Avoid Avon, Buy These Consumer Stocks Instead
David is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
It all started with that infamous question from David Einhorn at Herbalife's (NYSE: HLF) quarterly meeting of shareholders. Einhorn questioned how much revenue was coming from within the distribution network versus outside the distribution network - a litmus test for whether or not your company is running a Ponzi scheme. The stock subsequently fell off a cliff and went from $73 to a low of $42.15. Although value has started to rightfully recover, the firm is still well below its 52-week high. As the economy picks back up, I recommend investors become increasingly aggressive about buying consumer good businesses in the wellness & beauty and toy categories while avoiding Avon Products (NYSE: AVP).
In particular, I find Herbalife and Mattel (NASDAQ: MAT) undervalued while Avon looks overvalued. In regard to Herbalife, the direct seller has consistently beaten expectations in all of the last 5 quarters and by the double-digits each time. Although some may claim it is running a Ponzi scheme, the evidence points negatively towards that assertion. Operating under 79 countries under a diversity of regulatory procedures, Herbalife knows what is and isn't a pyramid scheme. That the company has distributors to sell one another is besides the point; at the end of the day, there are end consumers. In fact, MLM marketing is not allowed in China and the producer has grown terrifically in that region. Regulators are keenly aware of what distinguishes a MLM marketer from a pyramid scheme operator - where it's legal, Herbalife decidedly takes the former.
While inventory growth has been significant at 71%, this is not an issue given the high double-digit sales growth. In the nutritional supplement market, the firm has seen high single-digit global growth. Rising interest in anti-obesity methods through the approval of Belviq will drive unusually high cash flow in this category as the economy moves towards full employment. China will be a major catalyst due to the limited but growing exposure. The firm has an online segment that makes up an insignificant but growing share of revenue.
Other health and wellness firms, like Nu Skin and Pazoo, are flourishing in online retail. Pazoo has seen record Internet traffic and was able to leverage this growth to secure tens of thousands of TV spots and a distribution agreement with the largest pet store in New England. Deals like this have generated significant returns for shareholders and will probably do the same for Herbalife. As the firm continues to penetrate global markets, Herbalife needs to push its online category as a way to increase margins and drive back business to the legacy direct selling segment. Personally, I never heard of Herbalife until I began doing investment research. Greater visibility through TV spots and an online presence would thus go a long way in increasing my trust in the firm.
Mattel has similarly shown strong execution in this regard. Everyone knows what the toy maker does: produce Barbie - the most famous doll in the world. Given that it offers a stellar dividend yield of 3.5%, the firm is a very compelling "buy" at a respective 15.9x and 13x past and forward earnings. Analysts forecast the company to grow by 8.4% annually in terms of earnings over the next 5 years. I think this is a fairly low estimate given that 7.3% was achieved during the past 5 - a much tougher time period economically.
Assuming analysts are accurate, Mattel would be worth $55.20 at a 16x multiple. Discounting backwards by 8% yields a present value of $37.57. So, not only does the company have attractive growth potential with an increasingly large dividend distribution, but it i s also already undervalued. Debt to equity is quite low and margins are on the upswing.
A much riskier business is Avon, another direct seller. The company is in "turnaround mode" - only it isn't really working. Since rejecting the buyout bid from Coty for $10.7 billion, shareholder value has since fallen to $6.9 billion. Free cash flow has meanwhile fallen from $432 million in 2Q08 (ttm) around the recession to $376 million in 2Q12. Despite poor results, the company manages to trade at 28x past earnings - a significant premium to the already-high historical 5-year average of 21.2x. Although the company has attractive prospects in Brazil, even low double-digit growth would not justify the current valuation.
Sure, the stock offers a 5.8% dividend yield, but earnings are expected to be flat over the next 5. This will put payouts under pressure and could threaten the company's one compelling point: its shareholder-friendly capital allocation policy. In time, I see the company as a potential target for an activist investor that will be willing to attack struggling operations and reverse the trajectory. Until then, I recommend avoiding the stock and buying the other stocks mentioned herein.