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Price Increases Not Hurting Profits for Staples Companies

Posted on: August 2, 2008 - Email Article - Printable Version

Vinay Ayala

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With most of the earnings season complete, it looks like Consumer Staples fared pretty well with over 70% posting upside earnings surprises. One of the key issues that analysts were concerned with for Staples companies before earnings was how the rise in commodity prices and input costs would affect these stable companies. Most companies responded by increasing prices in the mid single digit to the low teens percent range and when examining how this affected earnings, it seemed as though Staples companies thrived as most of them provide mainly price inelastic goods. Lets take a look at a couple of companies and see how their earnings were affected by the price increases and see if this is a trend that is likely to continue even with the volatile commodity prices and worsening economy.

PepsiCo

PepsiCo Inc [PEP: 55.60, 0.00 (0.00%)] reported EPS of $1.05 vs analysts expectations of $1.02. While they PepsiCo Logo noted a slowdown in the beverage market in the United States, their international sales grew significantly as price increases did not have a significant impact on volume growth, which came in at 5%. By using cost cutting initiatives to reduce water, electricity and natural gas usage and due to gains in commodity hedging Pepsi was able to avoid any type of reduction in net income. Demand also seemed pretty strong considering the current environment and price increases.

Coca Cola

While, Coca Cola [KO: 45.44, 0.00 (0.00%)] has waited to significantly increase prices on most of their goods, it looks like they will be increasing their prices after the Labor Day holiday weekend. If Pepsi’s results are any indication, I would not expect a significant hit to demand in Coke sales. It is important to keep in mind though that Coke does not see as much effect on their bottom line as Pepsi does with the price increases because much of their processing costs are designated to third party firms such as Coca Cola Enterprises [CCE: 12.86, 0.00 (0.00%)]. As both firms are set to introduce new drinks featuring a natural sweetener called stevia, it looks like growth should continue to prosper for both beverage makers.

Colgate-Palmolive

Increasing prices 4.5% did not have much of an effect on Colgate-Polmolive [CL: 68.03, 0.00 (0.00%)] as the firm reported stellar results in its 2Q08, as they still experienced solid volume growth within their 5-8% targeted range. They were also able to gain market share in many of their key markets such as Western Europe and Latin America. The company earned $0.98 per share, above analysts expectations of $0.94.

Kraft

Kraft [KFT: 27.62, 0.00 (0.00%)] saw strong sales and improved margins as higher product prices helped to offset higher input costs in the quarter. They beat analysts expectations and revised their full year guidance upward as their product mix continues to drive sales.

Proctor & Gamble

Proctor & Gamble [PG: 62.35, 0.00 (0.00%)] just added to the list of Staples stocks that beat earnings estimates, as they also increased full year guidance. This surprised many analysts as they thought PG Logo PG could not maintain strong sales and margins with the rising costs, although due to effective cost cutting and a lack of slowdown in overall sales, Proctor and Gamble posted solid results as their strong brand recognition continues to drive them forward.

Kellogg

Even with a higher tax rate and higher input costs Kellogg [K: 44.79, 0.00 (0.00%)] posted solid sales growth YoY. They also increased their EPS guidance for the year, increased their dividend and announced a $500 million share buyback. While international sales growth may not have been as stellar as other companies, their diversified portfolio was able to drive them higher in the quarter.

Costco

Costco [COST: 52.29, 0.00 (0.00%)] is one firm that decided not to raise prices in order to try to gain a competitive advantage against other discount retailers like Wal-Mart [WMT: 56.52, 0.00 (0.00%)] and BJ’s Wholesale [BJ: 34.03, 0.00 (0.00%)]. This clearly hurt Costco as they announced that their earnings would come in well below expectations as they could not keep up with rising costs efficiently because they did not raise prices. They are also more heavily engaged in the gasoline business than either WMT or BJ, which is also hurting their bottom line. It will be interesting to see how increasing prices will affect demand for their products.

Bottom Line

The overall picture here says that price increases are not hurting these companies as demand stays strong, although most cited a tough environment in North America. There was not significant margin deterioration for any of the firms as the price increases helped to offset the rising input costs. I believe it was these companies diversified portfolio of goods and strong international sales growth that drove them this time around and I believe that is what will allow them to perform and beat expectations in the future, as people can not go without their toiletries and basic food elements. With the possibility of a recession looming these Consumer Staples stocks should continue to thrive as other more discretionary firms can expect their profits to fall. I would make a play into these diversified giants as their products mix, strong international exposure and price inelasticity should cause their stocks to be less risky and capture less of the possible downside in the markets.

-Vinay Ayala

Disclosure: The mutual fund that the author is associated with is long KO

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