Consumer Stocks: Losing Their Sparkle?

High commodity prices have taken their toll on Procter & Gamble and other makers of household items, dampening their appeal as defensive plays

by Ben Steverman

Companies such as Procter & Gamble (PG) and Colgate-Palmolive (CL) are supposed to be great places for investors to hide out in recessions. Even if the economy slows down, consumers need to eat, wash their clothes, and clean their bathrooms.

But with the notable exception of discount retailers like Wal-Mart (WMT), consumer-staples stocks have let investors down this year. The reason? This year's economic slowdown has been accompanied by massive commodity price increases.

Even as the economy has slowed, energy and raw material costs have skyrocketed at household products companies such as Procter & Gamble and Colgate-Palmolive, as well as big food companies like Kellogg (K) and Kraft (KFT). All four of those consumer icons reported first-quarter earnings on Apr. 30, giving important clues as to how well the consumer-staples sector will perform during this economic slowdown.

Passing the Costs Along

Companies in the sector are indeed seeing higher costs, but they're finding ways to post solid profits anyway. One tried and true method: Make up for the skyrocketing cost of grain, oil, and other materials by boosting prices. At Kraft Foods' U.S. cheese division, dairy costs were about up 30%, for example. "We have been pricing quite aggressively to recover those costs," Chairman and Chief Executive Irene Rosenfeld told analysts Apr. 30.

Procter & Gamble announced more price increases Apr. 30—for example: a 7% increase in hand dishwashing products such as Dawn and an 11% increase in the price of its Oral-B power brush products.

Will U.S. consumers pay more? In many cases, they have no choice. Despite higher price tags, executives at big consumer outfits said they're holding onto market share, as competitors and other private label brands are also being forced to raise prices. Still, most assume there are limits to the price increases consumers will accept, and consumer staples manufacturers have tried to maintain profits in other ways.

A Better Product For a Bigger Price

Industry players have been restructuring and finding other ways to cut costs, says Standard & Poor's equity analyst Loran Braverman, They're also bringing out innovative products. These new products have to be good enough to sell for higher prices, giving companies wider profit margins. "People have to feel they're getting something for [their money]," Braverman says. (S&P, like BusinessWeek is a unit of the McGraw-Hill Companies (MHP).)