Diaper Run.

Drypers has battled price wars, fires and devaluations to soak up a significant stake in Latin America's disposable-diaper market.

Over the last year, latin america has been doing to Drypers Corp. what babies do to their diapers.

First, a bitter price war that broke out in Mexico early last year gutted its sales. Then, last August, a fire broke out in its Buenos Aires manufacturing facility, wiping out all of its raw materials, most of its finished product and two of its four production lines. Finally, last January, when Brazil devalued the real, sales of its premium product got hammered and its exports from Argentina suddenly became expensive. "Everything that could have gone wrong, did go wrong," says Walter "Wally" Klemp, chairman of Houston-based Drypers.

But Drypers is hanging tough in an effort to soak up a bigger share of Latin America's fast-growing disposable-diaper market. Unlike the United States, where disposable diapers are used by 91% of the population, only 25% of Latin Americans use the throwaway version, preferring cheaper cloth diapers. Indeed, the entire Latin American disposable-diaper market amounts to only $2.5 billion, about half the size of the U.S. market and one-eighth the size of the worldwide market. But that's changing fast: Sales in Latin America are growing at an 8% clip, versus 0.5% in the United States.

Drypers is already well on its way to pinning up the market. Since entering the region five years ago, it's become the largest producer of private-label disposable diapers in Latin America, supplying store brands to such large chains as the U.S.-based Wal-Mart, France's Carrefour and Brazil's Pao de Acucar. Drypers is the third-largest diaper maker in Argentina and Brazil after U.S. giants Procter & Gamble (P&G) and Kimberly-Clark Corp. (KC) with a 12% to 15% market share. It is also the fifth-largest in Mexico. The company is now planning to add Colombia to the mix. About a quarter of its $332.6 million in sales last year came from Latin America.

Ironically, analysts say the publicly traded company is further along in Latin America than it is in the U.S., where it's a distant third after P&G and KC because of difficulty getting space on the shelves of such mass merchandisers as WalMart, Kmart and Target. "To Drypers' credit, they have substantial shares of all [the Latin American] markets, and certainly that's where the growth opportunities are:' says John Rogers, who follows the company for brokerage firm DA Davidson in Portland, Oregon.

How has Drypers not come undone with all its obstacles in Latin America? By sticking to the company's main principle as if it were gospel: to build brand not just with lower prices, but with innovative products. Over the years, Drypers has offered everything from diapers with baking soda to keep babies dry to aloe vera to help prevent diaper rash to germ guards to protect bottoms from bacteria.

"We certainly started out by having to compete on price," says Klemp, who founded the company with two former P&G executives in 1988. "But about four years ago, we realized we're better off competing on ideas, in providing value to consumers through features that they can't get anywhere else."

Mexico's crazy prices. In Mexico, that meant not cutting prices early last year despite a fierce price war that began between P&G and Puebla-based diaper maker Grupo Mabe. Later on, KC joined the fray. By the end, the three manufacturers slashed their prices by almost 40%. "That got crazy enough that we thought the right thing to do was to stand down and wait for it to subside," Klemp says. "And it did by the second half of 1998."

Instead of joining the fray, Drypers concentrated on fixing operational problems. It had entered Mexico in 1996 with its acquisition of Guadalajara diaper maker Pannolini de Mexico from the debt-strapped Castello family for $3.3 million in stock, cash and notes. It has since replaced the company's small, leased plant and old equipment with a new 100,000-square-foot facility and state-of-the-art technology. More recently, it brought in new operational managers across the board. As a result, its Mexico division reported record sales in the first quarter, versus sales declines in 1998.

It's been harder to recover from the fire at its Argentine plant. Drypers entered Argentina in 1994 by acquiring Seler, the number-five company in the market. It was able to build it up to the third-best-selling diaper maker in Argentina after P&G and KC, and was on track to have 25% growth in 1998.

Then came the blaze. While the cause is still undetermined, investigators believe a lighting fixture in its finishing warehouse fell to the ground and exploded, touching off the fire. Drypers figures it lost more than $20 million in raw materials, finished product and equipment. Luckily, no one was injured and all of its production equipment and materials were covered by a local insurer.

Still, Drypers had to scramble to import diapers from its other plants in Puerto Rico, Mexico, Washington state and Ohio to keep up with demand. But it was futile: Klemp figures the company lost about three months of production sales, worth between $6 million and $7 million, which it can never recoup. "When the dust settled, we just barely outgrew [the] last year's sales," Klemp says.

The good news is that Drypers was able to buy all new equipment and move to a bigger, more suitable facility. "We lost a lot of momentum," Klemp says. "But we're well on our way to regain that."

The Brazilian devaluation also took some of the wind out of its sails. Drypers entered the country in 1997 by buying 51% of the number-four brand, Puppets, from Chansommes do Brash for $12 million in cash and stock. It quickly turned it into a solid number-three after P&G and KC and later acquired the remaining 49% of the company for $5.3 million.

Then came a major plug: In April 1998, Drypers signed a licensing agreement with Xuxa (pronounced "Shoo-sha"), the blonde star of such popular TV programs as "El Show de Xuxa" and "Xuxa Park" who had become something of a Madonna to the Brazilian youth set. The two agreed to market a new line of disposable diapers called "Xuxa by Drypers" that carried her likeness. (It helped that Xuxa was expecting her first child.)

The new brand flew off the shelves. By mid-year, Drypers had sold its entire Latin American capacity for the year.

Protecting its bottom line. Then came the devaluation in January. Drypers saw sales of its premium diapers fall significantly. But at the same time, sales volume of its discount products rose. Obviously, consumers had become more price sensitive. But producers in Argentina were also supplying 10% of the Brazilian disposable-diaper market. When that suddenly became expensive and unprofitable, imports disappeared, creating more of a demand for diapers produced in Brazil- including those made by Drypers. "We're pretty close to plan in terms of unit volume," Klemp says. "But translated into dollars, sales volume is down."

Klemp is less certain about the future. The company put out a press release in mid-February about the possibility that dollar sales and earnings will be lower this year because of the devaluation. "We're okay increasing sales so long as profitability holds," he says. "But we're not going to grow sales at the expense of the bottom line."

U.S. ratings agency Standard & Poor's was sufficiently spooked. In late February it revised its outlook for Drypers from positive to negative, mostly due to significantly weaker-than-expected operating results in 1998.

Despite the thumbs-down from S&P, Drypers is moving ahead. After delaying the launch of the Xuxa brand in Argentina--where she is also popular--because of the fire, it plans to go ahead with it this year. It also aims to export to more of the Central American and Caribbean market from its plant in Puerto Rico, where it is the number-two player after P&G, but ahead of KC's Huggies. And in Colombia, after a year of importing product from Mexico and selling it out of a distribution facility in Bogota, Drypers plans to start making diapers in a new production facility in Cali this summer in a joint venture with Conticauca.

Does Klemp have any regrets about moving into Latin America? Not at all. "Without a doubt, over the long term, the big growth is going to come from [these] markets," he says. That is, of course, unless disaster strikes again.