The bad news is, Kimberly-Clark (NYSE:KMB) fell short of its earnings estimates. The good news is the paper-product company says it's going to raise prices in order to offset its shrinking margins stemming from high commodity costs. The really good news? At least it won't be alone in passing along higher costs to its customers.
Some analysts think even a modest increase in its selling prices could torpedo its sales volume, making the profit margin irrelevant. The company, however, is confident it can maintain demand well enough to keep cranking up (very) modest sales increases.
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Flashback to 2007
Kimberly-Clark earned an operating profit $1.09 per share in the first quarter of 2011, falling short of estimates of $1.18, and falling short of last year's $1.14.
Worse, income shrank despite a 4% increase in the top line to $5 billion. Only $350 million of that figure was turned into a profit though, where the company managed to earn $384 million in Q1 a year earlier on slightly less revenue. And here's the really troubling part: The company managed to carve out $60 million in savings in the first quarter of 2010 that it paid out a year earlier. Without that, the total profit would have slumped to less than $300 million.
The culprit? Higher commodity (input) prices. The costs of raw materials needed to make all those diapers, paper towels and tissues soared by over $175 million for the quarter, obliterating any real chance Kimberly-Clark had at pumping up its profits. Indeed, it's a miracle gross margins only fell from 34% to 29%. (To learn more, see The Bottom Line On Margins.)
Given that the rising commodity prices aren't apt to end anytime soon, passing those higher costs along to consumers may well be the only way to keep that paper-thin profit margin from turning into a loss.
While even-higher prices at the grocery store won't be well-received, the strategy may work by default if only because consumers are left with little to no choice.
Though not a direct competitor on all fronts, Procter and Gamble (NYSE:PG) has already announced it will be bumping up its prices on several of its paper product lines thanks to the same increased input costs Kimberly-Clark is feeling.
Even outside the personal product space, it's clear the cost of paper production is rising firmly enough for paper companies to take notice and address the trend. Temple-Inland (NYSE:TIN) noted it saw rising costs when issuing statements regarding its first quarter results, and Domtar Corporation (NYSE:UFS) acknowledged in its Q1 comments that the weakening demand in the Unites States coupled with rising input costs was forcing the paper company to think and act conservatively.
At this point, whether or not - and by how much - Kimberly-Clark can raise prices is a battle of willpower. Can consumers tolerate enough pain to allow KMB investors to avoid pain? It's a fine line to be sure, and one that the paper companies don't control as well as the market would like to think. It's single-digit percentage increases at best.
Remember 2007? The paper market didn't find that supply/demand equilibrium then, as pulp prices continued to rise through 2008 even as economic conditions were deteriorating on all other fronts. It wasn't until the meltdown in late 2008 that paper prices finally buckled, though it was too late for it to matter
Slightly higher retail prices now will likely create grumbling, but not stifle actual demand. When the price bumps aren't so slight, though, investors may want to head for the door.
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