May Begins With Margin Expansion

This was written by CNBC producer, Robert Hum

Consumer goods maker Clorox reported stronger-than expected Q3 resultson a notable improvement in margins.

During the quarter, gross margins soared 5.5 percentage points, with the rise due to a combination of “moderating commodity costs, significant cost savings and price increases.” In fact, this was the first year-over-year margin expansion for Clorox in nearly 2 years.

Additionally, Clorox expects improvements in margins to continue for the rest of the year and into its next fiscal year.

This has to be encouraging news for consumer goods companies in general:

1) Raw materials costs are leveling off.

While consumer companies were plagued by soaring commodity costs in 2007 & 2008, many have recently started to realize the notable benefits of falling commodity prices. Costs for these companies may continue to fall in the coming quarters too. For Clorox, in fiscal year 2010, it expects to save $90 million to $110 million thanks to lower commodity & energy costs.

2) Prices increases continue to be sustainable.

To combat their steep cost increases in past years, consumer goods companies implemented significant price increases on its products. Although commodity prices have fallen now, consumer companies are still benefiting from these more favorable pricing initiatives. In fact, many (including Clorox) continue to plan for selective price increases in the near future.

How important have these price increases been to these consumer goods makers? Aside from offsetting their higher commodity costs, raising prices has been an effective tactic to overcome weaker demand.

Just as its peers Procter & Gambleand Colgate-Palmoliverevealed in their quarterly reports yesterday, Clorox discussed how price increases boosted its results. For example, in its North American division last quarter, volume fell 4 percent, but overall sales were flat “primarily due to the benefit of price increases.”

Margin Squeeze

While higher prices have helped companies like P&G, Colgate, and Clorox, they can potentially be detrimental to their customers, such as supermarket chain Safeway. In fact, in its earnings report yesterday, Safeway noted a nearly 1 percentage point decline in its gross margin.

The primary cause of this decline - “investments in everyday prices, as well as an elevated level of promotional spending.” Translation: the company simply couldn’t pass some its higher costs along to its customers.

While its suppliers (the likes of the aforementioned consumer goods makers) were likely charging Safeway more for its products, the supermarket company discovered that it had to maintain lower prices to attract greater sales traffic. To do this, Safeway had to hold its lower prices steady and/or increase sales on selective products – even when their costs continued to rise. OUCH!

The end result for Safeway: a substantial earnings miss and a 25 percent decline in profits.




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