Chipotle, McDonald's well positioned as fast food chains deal with California's rising wages
Fast food companies aren't laughing this April 1.
In California, the day marks the start of a new obstacle. Fast food chains that have at least 60 locations nationwide need to raise their minimum wage for restaurant employees to $20 per hour, up from $16, as the FAST Act takes effect.
The industry will have to battle to maintain profitability, as sticky food inflation, value-conscious consumers, and softening growth trends leave few options on the table.
"On the cost side of the equation, it generally means that you're talking about restaurants having to either absorb that wage rate increase, or be passed along to consumers in the form of higher pricing," Citi analyst Jon Tower said over the phone.
Companies with strong branding power, value proposition, or diverse geographic footprint are likely to better weather the storm. Rising labor costs — 22 states raised their minimum wage on Jan. 1, while Oregon, Nevada, and Florida are set to increase theirs later this year — have contributed to restaurant meals becoming increasingly expensive.
Per the latest CPI data, the cost of groceries jumped 1% year over year in February, while the cost to dine out grew 4.5%.
The widening gap between eating out versus eating at home, as well as the numerous price increases companies already undertook since the pandemic, limit how much they can lift menu prices before cratering demand.
Chains that have a loyal following will have an easier time convincing diners to pay the extra cost. Chipotle (CMG), whose CFO Jack Hartung told Yahoo Finance that the company planned to raise their California prices in the mid- to high-single-digits, was identified by several analysts as having the power to adjust its menu.
"I think brands who provide a lot of value and have good traffic are best positioned," said Peter Saleh of BTIG, who pointed out that Chipotle's chicken bowl averages $9 across the country, compared to $12 to $13 for many burger meals.
"They've built quite a bit of momentum in their business with respect to traffic," Tower said. Consumers go to Chipotle's more frequently, partly due to the "abundant value that they offer on a per entree basis, relative to what you can get elsewhere."
Wingstop (WING), whose CEO Michael Skipworth told Yahoo Finance Live that its California franchisees will likely up prices by mid-single digits, also has a leg up. The chicken wings chain has been ramping up its brand awareness while keeping menu increases lower than its rivals, said Tower.
And chicken is cheaper and less inflationary than beef; the price of ground beef has soared 33% since 2020, and 7% in the past year.
For McDonald's (MCD), Wendy's (WEN), or Burger King (QSR), their sheer scale is a plus, as they can cover hits from California with the rest of their national and international business. However, as prices rise, the companies may have to compete more aggressively on discounts and promotions.
Wedbush analyst Nick Setyan said Domino's (DPZ), with their unbeatable low priced pizza deals, could emerge a winner. Its shares are up more than 50% in the past 12 months.
One company that may struggle is Jack In the Box (JACK). Around 43% of its restaurants, and 60% of subsidiary Del Taco's locations, are in California. Its diners skew lower income, and it's a more regional brand competing with multinational burger chains with more resources, said Tower.
"There's going to be a huge margin hit" for the business, said Setyan. Its stock has dropped 18% in 2024.
A murky future for the industry
"I think people are under estimating how much trouble restaurants are in and have been for years now. And so it's actually a very troubled industry that you're just, you know, hanging more anchors on," said Setyan.
Margins are down about "100 basis points for the industry" compared to pre-pandemic, according to Saleh. Price increases have not fully covered restaurants' skyrocketing expenses, even as foot traffic rises above 2019's level.
Prices are already up 30% at quick service burger chains since 2019, capping how much more companies can charge now, particularly at chains that serve lower income customers.
"No one's going to be able to take up all the pricing to offset the California impact," said Setyan, who predicts that food companies will see pressure on revenue and margins as a result.
However, University of California Berkeley professor Michael Reich said restaurants would only need to charge $0.08 more for a $5 Big Mac to pay for the wage increase.
"That's not going to deter most consumers. I think the restaurants will be able to weather this quite well given these actual facts as opposed to the fear," he told Yahoo Finance Live.
If stores can thread the needle — upping prices without affecting demand — companies with a franchise model could benefit. Corporations like McDonald's collect a percentage of its franchisees' revenue, and higher menu prices generally result in higher overall revenue.
Looming job cuts? Not for all.
Second-generation franchisee Alex Johnson, who owns Auntie Anne's and Cinnabon franchises in California, chose to lay off some of his employees, claiming the wage increase will cost him an additional $470,000 annually.
He told Yahoo Finance his stores have had "declining sales and traffic counts" so far this year, adding "it's the worst time" to increase prices. He's even considering selling off his locations in the state.
Others think any job losses won't be widespread, as restaurants are just getting back to their pre-pandemic staffing levels.
"I'm not exactly sure how they're cutting staff unless they're implementing some sort of technology that allows them to reduce labor hours somewhere else," said Saleh.
And the act could bring a fresh wave of raises across other industries, as companies compete with fast food chains for talent.
Joseph Bryant, member of the California Fast Food Council, claimed higher wages could lead to more jobs and higher profits.
In a statement to Yahoo Finance, he said: "The threats of price hikes and job cuts are the same scare tactics we heard when the wage was set to go up to $15 per hour. These warnings have been largely unfounded. In fact, the fast-food industry continues to thrive and profit. The top nine publicly traded fast food companies alone took in nearly $25 Billion in profits in 2023."
Since 2015, wages have increased in the state, yet "fast food restaurants in California added 142,000 jobs" during that same time period, per Bryant.
There may also be more automation on the way, as higher labor costs justify investing in tech and robotics.
Or some individual operators may decide to fold. "I don't see anybody like going bankrupt tomorrow, but you're gonna see a lot of store closures," said Setyan.
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Brooke DiPalma is a senior reporter for Yahoo Finance. Follow her on Twitter at @BrookeDiPalma or email her at bdipalma@yahoofinance.com.
