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When an industry leader announces a major shift in policy, investors rightfully take note. Wal-Mart Stores (NYSE: WMT) and McDonald’s Corp. (NYSE: MCD) are inarguable leaders of their respective industries. Both recently announced a major policy shift.
Specifically, the two industry leaders are increasing employee pay. Both have set a new minimum wage within their respective companies.
Wal-Mart will raise its minimum pay to $9 an hour – $1.75 more than the federal minimum of $7.25 – this month. The increase is expected to impact 500,000 U.S. workers. Beginning in 2016, Wal-Mart will up the minimum to $10 an hour.
Starting July 1, McDonald’s will pay at least $1 an hour more than the local minimum wage for employees at its U.S. company-owned restaurants. As with Wal-Mart, McDonald’s average hourly wage will be lifted to $10 an hour.
Wal-Mart’s and McDonald’s wage initiatives aren’t insignificant. Wal-Mart’s wage increase is expected to increase expenses by $1 billion this year. Wal-Mart’s business has always been to drive down costs and increase inventory turnover. Even the most successful retailer runs on thin margins.
McDonald’s wage increase is less onerous. It’s expected to cost the company $78 million this year.
Higher expenses translate to lower profits if the status quo is maintained. But the status quo won’t be maintained.
Wal-Mart is already moving to recoup its higher wage expense. The company has upped pressure on suppliers to cut their costs. Wal-Mart has a long history of wringing savings out of suppliers. Look for Wal-Mart’s per-unit cost to fall, allowing it to both increase sales and recapture a portion of its increased wage expense.
As for McDonald’s, the headlines fail to tell the whole story. The $1-an-hour increase applies only to those workers in the 1,500 restaurants the company itself owns. The vast majority of McDonald’s U.S. locations – 13,000 – are franchised. Roughly 90% of McDonald’s business is unaffected by the wage hike. It’s up to each franchise owner to set wage rates.
So should Wal-Mart and McDonald’s investors worry about the sustainability of their respective dividend?
No, because it’s more likely that both companies have positioned themselves to increase profitability, dividend payout and share price. I proffer my rising prosperity hypothesis on both companies having upped the ante in their respective industries. The competition will have to increase their payroll expense in order to compete.
Retailers TJX Companies (NYSE: TJX) and Target (NYSE: TGT) have already followed Wal-Mart’s lead. Both have announced they’re increasing worker wages.
The dollar stores are even more expense sensitive. Dollar General (NYSE: DG) and Family Dollar Stores (NYSE: FDO) are driven exclusively by price. They must keep their inventory of unbranded commodity products below the unbranded products of Wal-Mart to compete. If they are forced to follow suit, their price advantage could erode.
Most of McDonald’s competitors are also mostly franchises, so they will have more leeway in setting wage expenses. McDonald’s won’t be able to exert the same wage competition on Burger King et al. as Wal-Mart does on its respective industry.
That said, both Wal-Mart and McDonald’s are now attracting higher quality workers. Productivity at both companies should increases. The math is easy: More productivity per worker sums to more profits for the company. More profits, in turn, tend to lead to more dividends.
The key to this rising-wage alchemy is that both Wal-Mart and McDonald’s acted voluntarily and proactively. Had both companies been mandated to raise wage, the results would be far inferior.
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