Avon Might Reach $25 In Two Years

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In a previous article, I talked about PNC Financial Services, a financial services firm that Brian Rogers, chairman and chief investment officer of T. Rowe Price, recommended at the 2013 Barron’s Roundtable. In this article, I will focus on another stock that he liked: Avon Products (NYSE: AVP), the direct selling company with beauty and fashion-related products.

2012 Losses With High Amount of Debt

Avon, incorporated in 1916, is a global manufacturing and direct selling company in 65 countries and territories with three main product categories: Beauty (cosmetics, fragrances, skin care), Fashion (watches, jewelry, accessories) and Home (decorative products, housewares). The majority of Avon’s revenue, $7.64 billion, or 71.4% of the total revenue, was generated from the Beauty category. The Fashion category ranked second with $1.89 billion in revenue in 2012, while the Home category generated more than $1 billion in 2012 revenue. In terms of geography sales, Avon seemed to be quite strong in Latin America, with nearly $5 billion in 2012 sales. Europe, Middle East & Africa ranked second with $2.9 billion in sales.

In the full year 2012, the total revenue decreased by 5% to $10.7 billion. The operating profit experienced a significant decrease of 63% to $315 million. However, Avon generated losses of $42.5 million, or a loss of $0.10 per share. At first glance, investors might be scared of Avon’s high level of debt compared to its equity. As of December 2012, Avon had $1.23 billion in total stockholders’ equity, $1.2 billion in cash, and nearly $3.2 billion in short and long-term debt. However, the low equity base was due to the fact that Avon has bought back a significant amount of its own shares over time. The treasury stock has reached $4.57 billion in December 2012.

$25 Per Share in the Next Two Years

Five years ago, Avon traded at around $40-$50 per share. At this time of writing, the company is trading at nearly $20.50 per share. At the beginning of 2012, Coty, a French beauty products maker, offered to acquire Avon at around $23.25 per share. Several months later, Coty made a second offer of $24.75 per share, valuing Avon at $10.7 billion. What makes Coty interested in Avon was Avon’s distribution abilities and good product R&D. However, as there was no response from Avon, Coty withdrew its bid. Brian Rogers thought that in a friendly transaction, Avon could have gotten a $25 - $26 per share offer. He was betting on Avon’s new CEO, Sheri McCoy, who had been working for Johnson & Johnson for 30 years. McCoy has already launched a big cost-cutting program to get the profit margin back to historical levels. Thus, it might earn $1.50 - $1.75 per share in the period of 2-4 years. If a consumer-products multiple was applied to Avon, Rogers thought Avon’s share price might reach $25 in two years.

Peer Comparison

According to Rogers, Avon’s current problems in several markets were fixable. Tupperware Brands (NYSE: TUP) also had some problems several years ago, but a new management team came in and fixed those problems. After that, the market recognized the business improvements and drove its share price up. At the current price of $77.50 per share, Tupperware is worth $4.3 billion on the market. It is valued at 21.5 times trailing earnings and 10.7x EV/EBITDA. Avon is valued a bit more expensive at nearly 11.8x EV/EBITDA.  As Avon had a negative net income in 2012, the P/E ratio is not valid.

Revlon (NYSE: REV) is the smallest company among the three. It is trading at $21.23 per share, with a total market cap of $1.1 billion. It also seems to have the cheapest valuation, at 9.2x EV/EBITDA. Among the three, Avon had the lowest operating margin at 6%, while the operating margins of Tupperware and Revlon were both 15%. Revlon has not been paying investors any dividends, whereas Avon is paying the highest dividend yield at 3.7%. Tupperware is paying a 1.9% dividend yield to its shareholders.     

Foolish Bottom Line

Avon seems to be an opportunistic stock for long-term investors. By buying Avon, investors are betting on new management's ability to bring the business back to its historical high profitability.  

hoangquocanh has no position in any stocks mentioned. The Motley Fool owns shares of Tupperware Brands. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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