Estee Lauder Surprised, Let’s Look at Avon

Avon (NYSE:AVP) shares have taken a beating in the past few months with its stock falling almost 20% since October 2010. What differentiates Avon from other beauty and personal care players such as Procter & Gamble (NYSE:PG), Unilever (NYSE:UL), Estee Lauder (NYSE:EL) and L’Oreal (PINK:LRLCY) is that it sells its products worldwide directly through sales representatives and not through third-party retail establishments such as department stores, pharmacies, mass-volume retailers etc. With 6.2 million direct sales representatives and more than $10 billion in annual revenues, Avon is the world’s largest direct selling organization.

We see value in that footprint despite the cautious tone of sell side analysts, and we continue to be optimistic with regards to Avon’s outlook with our $36.60 Trefis price estimate of its stock, which is around 27% higher than the current market price.

But why has the market been pessimistic?

The slow pace of economic recovery in the U.S. limits Avon’s sales growth potential in Avon’s oldest and largest market, which contributes 18% to its net sales. Its full year guidance last surprised the market in below analysts’ estimates and led to sharp drop.

However, Avon has a well-diversified business with over 70% of its revenues coming from outside U.S. Latin America, which is twice as large as North America in terms of revenues has grown in excess of 70% over the last 5 years. Avon is well-positioned to benefit from the double-digit growth in emerging economies in Asia, mainly China and India, compared to the U.S. and Western Europe which have been struggling to breach the 4% levels.

China, the engine of growth in the near future

Our optimism with regards to Avon’s outlook is further fueled by China’s unrealized potential. China had banned direct selling in 1999 and only recently, in 2006, allowed Avon to pursue its business via direct selling. With the result, China presents a huge untapped consumer base and sales force. This combined with the rising affluence of the Chinese consumers, preference for luxury cosmetics and consumer products and higher Asian males’ consumption of skin care products presents Avon with an excellent growth opportunity (China, The Next Engine of Growth for Estee Lauder).

Overhaul in operations to present additional upside

Avon’s CEO has embarked on plans to save $1.1 billion by 2014 by realizing efficiencies in operations, which include cutting out layers in management, reducing production costs, simplifying product lines and recruiting more sales representatives. ^[1] We currently estimate Avon’s EBITDA margins to improve from under 12% to almost 14% by 2014. But if the cost-cutting initiatives are realized, we expect the EBITDA margins to improve by additional 1.2% over our current estimates leading to a 13% potential upside to our current $36.6 Trefis price estimate of Avon’s stock.

You can drag the graph below to see the impact of Avon’s stock price.

You can see a detailed analysis of our $36.6 Trefis price estimate of Avon’s stock here.

1. Avon Sees Beauty In Emerging Markets, Barron’s, Jan 26., 2011 [↩]