Investors Could Use Some Make Up

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Beauty is a valuable commodity, and emerging markets will further fuel profits for beauty suppliers. But are companies hitting the key on changing markets? And, most importantly, are they cashing in on those changes? With different success, Avon (NYSE: AVP), Flavors & Fragrances (NYSE: IFF), and Estee Lauder (NYSE: EL) have done it.

Emerging markets are key

Leader in skin care, makeup, fragrance, and hair care, Estèe Lauder focuses on high-end products. The firm has recently been in the press, due to high management replacements and because third quarter results barely missed consensus estimates. However, can slower performance and managerial renewal hurt shareholders who outweigh market preferences?

Right now, attention is set on returning its market performance to previous levels. For the long haul, Estèe has to retain and expand, when possible, its market share. Cash volumes are expected to increase, aided by strong brand recognition, loyalty, and a new pool of customers in emerging markets.

The balance sheet is spotless. During the last decade revenue, net income, and cash flow took on an upward trend. Additionally, debt remained stable while operating margin rose 4 points, reaching the industry average of 14.5%. Last, the company generated a small economic moat through a diverse portfolio, an assertive marketing campaign, and further integration of local preferences to products.

Currently trading at 25.77 times consensus earnings, carrying a 16% premium to industry consensus, its dividend yield stands at 1.61%, making the stock not very attractive. Nevertheless, Estèe has a history of paying dividends, and new customers at emerging markets will pay for future dividends.  It is recommended to buy because prospects are good and the premium is moderate.

Emerging markets demand new products

International Flavors & Fragrances develops and distributes flavors and fragrances for third parties like the company previously analyzed. Principal customers are found in the perfumes, cosmetics, soaps, detergents, flavored products, prepared foods, beverages, dairy foods, and pharmaceuticals, among other segments. Can this business model continue to succeed and pay dividends amid market changes?

In the short run, Int’l has to continue high research and development levels to meet a rising demand for new products destined for emerging markets. This, coupled with some pricing power, moderate competition, and high barriers to entry, granted the firm a small economic moat. Additionally, because the ingredients segment has seen a small retreat during economic harshness, management has tweaked the model in order to improve revenues for the long run.

Financially, Int’l F&F is clean. Revenue, net income, and cash flow have seen steady increments during the last ten years. Meanwhile, operating income oscillated in the high teens, and debt remained stable in the same period. Today, the company almost doubles the industry’s average operating margin, and holds enough cash to feed the pipeline.

Trading at 17 times consensus earnings, a 21% discount to industry consensus, and a price close to its 52-week high, the stock is a bit overpriced. Since the price is expected to drop, while the dividend yield stands at 1.76%, it is recommended to hold until its premium is reduced by at least 15%.

Emerging markets may also sink you

Based in New York, Avon is the second largest beauty producer and manufacturer in the world with products sold in over 140 countries. More recently, the firm has sold one of its jewelry businesses while analyst keep ratings high. However, this analyst is not so sure this company will reap benefits from new markets.

At the moment, Avon has developed a cost reduction policy, a new representative valuation program, and has taken steps to reduce debt levels. Down the road, the firm will have to tweak the business model in order to revert decreasing revenues, improve returns on capital invested and performance at emerging markets, complete costs cuts, and test the new management.

The company is currently at a financial crossroads. During the last five years, revenue has stagnated, while net income and cash flow have decreased. In the same period, operating margin has been reduced sixfold, long term debt has risen worryingly, and revenue per share has begun a downward trend. In all, today the firm is navigating while pulling water out of the ship. The sell of Silpada for seven times less what it paid for originally, is a living proof of growing difficulties.

Avon is trading at 17.9 times consensus earnings, a 19% discount to industry consensus, a 1.92% dividend yield, and a price close to its 52-week high, making the stock not so attractive. The stock is certainly fairly priced, but the discount is a reflection of high risks. It is recommended to hold until the price falls, management is tested, and new policies display some degree of success.

Bottom line

New markets bring opportunities, and they require innovation. While adapting may be an easy task, developing profitable products will require a new market strategy. Avon has failed to develop a successful strategy to profit from emerging markets. Consequently, finances have suffered and market share dropped. Int’l F&F and Estèe have found bigger success on the task, and hold a stronger market position.

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Vanina Egea has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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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