Hikes in the minimum wage in cities and states around the U.S. will dent profit margins at restaurants, particularly at casual-dining chains, according to Moody's Investors Service (MCO).
"Clearly the restaurant industry is going to pay a price, or be among the sectors most affected by this," said Jacob Kirkegaard, a senior fellow at the Peterson Institute for International Economics, a nonpartisan research group, citing the large numbers of restaurant workers at or below the minimum wage. "The question will be to what extent it will only bleed into margins or whether the prices will go up, and whether we still have the 99 cent burger."
Seattle helped set the stage last year by approving a $15-an-hour minimum wage, and the mayor of Los Angeles on Saturday signed an ordinance gradually raising the city's minimum pay to $15 an hour, making it the biggest U.S. city to do so.
"Wages are a big issue that are going to continue to play out," William Fahy, a senior credit officer at Moody's, which stated in the report on Thursday that operating profit margins for restaurants could contract by one to four percentage points as cities and states increase workers' base pay. "It's going to be another cost that they have to deal with that could hurt profitability."
The biggest challenge for the industry could be the prospect of having to increase pay for valued employees already earning more than the minimum wage, as they would likely expect the spread between them and entry-level employees to continue. "Do you maintain the gap with the rest of your employees -- that's a decision that companies will have to make," Fahy said.
Olive Garden, Applebee's and other casual restaurants are likely to take the greatest hit because they are typically more labor-intensive than fast-food outlets, Moody's said. Such restaurants must also often make up the difference for servers between the minimum wage and tipped wages, which are lower.
For instance, a restaurant operator in which 20 percent of its workforce gets a minimum wage hike will see its operating margins contract by 2.3 percentage points, to 9.7 percent from 12 percent, should the baseline wage climb to $10.10, Moody's found.
"Increases in the minimum wage will result in fewer jobs being created, higher prices for consumers and fewer opportunities for people to become small-business owners as franchisees," Matt Haller, a spokesman for the International Franchise Association, said. "You need to have employers in order to have employees, and as the Moody's report demonstrates, the profit margins in the restaurant industry are razor thin. Something is going to have to give."
The Moody's report offers an "overly simplistic view of the situation" in that it fails to take into account the decreased costs that come with higher employee retain and productivity rates that result with increased pay, said Judy Conti, the federal advocacy coordinator for the National Employment Law Project, or NELP.
At an event related to Walmart's (WMT) annual shareholder meeting earlier this month, CEO Doug McMillon offered anecdotal evidence, saying the discount retailer's decision to increase wages for 500,000 of its workers to at least $9 in April has already yielded dividends, with job applications rising and turnover on the decline.
The Congressional Budget Office in 2014 projected that increasing the federal minimum wage to $10.15 an hour from $7.25 would result in the loss of 500,000 jobs as companies tried to offset the increase by cutting costs. The nonpartisan CBO also estimated it would lift 900,000 low-income workers out of poverty.
Perhaps seeing the handwriting on the wall, McDonald's (MCD) plans to increase pay at least $1 more than the local minimum wage on July 1 for the 90,000 employees at corporate-owned restaurants. The increase doesn't affect the roughly 1.5 million employees of McDonald's franchisees.
For McDonald's and other publicly traded companies, "their margins are appropriate for the industries they are in," said Fahy, who added that individually owned franchisees are harder to gauge since the numbers are not public. That said, the restaurant industry is already contending with weak sales, which could weaken further if menu costs climb, he added.
The Peterson Institute's Kirkegaard believes the increased labor costs will initially eat into restaurant's margins, but in the longer run will be covered largely by higher prices.