Investors should have known going in that Wal-Mart's (NYSE:WMT) decision to unilaterally raise the minimum wage of its employees was going to hurt the retailer's earnings. Incurring $1 billion in new expenses without any offsetting increase in productivity was going to create a profits vacuum and suck the air out of any gains the company may have otherwise generated.
It's going to kill profits next year, too, as Wal-Mart said its investments in wages and training would lower operating income by about $1.5 billion in fiscal 2017.
Of course, the retailer never promised immediate improvements, either. When it announced it was hiking pay to $9 per hour this year and $10 per hour next, it said the goal was to improve employee morale and turnover, which would lead to a better customer experience that would eventually help boost sales. That's not something that happens in just a few quarters; we're talking years here to change people's perceptions.
Although it's hard to dismiss the value of improving the lot of employees, the wage hikes also mean Wal-Mart is no longer a good investment. Here are three reasons why.
1. Wage increases actually aren't improving morale.
In fact, they've arguably made the situation worse. More senior employees who've worked for years to get to their pay grade -- and didn't get a raise -- are reportedly disgruntled with the policies. Wal-Mart's going to have to lift the pay scale for those workers, too, if it really wants to improve morale, but it'll be at the expense of adding more costs to its ledger and further depressing its profits.
2. Pay increases are forcing the company to cut costs elsewhere.
Wal-Mart has been cutting employee hours and closing (for at least a few hours anyway) stores that were previously open 24 hours. While it says the moves are unrelated to the pay raises and are part of its overall cost-cutting initiatives, even the employee union speculated it was about giving them a benefit with one hand then taking it back with the other. Then, earlier this month Wal-Mart announced it was eliminating 450 corporate positions, indicating there may be more unintended consequences for its escalating wage costs.
3. The wage hikes are bad news piling on worse news.
Wal-Mart's business can't support the added costs. Since 2013, there has only been one quarter where traffic at its U.S. stores has seen more customers coming in. Fewer customers and higher costs can only means more cuts are on the horizon, whether it's employee hours, store hours, or the employees themselves. Moreover, even if it does generate the higher productivity Wal-Mart expects, that means it will be able to get by with fewer employees. Either way, you can expect fewer Wal-Mart workers than there otherwise would have been.
Down the rabbit hole
Of course, Wal-Mart wasn't the only retailer to raise wages. Once it made its announcement, pressure was applied to others in the industry to follow suit, and we saw companies like McDonald's (NYSE:MCD), TJX Companies, and Target (NYSE:TGT) all make their own commitments to higher pay.
But these initiatives are also taking a toll on companies' bottom lines. The Gap (NYSE:GPS) was one of the first retailers to raise the minimum wage for its 65,000 employees, lifting it to $9 per hour last year, but it can't afford the added costs, and has since announced it will be closing 175 stores. Its operating income has plunged 25% so far this year. Similarly, at a time when McDonald's is struggling to reverse a sustained decline in sales, the higher expenses are reducing its operating profits, which have fallen 5% so far this year. And Target -- which, like Wal-Mart, raised pay to $9 this year and $10 next year -- has also said it's cutting 1,700 jobs and letting an additional 1,400 positions go unfilled.
Starbucks (NASDAQ:SBUX) has reported a 20% increase in store operating expenses this past quarter because of higher wages, and they're up more than 28% so far in 2015. Starbucks has responded by raising prices on its coffee despite coffee costs falling.
But companies like Starbucks and Costco can afford to pay their employees more because their customers tend to be higher-income earners and are able to absorb price increases more easily. Wal-Mart, whose core customer is the price sensitive low- and middle-income shopper, and which already operates at razor thin margins, can't afford these higher costs.
What it means for investors
Investors can certainly laud Wal-Mart for raising its employees' pay, but they can also see the impact it's going to have on its financial performance. The wage hikes are already wreaking havoc on its bottom line, and they promise to bring more problems in the future. For the time being, and perhaps for several years to come, Wal-Mart is no longer a good investment.
Rich Duprey has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Costco Wholesale and Starbucks. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.