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Will The Living Wage Cut Profits At Tesco PLC, Whitbread plc and J D Wetherspoon plc?

The National Living Wage is due to take effect in April 2016. Will this large-scale pay hike cause profits to slide at firms employing large numbers of staff on low wages?

The government has said that the current minimum wage of £6.50 per hour will be increased to £7.20 in April 2016, and will rise to £9 per hour by 2020. That’s a 38% increase in five years.

Management at Whitbread (LSE: WTB), which owns Costa Coffee and Premier Inn, warned shareholders today that adopting the National Living Wage will result in a “substantial cost increase”. The firm hopes to combat this with productivity improvements and improved systems, but admitted that “selective price increases” are likely to be necessary. The news disappointed investors, especially as the firm also admitted that like-for-like sales growth slowed during the second quarter, falling from 4.3% in Q1 to just 3.3%.

Whitbread shares are down by 3.5% as I write, but the firm isn’t the only larger employer who might be affected.

Supermarkets

The UK’s grocery sector employs around 1m people. More than 310,000 of these are employed by Tesco (LSE: TSCO), which is the UK’s largest supermarket. A recent report by credit rating agency Moody’s estimated that Tesco’s profits could be 7% lower in 2017 if the group doesn’t take any action to mitigate the cost increase resulting from the living wage.

I’m pretty sure this issue will be on the radar for Tesco management. One possibility is that the level of automation in stores, such as self-check-outs, will increase, making job cuts possible. A second possibility is that Tesco might also focus on recruiting younger workers, as under-25s are not eligible for the living wage.

One thing that is unlikely to happen, in my view, is price increases. Given the tough battle for market share currently taking place in the supermarket sector, I find it hard to imagine that any of the big supermarkets will increase their prices to compensate for rising pay costs.

Who else might be hit?

Over at cut-price pub chain J D Wetherspoon (LSE: JDW) the situation is potentially even more serious. According to the FT, Morgan Stanley analyst Jamie Rollo believes that the increase to £7.20 in April 2016 could reduce Wetherspoon’s pre-tax profits by as much as 21%.

However, analysts remain bullish about the outlook for Wetherspoon, despite this risk. The latest consensus forecasts for the firm show that earnings per share are expected to rise by 22% in 2015/16, and by 14% in 2016/17.

How bad will it really be?

It’s worth remembering that there are two sides to every story. There were lots of complaints when the original minimum wage was introduced in 1999, but most companies adapted without any major problems.

Large firms like Tesco, Wetherspoon and Whitbread wouldn’t be where they are today if they couldn’t deal with changes like this. Although wage bills will rise, customers should also have more cash in their pocket to spend, and staff retention and efficiency may rise, cutting costs elsewhere.

I don’t expect corporate profits to collapse when the National Living Wage is introduced, and I certainly wouldn’t make any changes to my portfolio for this reason.

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Roland Head owns shares of Tesco. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.