Avon's Makeover Could Produce Lovely Results
Beauty may be in the eye of the beholder, but try telling that to shareholders of Avon Products.
Two years into a turnaround under new CEO Sheri McCoy, the beauty-products company remains an ugly duckling in most investors' eyes. It stock sits 25% lower than in May 2012, when fragrance maker Coty (ticker: COTY) withdrew a $24.75-a-share buyout offer.
While patience has worn thin on Wall Street, the shares (AVP) look compelling at a recent $13.87—about the same price they fetched in the late 1990s.
So far, tangible signs of progress have been elusive, but McCoy, previously a star at Johnson & Johnson (JNJ), and her new management team have been laying groundwork that could ultimately right 128-year-old Avon. They've already notched a few notable achievements, including refinancing the balance sheet, improving cash flow, and reaching a settlement this month with the Department of Justice over a costly six-year probe into whether the company bribed Chinese officials.
To stabilize the business and then rekindle growth, McCoy is trying to reinvigorate recruiting for Avon reps, introduce new products, slash costs, and exit unprofitable markets. She has targeted double-digit operating margins by 2016, well above last year's 7.9%. Margins peaked at 16% in 2004.
IF SHE'S SUCCESSFUL, earnings could jump to $1.50 a share or more, from the 84 cents expected this year, sending the shares back into the low $20s in the next few years. With more than three-quarters of Avon's revenue tied to emerging markets, and to growing demand for beauty products, the potential is there. Direct-selling can be a high-return enterprise.
Mark Astrachan, an analyst at Stifel Nicolaus, is among the minority on the Street with a bullish view of Avon. He believes that the margin goal is attainable, but thinks the timetable could be drawn out. "The turnaround has taken longer than we had thought," he says.
This year, he estimates, earnings will fall 20%, to 82 cents a share, on 9% lower revenue of $9 billion, before improving next year to 96 cents a share, on flat revenue, as management's initiatives take hold. Profitability has slipped steeply since 2008, when the company earned $2.13 a share.
Critics say Avon's problems have roots in mismanagement under prior chief Andrea Jung, who led the company for 13 years. A lack of product innovation, bloated costs, the bribery probe, and other self-inflicted wounds have all weighed on the business. Avon's army of representatives, the lifeblood of its direct-sales business, has been declining for the last three years—the company now has about 6.4 million reps.
Founded by David McConnell, a traveling book salesman who saw opportunity in selling perfume door-to-door, Avon is the world's largest direct seller of beauty products, operating in 62 countries. Representatives, who generate the majority of sales, buy products from the company at a discount, and sell them to their customers, who order from sales brochures. Reps are recruited and trained by a company-hired district manager or leader.
Avon sells perfumes, makeup, skin-care products, and others under the Avon brand, as well as under the names Anew, Skin So Soft, and Christian Lacroix. Its wares include jewelry, watches, footwear, and decorative home products. Latin America is the beauty-product merchant's largest market, accounting for nearly 50% of sales. Europe, the Middle East, and Africa are also big contributors, with 29%. North America and Asia account for the remainder.
A KEY PART OF THE turnaround hinges on fixing the business in North America, where sales declined 24% last year and where Avon had a $48 million operating loss. The region accounts for 15% of revenue, but has been faltering since 2008, as its pool of reps has shrunk at an alarming rate. The losses, in large part, stem from organizational missteps made during the Jung regime, which have hampered recruiting. Competition from rival direct-sellers hasn't helped, either.
McCoy has made returning the region to profitability by 2015 a top priority. Last year, she named Pablo Munoz, a former top executive at Tupperware Brands (TUP), head of the North America division, to improve sales-force recruiting and retention. The company has rolled out a new recruitment kit, and focused recruitment efforts on districts with high potential. Updating its sales brochures and improving pricing could also perk up morale, by helping reps earn more. Avon is also launching new products and acquiring additional brands, which could drum up excitement in its sales force.
At the same time, the company is targeting $400 million in savings by 2016, helped by head-count reductions and exits from unprofitable markets. Already, it has abandoned South Korea, Vietnam, and Ireland.
Another goal is to improve working-capital management, to boost free cash flow. Resolving the bribery probe will certainly help. Avon had spent about $340 million on its internal investigation of the allegations. As part of the accord, Avon agreed to pay $135 million to the Justice Department and the Securities and Exchange Commission, and accepted a deferred prosecution agreement.
In the March quarter, sales declined 11% from the year-earlier level, hurt by weak economic conditions in Russia and unfavorable currency-exchange rates. In constant dollars, sales slid 3%. The number of active representatives fell 4%, driven by an 18% drop in the ranks in North America.
In North America sales declined 21% in constant dollars, but there were pockets of strength. In Brazil, Avon's largest market with 20% of revenue, sales rose 5%.
McCoy, who couldn't be reached for comment on this article, has guided for margin and sales growth to resume in the second half of the year, on a constant-dollar basis. She is targeting mid-single-digit sales growth by 2016.
Stifel's Astrachan suggests in a report that if the North American turnaround "shows little or no progress, management should begin exploring strategic alternatives for the business." He argues that selling or closing the regional business eventually would result in overall sales growth and higher margins (measured by earnings before interest, taxes, depreciation, and amortization), and he estimates that it could unlock $3 to $4 of value per share.
It's worth noting that after the 10% stock drop, following the May 1 earnings report, more than a few insiders picked up shares. Five directors and three senior vice presidents spent about $1 million on Avon shares in the mid-13s. If nothing else, that's a vote of confidence in McCoy's leadership. Patient investors should consider taking their cue.