(By Mani) With the election now behind us, it seems more certain that healthcare regulations that were put into law during the first Obama term will indeed be enacted in 2014. For retailers the primary issue will be the need to offer medical coverage to its full time hourly in-store employees.
While most store and field managers are covered, most of the hourly workers are not. Most of the retailers universe have yet to publically address the issue as it is not scheduled to be in place until 2014.
Home Depot (NYSE: HD) did previously indicate that its long term outlook did not include a specific estimate on the impact of the healthcare law, but if it was enacted, it would likely have an impact to SG&A.
Moreover, a failure to comply with the new law and not offer healthcare to full time employees could result in a $2,000 penalty per full time employee for the employer. There are other potential penalty amounts depending on which employees are offered healthcare.
"But, in the broadest terms, retailers could theoretically scrap their entire health plan obligation and opt to pay $2,000 per full time employee. Practically, this is not likely, but we think it serves as a reality check to what the cost to employees could theoretically be," Deutsche Bank analyst Mike Baker wrote in a note to clients.
Assuming a 60 percent increase in healthcare costs, the average impact to employees would be just under 45 basis points (bps) to 2014 sales.
"While this will be a negative to retailers in 2014, we believe it as absorbable and can be offset in several ways.," the analyst said.
At the outset, most retailers will try to move more employees to part time employment status versus full time, which would lower the impact, and retailers would look to pass on the increases in price as competitors would likely be faced with the same issues and also look to raise price.
In addition , employees could look to keep hourly wages down as workers would be getting an added benefit from the new healthcare benefits.
"So, overall, an issue, but at 43 bps on average, with some offsets, not something that is insurmountable in our view," Baker wrote.
Now, the key question is which retailers would be the most and least impacted in this scenario.
The most important measure of the impact on a retailer is to compare the basis point impact to expenses from the legislation to that company's overall operating margin. In other words, a retailer with a very low operating margin will have a harder time absorbing the roughly 43 bps impact from the law compared to a retailer with higher operating margins.
"On this measure, the retailer again with the lowest impact as a percent of overall profitability is Ross Stores, Inc. (NASDAQ:ROST), where the 12 bps impact is less than 1% of our 2014 operating margin estimate of 13.6%," Baker added.
Similar to the basis point impact measure, when the impact as a percent of profitability is considered, the off price retailers and the home goods retailers, look good. This is because of their high operating margins, low full time penetration and low sales intensity model in the store.
"But, and this is probably the most important conclusion, low margin names like OfficeMax, Inc. (NYSE: OMX), Office Depot, Inc. (NYSE: ODP) and RadioShack Corp. (NYSE:RSH) will probably see the biggest impact from the healthcare legislation," Baker noted.
The above companies would feel the impact not because they'll see a huge increase relative to others in their healthcare cost as a percent of sales, but rather because the 43 bps increase is such a large percent of these companies estimated 2014 operating margins.
By looking at the basis point impact for each retailer, the range of impacts goes from 12 for Ross Stores to 84 bps for O'Reilly Automotive, Inc. (NASDAQ: ORLY). The key variable is the percent of full time employees, with those that have less full time employees having a lower basis point impact.
"In general, it looks like the off price retailers and the home goods retailers have the smallest basis point impact. At the high end, because they are relatively labor intensive businesses and have high full time employee mixes, we see the auto parts retailers. LOW is also relatively high at 67 bps," Baker said.