For sure, President Obama cares about the health of Americans, but will this care come in the way of economic growth? The Affordable Care Act, or Obamacare, which intends to extend coverage to nearly 32 million uninsured Americans, is indirectly posing a threat to the US restaurant industry.
Let’s dig a little deeper to understand how the Healthcare Reform is expected to hurt restaurant operators' margins, starting 2014.
What Does the Law Require?
The law entails companies to provide health insurance coverage to workers or face government penalties ($2,000 per employee). It does not, however, cover employees who work less than 30 hours per week on average.
The law is applicable for employers with 50 or more full-time workers. An organization with 25 full-time employees (FTE) and 50 half-time employees is also considered as having 50 FTEs. All such organizations must provide health care coverage or face penalty.
It is also mandatory for employers to provide “minimum essential” and “affordable” health care. The Act defines minimum as 60% of the actuarial value of the cost of benefits. By affordable, the act connotes that an employee’s share of premium cannot exceed 9.5% of his or her household income.
Restaurant Industry: A Victim?
The restaurant industry has been a major contributor to job growth in the U.S. over the last couple of years. Presently, the sector employs around 10% of the U.S. workforce.
According to the National Restaurant Association, in 2011 and 2012, total U.S. employment grew a respective 1.0% and 1.4% while restaurant employment increased 1.9% and 3.0%. The Association expects this industry to create 2.4% additional jobs in 2013 against the projected 1.5% rise in total U.S. employment.
As a result the industry has now automatically become more vulnerable to Obamacare given the better job growth and employment of more low-paid employees than the other sectors.
The companies with more company-owned units and larger players will directly feel the brunt of the legislation. These include the likes of Darden Restaurants Inc. (DRI - Analyst Report) and The Cheesecake Factory Inc. (CAKE - Analyst Report) which have a substantially higher number of company-owned stores than franchised.
On the contrary, operators like Burger King Worldwide Inc. and McDonald's Corp. (MCD - Analyst Report) with a respective of 93% and more than 80% of operations franchised will be less affected. DineEquity Inc. (DIN - Snapshot Report), which has sold its entire business to franchisees, is also safe. However, in such cases, franchisees will feel the pressure of healthcare reform.
Coming to larger players, quite expectedly these have a higher number of workers. Even if these restaurateurs seek to escape the law by recruiting more part-time workers, they will actually not be able to avoid it as 100 half-time employees will be considered as 50 full-timers.
On the other hand, large national chains, which have significant scale advantage and report high profits each year, will be better positioned to weather increased labor costs. Smaller chains operating on lean margins will have to bear down to withstand the law.
Steps to Avoid Austerity
To endure the above-mentioned austerities, most of the companies thought of trying out different labor models like involving more part-timers and cutting work hours before the implementation of the healthcare reform.
In fact, the law also provides a tax benefit to employers recruiting more hourly workers than full-time employees. This criterion is probably targeted to improve the nation’s overall employment picture.
The companies can also opt for charging higher price for its menus as a tool to counter falling margins in the wake of this law. And with growing consumer confidence and the overall improvement in the US economy, we believe, operators will be successful in doing so.
In fact, Cheesecake Factory, Panera Bread Co. (PNRA - Analyst Report) and Chipotle Mexican Grill Inc. (CMG - Analyst Report) catering to higher-income consumers should face lesser difficulty in passing on the increased costs to consumers. Darden is also gradually shifting its focus towards the upscale environment with acquisitions like Eddie V’s and Yard House in last two years.
That’s not all. Some operators fear a slowdown in their pace of restaurant openings because of Obamacare.
How Much Will the Law Cost?
There is a mixed view on this. While some say that costs will be manageable, others expect it to be quite expensive.
One of the leading pizza chains, Papa John's International Inc. (PZZA - Analyst Report) commented in its second-quarter 2012 earnings call that it expects the reform law to cost about 11–14 cents a pizza, or 15–20 cents per order. However, on a positive note, Papa John’s can probably afford Obamacare given its strong unit economics at the store level. Darden expects its earnings in fiscal 2014 to be adversely affected nearly 6 cents per share by the implementation of the Affordable Care Act.
The largest burger chain in the world, McDonalds does not feel threatened by cost increases that this law will lead to. Already used to ups and downs in commodity costs, McDonalds sees the Affordable Care Act as just another cost driver. In its second-quarter 2012 earnings call, the burger chain estimated the Obamacare to cost each restaurant unit in the range of $10,000 to $30,000. The restaurant chain finds this cost increase manageable as restaurateurs endured even greater commodity cost issues in 2011.
Wendy’s Co. (WEN - Analyst Report) initially estimated that the healthcare law will lead to a cost hike of $25,000 a restaurant a year. But on Mar 14, management notified that costs per restaurant will be as low as to $5,000 a year, given the expectation of a low acceptance rate, meaning many employees are likely to decline the insurance offering.
Is the Law that Harmful for Restaurants?
Implementation of the law will be in a slow but steady mode. Further, as per the quick-service restaurateur Wendy’s, many of its employees will likely turn down company-offered insurance. Employees who are poorly paid generally get insurance through government-offered Medicaid. If not so, they would rather choose to pay the penalty ($95 per year) for avoiding health insurance as it will be lesser than the company-backed insurance premium in 2014.
Another operator, AFC Enterprises Inc. is also supportive of the view. However, the U.S. Department of Health and Human Services believes the opposite as penalties will get harsher from $325 per person in 2015 to $695 in 2016. The government body seems convinced that this will compel many to sign up for the program.
From the consensus view, we get a feeling that the new healthcare law will be quite manageable in the short run, at least in 2014. With the prevailing upbeat sector sentiment and easing food cost inflation, the healthcare costs should not take a toll on operators’ profits in the short run.
However, with stricter rules to be implemented over time, the long-term outlook appears hazy. As of now, we can say that restaurants will try to recruit more part-timers rather than full-time employees post implementation of the law. Only time will tell how receptive the sector will be to Obama’s care.
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