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
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.
The Cheesecake Factory Inc.
) which have a substantially higher number of company-owned
stores than franchised.
On the contrary, operators like
Burger King Worldwide Inc.
) with a respective of 93% and more than 80% of operations
franchised will be less affected.
), 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
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
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.
Chipotle Mexican Grill Inc.
) 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.
) 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
) 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
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.
AFC ENTERPRISES (AFCE): Free Stock Analysis
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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.