Are Labour Unions Bad for Business?

As United Auto Workers strikes continue to ripple across North American factories, the debate between workforce compensation and unionized companies’ ability to compete wears on. Workers are arguing for a slice of the sharply rising profits of North American automakers General Motors GM, Ford F, and Stellantis STLA, but the industry’s turbulent past, littered with bankrupt vehicle makers, weighs on the minds of executives and investors alike. Meanwhile, the nonunionized workforces of the Japan Three, and more recently Hyundai-Kia along with Tesla TSLA, cast a long competitive shadow.

Amid this backdrop, it’s worth asking: Do unions lead to bad outcomes for businesses? The answer isn’t always clear-cut—despite lower profitability among companies with higher unionization, these firms also tend to see reduced employee turnover and lower average Morningstar Uncertainty Ratings.

As we’ve previously noted, traditional financial theory typically views unions as an opposing force to shareholders, leading to higher labour costs. And indeed, taking a look at unions’ impact on stocks across the broader market, we find that companies with higher percentages of employees covered by unions have generated lower historical returns on invested capital and are less likely to have economic moats.

Companies With Greater Unionization Tend to See Fewer Moats and Lower ROICs

Economic Moat Distribution by Unionization Level

This data spans more than 1,000 companies followed by Morningstar equity analysts and uses Sustainalytics’ data on collective bargaining agreements: A score of 0 means none of the company’s employees are covered by such agreements, while 25 means up to 24% are covered, 50 indicates 25% to 49%, and so on. Roughly half of the companies in this study had no employees covered by collective bargaining agreements.

Admittedly, correlation does not equal causation. And there are examples of industries with both high levels of unionization alongside a high proportion of narrow and wide moats and solid returns on invested capital—companies in the rail transport space are a good example. Nonetheless, on average, the proportion of economic moats falls sharply as unionization levels rise.

Beyond moats, the investment risk presented by unions can manifest in a variety of ways for company shareholders. Perhaps most visible are strikes, although such incidents can also include pay disputes, protests, or other work stoppages. Again, we see a moderate positive correlation between the average amount of employees covered by collective bargaining agreements and the number of these human capital incidents from 2018 through mid-2023.

A Higher Degree of Unionization Has Led to a Greater Number of Strike-Related Incidents

Average Number of Work Stoppage Incidents Per Company by Unionization Level, 2018 - YTD 2023

Of course, there’s no guarantee that every company with a high level of unionization will face a future strike; companies can and typically do manage these risks effectively. And certainly, employee issues can occur at lower levels of unionization, too. But the data suggests that investing in a stock with high levels of unionization runs a greater risk that the underlying company may have to endure future work stoppages.

But There Are Some Positive Aspects of Unions for Investors

Despite correlation with lower returns on capital and a greater potential for work stoppages, unions aren’t always entirely negative for investors.

For one, the existence of unions could potentially lead to increased workforce stability. Using Sustainalytics’ Employee Turnover Score (where higher scores are better, indicating lower turnover levels), we can see that higher percentages of unionized employees are correlated with lower employee turnover (outside a dip at lower levels of unionization).

Companies With a Higher Level of Unionization Have Lower Average Employee Turnover

Average Employee Turnover Score (Higher = Lower Turnover) Per Company by Unionization Level.

Similarly, companies with a higher percentage of employees covered by collective bargaining agreements tend to report stronger lost-time incident rate, or LTIR, performance over time, as measured by Sustainalytics’ LTIR Trend indicator. This indicator assesses the trend in a company’s LTIR by comparing the rate in a given fiscal year relative to its previous three-year average; again, higher is better. Better work safety performance may arguably translate into lower future costs associated with compensation for injury or death, alongside lower productivity losses.

A Higher Level of Unionization Correlates With Improving Lost Time Incident Rates

Average Lost Time Incident Rate (LTIR) Trend Score Per Company by Unionization Level

Finally, among companies with higher levels of unionization, we see lower average Uncertainty Ratings as assigned by Morningstar equity analysts. While industry-specific considerations remain critical, a lower Uncertainty Rating requires a lower discount relative to the estimated fair value of a company before a stock is automatically assigned a non-3-star rating, given a slimmer range of potential future outcomes.

Companies With Higher Unionization Tend to Have Lower Uncertainty Ratings

Uncertainty Rating Distribution by Unionization Level

Case Studies Show How Unionized Companies Can Compete

Digging deeper, it can be helpful to examine a couple of case studies to help illustrate the puts and takes of unions’ impact on companies’ individual prospects.

One example is in the freight and logistics space, between rivals UPS UPS and FedEx FDX. Despite its unionized workforce and asset intensity, UPS produces operating margins well above those of its competitors, thanks in large part to its leading package density. Shippers also appreciate the convenience of using the same driver to handle both express and ground packages in UPS’ single network. Although recent union negotiations will likely lead to painful wage hikes, Morningstar’s equity analysts assign UPS a Morningstar Economic Moat Rating of wide compared with a narrow moat for FedEx.

We can also look to the airline industry as another good example. Most major carriers are highly unionized including Air Canada AC, American AAL, United UAL, and Southwest LUV. Delta Air Lines bucks this trend, with a mostly nonunionized workforce. And indeed, compared with its legacy carrier peers, Delta’s DAL ROICs have been higher in recent years—both pre-COVID-19 and over the past six years.

Delta Outperforms Unionized Legacy Peers on ROICs, but Southwest Strongest Among All

Return on Invested Capital (ROIC) by Company, 2017 - 2019 and 2017 - 2022

But as the chart above shows, unionized Southwest has managed to outperform each of its primary rivals. This is likely due to the carrier’s low-cost focus, and its dense U.S. route network using a single model of airplane. Outside the higher ROICs, Sustainalytics also notes that Southwest’s employee turnover has been comparatively low.

To sum: While unions overall are shown to lead to lower returns and are correlated with lower company quality, this is not a universal truth; highly unionized companies can still compete with nonunionized competitors through some combination of differentiated strategy, solid execution, and robust structural advantages.

GM Remains a Top Pick

Before the start of the coronavirus pandemic, General Motors GM was starting to see the upside to high operating leverage, thanks to lower fleet sales and smarter manufacturing than in the past, including a reduction in its vehicle platforms. There’s no doubt that the recent UAW strikes have increased uncertainty; along with an ongoing semiconductor shortage, GM and other automakers face substantial near-term challenges. But Morningstar’s equity analysts like the firm’s shifted strategy to focus only on markets where it can be profitable over the long run.

While Tesla will likely continue growing its sales volume while also leveraging its brand- and cost-led economic moat, our analysts believe GM can complete under its retooled strategy. And importantly, there appears to be a larger margin of safety in the 5-star stock’s price at present.

However, again highlighting the negative aspect of unionization for shareholders, it’s worth noting that management at GM and the other Big Three North American automakers believe that reopening pension plans and retiree healthcare—a key UAW demand—could put the manufacturers on a path to financial ruin. If the UAW is not willing to give up that fight, the strike could last a lot longer and possibly even lead to bankruptcy. In this case, GM’s High Uncertainty Rating is well-earned.