When Avon Comes Calling

 | Aug 13, 2013 | 5:00 PM EDT
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According to a Form-4 filed with the SEC, Avon Products (AVP) Senior Vice President Pablo Munoz purchased 12,000 shares of the beauty and personal products company's stock on Aug. 7 at an average price of $21.94 per share (roughly where the stock is trading as of this writing). Studies generally show a small outperformance effect for stocks bought by insiders, and we attribute this to the fact that unless they are particularly confident in the company, insiders should generally prefer to diversify their wealth. As a result insider purchases can serve as signals that a stock may be worth a closer look.

The $9.5 billion market-cap company's sales slipped slightly in the second quarter vs. a year earlier. Costs were also down, so earnings from continuing operations increased considerably in percentage terms. This was offset in net terms by a loss from discontinued operations -- Avon sold its jewelry business, which has racked up high operating losses -- and as a result reported earnings were lower. Earnings from continuing operations for the second quarter, which are likely the best guide for future results, were $0.19 per share. Annualizing this figure would likely underestimate the company's full-year earnings, as there seems to be a seasonal uptick in business during fiscal fourth quarter.

Operating margins improved in most of Avon's geographic segments. Latin America, which accounts for about half of the company's revenue, and Europe/Middle East/Africa each managed a small amount of revenue growth as well, making those geographies key for any bull dependent on future moderate-to-high earnings growth. North America, however, continues to lag the rest of the company: its operating losses actually increased compared to the prior year period.

Wall Street analysts expect Avon to earn $1.35 per share next year, and so the forward earnings multiple is 16. Over the long term, the sell-side continues to be bullish, expecting high earnings-per-share growth rates over the next several years. It could be positive that the company has dumped its underperforming jewelry business, as it's possible that this will help management better focus on core operations, but analysts seem to be setting a high bar for future results. Of course, the insider purchase suggests that at least one company officer believes that Wall Street's targets are makeable, and adjusted earnings per share numbers have been significantly above final consensus estimates each of the last three quarters.

Revlon (REV) is a comparable personal products company. Following an 80% rise in the stock price over the last year, Revlon's market capitalization has reached $1.3 billion, pricing it at more than 25x trailing earnings. Net income has been up considerably in percentage terms, though this has been entirely due to cost-cutting as well: in the first half of the year, the company's sales were down compared to the same period in 2012. It is also expected to improve its financials over the next year, resulting in a forward price-to-earnings ratio of 14, but as with Avon, we would be wary of buying the stock given the recent trends in revenue. In addition, Revlon has in fact been underperforming analyst expectations in terms of adjusted EPS in recent quarters.

Both companies have been struggling in terms of sales, and with their current valuations already pricing in higher profits in the future, markets seem to either be expecting a turnaround on the top line or continually higher margins. The latter is not a sustainable source of earnings growth, and while it's possible that a stronger global economy could result in better revenue growth rates, it seems speculative to depend on that for a bull thesis. Avon does have the advantage of having abandoned one of its assets as well as this insider purchase, but we would still hesitate to buy the stock.

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