Is This the Biggest Threat to Retailers in 2016?

Whether it's restaurants or retail, this expense is going to keep growing and weigh on profits in the future. Source: www.audio-luci-store.it

Has Texas Roadhouse (TXRH 0.07%) unwittingly given investors a hint of the hidden time bomb that could explode, not only for the restaurant industry but for all retailers in the near future?

The market didn't much care for the steakhouse chain's third quarter earnings report that missed analyst projections for top and bottom line growth. While the size of the miss was relatively small -- just a penny per share on the earnings front -- and the restaurant's franchisees posted particularly strong growth in same-restaurant sales of 7.7%, it got dinged by one cost in particular that shows no sign of abating this year and will only continue to grow in 2016 and beyond.

It wasn't beef prices that hurt the chain (they actually closed last week some 15% below their all-time highs) but rather rising labor costs that toyed with expectations for the company's performance. It suggests that other restaurant chains -- and all of retail -- could be in for a tough year in 2016.

The restaurant operator said labor costs as a percentage of restaurant sales more than wiped out the gains it made in average unit volume, as they jumped 32 basis points due to higher wage rate inflation and healthcare costs. Restaurant margins collapsed 22% in the quarter as a result.

With the labor market tightening and costs growing into next year, Texas Roadhouse has to raise prices this month despite falling commodity costs. The 1.7% increase, though, is still below the 2.5% to 3% inflation in wage rates it is forecasting. This challenge, however, is one Texas Roadhouse isn't alone in facing.

Pressure to raise worker pay is hitting businesses from all sides: from within industry itself, activists, and state governments. Source: Maryland GovPics

Retailers everywhere are expecting to have difficulty filling positions this holiday season. While the industry will hire the same number of seasonal employees this year as it did in 2014 (about 755,000 people), some outfits like Amazon.com are adding as many as 100,000 people to its payroll, pushing labor costs higher.

A number of states will also be raising their minimum wage soon. According to the National Council of State Legislatures, businesses in 15 states will face higher state-mandated labor costs in 2016 than they did this year, and more than half a dozen of those states will be pushing rates even higher in 2017 and 2018, too.

While Texas Roadhouse estimates 70 of its restaurants are in states covered by mandated minimum wage hikes, or some 15% of its base, the problem could be even more acute in the retail industry where The Wall Street Journal reports wages are rising faster than the overall economy.

Part of that was a result of Wal-Mart (WMT 0.57%) unilaterally giving a half million employees a raise to $9 per hour this year -- that will be followed by an increase to $10 in 2016. Other retailers like Target (TGT -0.54%) and TJX Companies also raised worker compensation in response, as did McDonald's.

But the market pummeled Wal-Mart when it revealed that the wage bump cost it about $1 billion, and it said next year's hike will cost it $1.5 billion more. It's also hiring 60,000 temp workers for the holiday season, the same number it hired last year, and will be paying them the same higher pay rate.

Target, which is putting 70,000 people on its payroll for Christmas (the third year in a row it's hiring that many seasonal workers), is finding it needs to offer "bounties" to workers to get them to cover the busiest shifts this year, including an extra $1 per hour for employees willing to work Christmas Eve.

With momentum in the industry pushing pay higher, activists advocating for doubling the minimum wage to $15 per hour, and the states taking the lead on their own to increase labor costs, restaurateurs and retailers will find their profits getting squeezed, perhaps beyond the sales growth they thought they'd be able to achieve.

While steakhouse chains like Texas Roadhouse are still benefiting from America's love affair with beef and the recent drop in commodity costs, higher labor costs will take their place, and it may be a price too high for some restaurants and retailers to pay.