This Company is Still in Hot Water
Palwasha is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
When I first started watching Avon Products (NYSE: AVP) four months ago, the stock was trading between $14-$15. I made a bearish call on it, assuming that there would be no change in the company's management, business style, or influence of external factors. But the four months that followed brought some good news for the company and some bad that apparently got outweighed.
Avon's former CEO Andrea Jung's 13 year long reign, under which the company missed analysts' forecasts quarter after quarter, is finally coming to an end. The poor corporate governance structure at the company, where Jung held both the designations of Chairman and CEO, is going to change. Not only is Jung exiting the CEO-ship of the company, but also the Chairmanship.
That brings in two fresh faces to Avon--CEO Sherilyn McCoy, with a strong R&D and management experience at Johnson & Johnson, and Non-Executive Chairman Fred Hassan, with a wide experience in the Pharma industry. The news has made way for the stock to recover some of its lost glory. The change in management may be a breath of fresh air for the shareholders, but it's sensible not to let our hopes fly high without putting everything into perspective.
Avon's revenue model is based on direct selling to customers, eliminating the need for a middleman (a.k.a. retailer/wholesaler). Former CEO Andrea Jung, a marketing expert, was able to keep the company going under that model. However,Sherry McCoy doesn't have the experience of door-to-door selling. We don't yet know whether the management would consider a change in its business model.
Also, speculations are making rounds on the market that the new Chairman, Fred Hassan, known for taking potential acquirers to table and bringing a good value for shareholders out of successful acquisition deals, will be able to do something similar for Avon's shareholders. That is probably why the stock jumped to cross the $17 mark for the first time in months. However, bear in mind that Avon refused Coty's lucrative takeover offer earlier this year and the board may not be in favor of taking any more such offers in the near future--assuming there comes another good offer (which I don't see happening anytime soon).
In addition to the hiked uncertainty regarding its new management's future course of action, Avon's lackluster fundamentals are another negative aspect the company has to deal with. Upon comparing its fundamentals to that of the industry peers, Revlon (NYSE: REV), Estee Lauder (NYSE: EL) and Proctor & Gamble (NYSE: PG), the troubles at Avon become even more evident.
It has the highest debt/equity, lowest profit margins, and cash on hand of $1.28B is less than P&G's $4.44B and Estee Lauder's $1.35B. Avon's current ratio is above 1, which is good but not the best amongst peers, and free cash flows of only $32 million, compared to Estee Lauder's $108 million and P&G's whopping $5.2 billion. Below is its EPS growth trend for the last six quarters. While all the four competitors initially had their EPS growth declining, all except Avon saw a recovery in the last two quarters. Avon is the only company amongst these peers that currently has a negative earnings growth.
Despite the weak fundamentals, it is interesting that the cosmetics company boasts the highest dividend yield (5.3%) amongst its competitors (although dividends in absolute terms are amongst the lowest, currently at $0.23 per share). Dividends account for almost half of Avon's total returns compounded for the last two decades, thus making it an income stock. But the deteriorating fundamentals raise questions in a potential investor's mind whether the company will be able to continue stepping up dividends or, at least, maintain the current stream.
Only two quarters ago, the company incurred over $260 million of goodwill impairment charges that caused it to report a net loss, and later the stock price tanked from the twenties to the teens. Apparently, the company is starting to pick up a little pace and has shown increasing net income in the two post-loss quarters, but it still is the riskiest investment amongst the competitors mentioned. Avon's systematic risk (beta) of 1.78 is way above the average market risk of 1 and also above that of its competitors--Estee Lauder's is 1.24, Revlon's is 1.08 and P&G has an attractive below average market risk of 0.71.
At present, Avon generates over 60% of its revenues from emerging markets. Macroeconomically speaking, economic slowdown in China, rising inflation in India, and the debt crisis in the Eurozone are some of the biggest hurdles in its revenue growth. Avon has seen a decline in its Active Representatives around the globe who bring in revenues for the company through direct selling. The only emerging market that has seen a rise in Active Reps (1% increase) is Latin America, which accounts for about half of Avon's total revenues.
In a nutsell
Until the new management decides on its future plan of action, the company improves its business model and thus its fundamentals, and works on its branding to reach or beat that of Estee Lauder and Garnier (by Loreal) and the like, the stock is a weak hold for me.
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