Stressed Out: Is Avon Using Vanishing Cream on Its Cash?

 | Jan 26, 2016 | 9:30 AM EST
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This article is part of a Real Money series on 20 companies investors should consider adding to their distressed watch list.

Avon Products (AVP) needs to stop burning cash, and it needs to stop soon.

The company booked a net loss of $669 million over the 12 months ended in September, its most recent reporting period, and before that a $559 million loss in 2014.

For a fragrances and cosmetics maker that carries more than $2.3 billion in debt, the disappearance of more than 29% of cash from its balance sheet over the last four reported quarters is really not a good look.

Shareholders seem to have the right idea, and most have already exited their positions, deflating Avon's market cap by 74% over the period. Just this year, shares have fallen by more than 37%.

Its debt holders are not far behind. Just look at how quickly they are turning in Avon notes in the hope they never have to see the day of debt restructuring or bankruptcy. The tranche of Avon's senior unsecured notes that pay a hefty 6.5% annual interest rate have lost 22% of their value in secondary markets over the past 12 months, according toBloomberg pricing data, and are rated B+ by Moody's, four notches below investment grade.

The Deal: Cerberus to take stake in Avon, buy North American operations for $600M

Avon's solution to save costs has been to suspend its dividend and use a $435 million capital infusion from Cerberus Capital Management, which bought roughly 80% of the company's North American business in December. (They may be thinking twice as shares have been in free-fall this month.)

"The $435 million investment from Cerberus Capital in Avon Products combined with the transfer of the $230 million of long-term liabilities to Avon North America will strengthen our balance sheet and allow for strategic investment; $100 million of the proceeds will be used to partially offset the transferred liabilities and approximately $250 million may be used to opportunistically reduce debt," CFO James Scully said at a December investment conference.

Avon's other major strategy has been to slash inventory in order to cut costs and model itself off competitors like Amazon (AMZN) to build customer loyalty. Inventories of $847 million in the third quarter were down 15%, year over year, outpacing a 12% decline in debt.

"We solved the paradox of how to reward the long-term loyalty while we manage the cost,"  Angela Cretu, Avon's vice president of Turkish operations, at Thursday's investor day conference.

Forming alliances with established e-commerce sites is one way of allowing Avon to pivot away from storing so much of its own inventory, which has proven to be one of its most costly expenses, Cretu said.

In Turkey last quarter, revenue declined 23%, which was unfavorably affected by foreign exchange. (In fact, Avon accounts for 22% of its $690 million loss last quarter to unfavorable currency adjustments.)

While Cerberus's investment will allow Avon to dodge nearly half of its $500 million in looming debt maturities, the jury is out on whether it will be able to take care of the remainder of its debt in the 2018 and 2019, as Scully has predicted.

"You have a big debt position, you owe a lot of money and you have been burning cash," Jim Cramer told CEO Sheri McCoy on CNBC's "Mad Money" Friday. "Will you be able to change that? Because the stock is at $2 in part because it's got credit issues."

McCoy responded that the $435 million that will be recieved from Cerberus to the parent company will allow them to reinvest in the company and pay down debt. She also said that, barring foreign exchange adjustments, Avon would have posted 3% growth in its international business, a possible sign the company's getting on the right track.

However, many of the countries where Avon is attempting to take off are facing credit and growth risks of their own.

"You're making a major push and spotlight on Brazil, spotlight on Turkey and Latin America," Cramer said in the interview. "These are tough places to do business."

There certainly will be short-term challenges in the regions Avon has targeted, but untapped demand in rich places such as the Brazilian beauty market could offset currency and credit risks, McCoy said. "We're in it for the long term," she added.

The bottom line is that slashing Avon's dividend and inventories and paying down debt may be a start, but the company cannot just put cover-up on this kind of sustained cash burn. Its future will hinge on whether it can start turning a profit in 2016, and investors will get an early peak at its chances in its early February earnings report.

For more on Real Money's 20 distressed companies to watch:

Stressed Out: Introducing Real Money's Distressed Index

Stressed Out: 5 Steelmakers to Put on Your Distressed Watch List

Stressed Out: Sprint Is Collapsing Under the Weight of Its High-Yield Debt

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