Numis has been examining the consequences of the introduction of the National Living Wage (NLW) and as a consequence is altering its forecasts across most of the managed pub and restaurant sector.
The new NLW is set at £7.20 in April 2016 against a National Minimum Wage (NMW) which is currently at £6.50, rising to £6.70 in October 2015.
Numis has downgraded 2017E earnings forecasts: by 14% for Mitchells & Butlers (from Add to Hold; TP from 500p to 450p); by 6% for JD Wetherspoon (Reduce; TP 700p); vs +1% to -3% for most other operators.
- Around half of the employees earning the NMW are 25 or under within the pub/restaurant sector; and are therefore not covered by this legislation. As a result, whereas typically a third of staff are currently on the NMW, accounting for 20-25% of labour costs, over-25’s on the NMW account for 10-15% of labour costs. Numis believes that about 35% of outlet employees are over-25’s earning below the NLW, accounting for 25-30% of labour costs.
- The key to determining the level of costs increases will be each company’s desire to maintain pay differentials internally (under vs over 25’s) and against the competition. Most companies should show restraint from maintaining almost all differentials, resulting in 0 to -3% changes in 2017E PBT.
- Mitchells & Butlers is assuming it will maintain wage differentials throughout its outlets, resulting an incremental 5% increase (£34m) in total outlet labour costs in 2017E and a 14% PBT downgrade for that year.
- Numis estimates that JD Wetherspoon will increase hourly-pay rates by 8% on 3 August 2015, resulting in an estimated 6% PBT downgrade for both 2016E and 2017E.
- The new legislation does not directly affect franchised, leased and tenanted companies, but it could undermine the underlying profitability of their franchisees, lessees and tenants. Offsetting tax benefits should compensate smaller, wet-led pubs with few staff (good for tenancies), and increase the downside risk of larger, food-led leased pubs which choose the Market Rent Only option, removing themselves from pub company support.
- Mitigating action. Companies are likely to invest even more in labour scheduling systems to offset rising labour costs. The proposed changes should boost disposable income for some customers, and create a more inflationary environment in which the more premium operators should be most capable of passing on rising costs. Discounters, which are also more likely to be affected by welfare cuts, are more likely to struggle to pass costs on.
In summary, the changes for most companies are minor. They coped with a 31% increase in the National Minimum Wage between 2000 and 2004, and they should adapt to cope with a 38% increase for over 25’s during the next five years.