Avon: Still Early, but Worth Getting to Know

 | Dec 13, 2013 | 11:00 AM EST  | Comments
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Avon Products (AVP) has been a stock market laggard during the past several years, down more than 60% since 2008. It is one of a handful of names that has not participated in the post-2008 strong market rally. 

Having said that, the stock has a great brand name, has a well-regarded new CEO and is statistically cheap. So, with that in mind, we did a deep dive on it to see if an investment is warranted. Our conclusion: the stock will ultimately be profitable from current levels, but it will take some time to get there.

Avon faces a number of significant problems and they are likely facing a two to four year turnaround. Therefore we think it's too early to buy (unless you have that kind of time horizon); however, it does warrant being put on a watch list for consideration down the road.

The vast majority of Avon's shortfalls have stemmed from self-inflicted wounds, in particular, from the North American and Asian operations. In these regions sales, profits and representative counts have been declining at double-digit rates due to management mis-execution, product shortfalls, inadequate computer systems and poor sales force management. The North American unit is losing more than $100 million per year while Asia is barely break-even. There are still no signs of business stabilizing in either region.

In addition to poor operating results from these business units, Avon is also facing bribery allegations in China, a development which has kept a lid on the stock price. The company is alleged to have made payments to local officials in order to conduct business. While the fines should be affordable and most expect the investigations to be resolved within the next 12 months, there have been substantial costs to the investigations, not only in terms of fines and restrictions on the emerging China operations, but also to the perception of Avon's valuation.      

Fortunately, the balance (and major share) of Avon's business, in Latin America and Europe, has been doing much better than the rest of the company. Latin American and European operations continue to grow revenue, earnings and rep counts with sales and earnings close to historical highs. Latin America accounts for 50% of revenue while Europe accounts for 25%. Together they account for 100% of company profits. Management has done a good overall job running these operations, and their strength has provided something of a floor for the stock.    

We think that over time, the successful Latin American and European operations should allow Avon to execute a successful turnaround across the rest of the company. The company still has an outstanding global image under the "Avon" brand name. The core company products in cosmetics, skin creams and fragrances are still very attractive in an industry that is large, growing and highly profitable. The large six million person direct sales force is still an effective way to get Avon's products to market. 

For investors with a 12 to 18 month time horizon, one should probably wait for a resolution of the bribery case and more signs of stabilization in the core North American and Asian operations before purchasing the shares. Nevertheless, ultimately, Avon should have the essential characteristics for a successful turnaround: a strong brand image and global scale and distribution.

The stock is reasonably priced at 14.4 times 2014's EPS estimate of $1.17. Once the turnaround is complete, there is more upside to the earnings as margins get back to normal long term averages. Avon should eventually be able to earn $1.50 to $1.60 in EPS per share at normal levels. 

For very patient investors with an exceptionally long term horizon, Avon Products could be of interest here, for most however it is an interesting name to put on a watch list and to start getting to know. We don't believe action is warranted at the current time.

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