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After Wal-Mart, Will Minimum Wage Increases Affect McDonald’s?

Are Wal-Mart Stores Inc.’s (NYSE: WMT) woes, apparent in its four cent earnings miss in the most recent quarter, due to its own minimum wage increases back in April? And if so, will minimum wage trouble spread to McDonald’s Corp. (NYSE: MCD)? The short answer is no to both questions. Here’s why.

Wal-Mart voluntarily increased its minimum wage in April to $9 an hour for U.S. workers, and it also increased wages further for 100,000 specialized workers and department managers in June. Since earnings missed estimates by four cents, the simple explanation is that this is due to increased labor costs, but a deeper look at the numbers raises the question whether this is really the case.

First of all, the largest private employer in the United States said right out in its earnings release, in fact in the very first line, that currency exchange rates had a negative impact on EPS of four cents. So there’s your miss. This does not by itself negate the assertion that rising labor costs are equally responsible for the miss, because margins were still affected by increased administrative expenses, which includes labor costs. But by how much?

Standard, general and administrative (SG&A) expenses increased absolutely by $729 million across the whole company, and operating income decreased by $671 million. By these numbers, a case can still be made that minimum wage increases are responsible. However dig a little deeper to see where the biggest drops in operating income were from, and the answer is Wal-Mart International, which has nothing to do with U.S. workers at all.

International saw a 14.2% decline in operating income, or $212 million absolutely. Subtract that from the $671 million decrease overall and you have a $459 million operating income decrease. Add on the slight increase in cost of sales year over year of $46 million and a further $5 million in interest expenses, and you have only $408 million in SG&A increases. Since labor costs are only one factor of that number, which includes electricity bills and the like, the actual impact of labor cost increases on Wal-Mart’s operating margins this quarter is minimal.

Minimum wages affect low skilled workers who depend entirely on their own labor much more than they affect large corporations that only partly depend on that unskilled labor. The only way that minimum wage increases would visibly affect margins is if it were increased enormously and quickly, say to $15 an hour overnight. That way, a corporation like Wal-Mart would not be able to mask its work force cuts and adapt, so it would have to take an obvious hit.

Politicians rarely raise minimum wages very high very quickly because the detrimental effects would be so obvious that even the protesters would stop asking for it. Sometimes, though, they get bold and do it anyway. For example, take Seattle, where local politicians increased minimum wage to $15 an hour by 2017. This is still time-buffered, but in preparation, employers are reducing low-skilled staff already. The law does not have to be in effect to start disrupting labor markets.

Seattle has already lost 1,000 restaurant jobs in May, following the announcement of the huge minimum wage increase in April, for the largest one-month job decline since January 2009, during the Great Recession. For Wal-Mart, the only state that has a minimum wage that bumps against its voluntary minimum wages of $9 is California at $10. There, the company can simply lay off one low-skilled worker, say a greeter, keep the other nine and spend the same amount of money and barely anyone will notice the effect on the weakest workers in the labor market.

With McDonald’s the situation is slightly different because fast food is specifically being targeted for massive wage increases due to political agitation by low-skilled workers who do not understand that they are lobbying for their own unemployment. Last month, New York Governor Andrew Cuomo increased the minimum wage for the fast-food industry to $15 an hour by 2018. This affects McDonald’s directly, but not Wal-Mart.

But why not increase it tomorrow? Because then struggling McDonald’s franchisees would be unable to order enough McDonald’s-branded automated cashiers to absorb the shock and would have to lay off workers immediately or take a dangerous loss.

This way, they will have time, and the only ones negatively affected by the increase will be potential fast-food workers, now unemployable, as well as the currently unemployed who cannot jump over the ever increased minimum wage barrier to entry. McDonald’s will be fine, thanks to the good old player piano.

By Rafi Farber