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Thu 9th Jul 2015 - Analyst: Living Wage will feel like a tax on employers
Jamie Morgan – The Living Wage could impact PBT by up to 21% in 2016: Morgan Stanley leisure analyst Jamie Rollo has forecast that the introduction of Living Wage by the government could hit profit before tax by up to 21% in 2016 for some companies – and amounts to a tax on employers. He said: “The UK government’s surprise introduction of a £9 National Living Wage (NLW) by 2020, 34% above 2015’s £6.70 national minimum wage, could have a material impact on a sector where labour costs average 25% of sales and operating margins average 10%. We see the largest hit at UK managed pub companies, bookmakers, tour operators, and hoteliers, with a potential impact range of 4-21% to profit before tax just for the step-up in 2016. While there could be a commensurate demand offset from higher disposable income, the simultaneous proposals to reduce welfare spending mean UK household income will effectively be little changed, meaning the NLW will feel like a straight tax on UK employers. The government will ask the Low Pay Commission to set out how the new NLW will reach 60% of median earnings by 2020, which based on the OBR’s earnings forecasts, means that the NLW will reach the government’s target of over £9 by 2020. This would be a 5.7% CAGR in the NLW over 2016-2020. Labour cost is the largest operating cost for most quoted leisure and hospitality operators, particularly the managed pub, betting, travel and hotel companies. For the companies under our coverage labour averages 24% of total sales, with the majority of this coming from employees on or just above the minimum wage. Many operators have low profit margins (10% is the sector average, with a spread of 4-44%), so with most companies having wage costs in excess of their profits, small changes in the NLW can have a big impact on profits. For example, Wetherspoon is close to a 100% UK pub operator, has Ebit margins of just 7%, and staff costs of 23% of sales. We see the largest impact at managed pub companies (JDW, MAB, GNK), bookmakers (LAD, WMH), tour operators (TUI, TCG), and UK hoteliers (WTB). This ranges from 4-21% to 2016 PBT. The hit is obviously the largest for companies with a high proportion of UK-based low paid staff, low operating margins, and high financial leverage. Bear in mind this is just the impact from the step-up to £7.20, and there is then another 6% annual increase for four years. By contrast we see little impact on cruise lines (globally sourced staff, no national pay contracts), asset/management light operators (IHG, tenanted pubcos), and largely non-UK businesses. How might companies respond on an operational level? We think there may be little that UK-based employers can do in practice. They cannot ‘offshore’ their outlets. It might be hard to reduce headcount, as they run businesses where service standards are key (indeed, the government cites evidence that the 31% NMW increase over 2001-04 had minimal impact on employment). We also doubt employers can get away with employing mainly under 25 year olds. They might be able to close pay levels, or reduce bonuses (which in the Wetherspoon case above are c. 10% of its staff costs). They can also perhaps raise selling prices in compensation, particularly if the industry is facing the challenges en masse. The main mitigating factors are an increase in National Insurance Contributions Employment Allowance from £2,000 to £3,000 a year (which we estimate mitigates c. 8% of the extra cost), and a reduction in the UK corporation tax from 20% to 18% (but only in 2020). How about the demand offset? The government says the NLW will mean a direct boost in earnings for 2.7 million low wage workers, and the OBR has indicated that knock-on effects further up the wage distribution could mean a further 3.25 million people also see an increase in wages as a result. By 2020, it estimates that an individual aged over 25 working 35 hours a week and previously earning the NMW will see their gross wages increase by around a third compared to 2015-16, or £5,200 in cash terms. However, this should be largely offset by the simultaneous proposals announced yesterday to reduce welfare spending, and the government says the net effect of the change in the income tax personal allowance, NLW and welfare (including tax credits) will leave households just £130 per year better off. While studies on the marginal propensity to consume in this lower income cohort suggest most of this will likely be recycled, it seems insufficient to offset the additional staff costs. In effect then, employers will be giving their employees more money, but the government will be giving them less money, leaving individuals in a similar position but corporations worse off. We have yet to work through the net impact, but for now we suspect that investors will focus on what we can quantify more easily, which is the impact on corporate costs.”


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