expected U.S. labor cost pressure to build as the job market improves, more state and local minimum wage increases are enacted, and other large employers of hourly workers, such as Walmart and Target, raise wages. McDonald’s move may push restaurant industry hourly wage rates higher, but the impact is less significant than if the 14,350 system-wide restaurants acted in unison.
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S&P also moved the outlook on its debt rating for McDonald’s from stable to negative, considering the fundamental struggles that the company is facing. Ironically, the negative change in outlook could be a positive, in Merrill Lynch’s opinion, if it diminishes McDonald’s fixation on its A credit rating. If McDonald’s gets comfortable with a lower credit rating, the result could be that it could add debt to the balance sheet and return more cash to shareholders. Currently, McDonald’s has a relatively underleveraged balance sheet.
As the week came to a close shares of McDonald’s were trading at $95.83, in a 52-week trading range of $87.62 to $103.78.
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