The Trump rally may have stalled but the best trades of 2017 may still be made in companies that will benefit from policy changes in Washington.
One of those trades has gotten started early with a court decision mid-November and could help boost earnings in important sectors of the economy. Companies in these sectors were looking at dramatically higher staffing costs but now may be able to beat expectations as the economy heats up and costs stay low.
I’m going after two best-of-breed companies that stand to benefit big time.
Business Strikes Back Against Wage Regulations
A federal court judge in Texas issued an injunction mid-November blocking the Department of Labor from enforcing new regulations that would increase the minimum salary for supervisory workers that qualify for overtime pay.
Under the old standard set in 2004, employees classified in a supervisory role are not entitled to overtime pay as long as their salary is at least $23,660 annually. The new rule would have more than doubled the minimum salary to $47,892 and would have meant companies would have to pay overtime for more than four million workers.
The court found the Department of Labor (DOL) exceeded its authority in language around the new regulations. A group of 20 states challenged the new regulations arguing that the arbitrary increase would be detrimental to businesses.
The November ruling doesn’t automatically kill President Obama’s executive order for the increase. However, proponents may not have time to appeal through the Circuit Court system and the incoming administration is unlikely to push it forward. A previous attempt to expedite an appeal by the DOL on a district court’s decision in 2015 was denied by the Circuit Court and a ruling wasn’t handed down for nine months.
The business community may not have to worry about as much about federal pressure on the minimum wage over the next four years. President-elect Trump said in the Republican primary debates that he would not raise the federal minimum wage and has proposed tax deductions and credits for low-income households rather than mandated wage increases.
These Industries Stand To Benefit From The Change In Overtime Regulation
The Bureau of Labor Statistics reports wage data within industry occupations as well as hiring by job. More than 8% of food service workers are classified as supervisors, earning an annual median salary of $31,420 which is the lowest of the industry categories. Industries with lower annual median salaries for supervisory workers include personal care & services ($36,840), grounds cleaning & maintenance ($39,440) and retail sales ($41,330).
Under the proposed overtime regulations, companies in food service would have been looking at paying managers 52% more or paying them time-and-a-half overtime for extra hours. Raising the pay for more than a million employees classified as supervisors could cost more than $16.5 billion a year.
Beyond the potential for cost control, these consumer-focused industries might also be getting an economic boost over the coming quarters.
The University of Michigan’s Consumer Sentiment Index surged in November to 93.8 for the highest reading since May and the largest month-to-month increase (up 7.6% from October) since December 2013.
Combined with a surprisingly strong 2.9% economic growth in the third quarter, retailers, and restaurants could be looking at happy holidays this year.
These two companies look to be among the big winners…
Bed Bath & Beyond Inc. (BBBY) has been feeling the big-box pain this year with shares down more than 18% over the last twelve months. Shares trade for just 9.3 times trailing earnings, a 38% discount to the five-year average of 14.9 times.
The company has one of the stronger brands in retail with an estimated 11% share of the $104 billion US home furnishings category, according to Morningstar. The recent acquisition of online retailer PersonalizationMall.com expands its e-commerce presence and should help the transition to digital.
Yum! Brands, Inc. (YUM) owns some of the most recognizable brands in quick-service food including KFC, Pizza Hut, and Taco Bell. The recent spinoff of Yum China Holdings Inc (YUMC) will help to reduce earnings risk around foreign currency changes, especially if the U.S. dollar continues its climb higher. The stand-alone China segment will pay Yum Brands 3% of annual sales as a trademark franchise.
The company’s shift to a 98% franchise model is expected to reduce operating costs by $300 million and reduce annual capital expenditures by $400 million through 2019. That could help boost cash flow significantly and drive cash yield even higher than the current 3.2% dividend. Shares trade for 16.2 times trailing earnings, a discount of more than 36% to the average peer multiple (25.4x) and to its own five-year average multiple of 26.1 times.
Risks To Consider: Individual states will still be able to raise minimum wages, which could weigh on profitability.
Action To Take: Food service and retail sales stocks may do well as consumer confidence jumps and fear over wage pressure subsides. Take a position in some of the best-of-breed companies within these industries like Bed, Bath & Beyond and Yum Brands.
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