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Yesterday's earnings release by Kimberly-Clark (NYSE: KMB ) is a classic illustration of how price elasticity works. Wal-Mart (NYSE: WMT ) figured it out years ago. Lower prices sell more goods, allowing a company to lower prices again -- igniting a virtuous cycle.
But the cycle also works in reverse, as Kimberly-Clark has discovered. A few months ago, the company reported that it was going back to the pricing well to cover higher commodity costs. The strategy had been working well through the second quarter -- consolidated prices had risen 2%, with case volume running up 3%.
For the third quarter, management may have taken it a bit too far. Consolidated prices were 4% higher, but case volume ran down 1%. What's worse, the consumer tissue segment saw case volume decline 7% during the third quarter. Even toilet tissue obeys the basic laws of economics.
This price elasticity game is nothing new to consumer products companies. With the steep rise in commodity prices over the past year, everyone from Kraft Foods (NYSE: KFT ) to General Mills (NYSE: GIS ) to Unilever plc (NYSE: UL ) is exercising as much pricing power as they think their brands will bear.
Kimberly-Clark -- whose brands include Kleenex, Huggies, and Kotex -- still managed to make its numbers for the third quarter, though. Per-share earnings of $1.02 before unusual items were 5% below last year, but a penny better than the consensus analyst estimate. The rub is that management lowered fourth-quarter earnings guidance, which promptly clobbered the stock.
I've been preaching for more than a year that the consumer products companies are a (relatively) safe investment during tough markets. The logic of owning this group remains sound, but I believe there's room for picking among defensive plays. With best-in-breed choices like Procter & Gamble (NYSE: PG ) and Colgate-Palmolive (NYSE: CL ) also trading close to 12-month lows, I'd be cautious about Kimberly-Clark until it gets its pricing algorithms more finely tuned.