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Investment Overview for Avon Products (NYSE:AVP)
WHAT HAS CHANGED
Avon experienced a rough year in 2014. The company's sales declined by 12%, to $8.6 billion, as it faced a weak economic environment and underwent restructuring in its operations. Avon has been on a downhill journey since 2011 (its last profitable year) as its direct selling model is losing market share to retail outlets and online shopping. The main factors that affected the company’s performance in 2014 were:
- Economic downturn adversely impacted sales in Latin America
- Latin America contributes to over 50% of Avon’s annual revenues. Within the Latin American region, Brazil is Avon’s single largest market and Brazil is also the third largest beauty market in the world. Brazil is currently affected by a weak economic environment, higher consumer debt, and a currency devaluation. Growth is slow and the competition is intense.
- However, given its emerging middle class, the importance of beauty products, and the high penetration of direct selling in the company’s core categories, Avon will continue investing in Brazil and expects significant positive growth in the long term. In 2014, the company has forged strategic alliances with KORRES, a Greek skincare brand, and Coty, a French beauty and personal care company, to provide a boost to the Latin American, and specifically to the Brazilian, market.
- Representative base erosion
- Avon’s direct selling model is based on its active representative base. As of 2014, the company had a representative base of 5.96 million, reflecting a 4% year-on-year decline. Avon competes with prominent color cosmetics and skincare companies, who sell through retail outlets, standalone shops, as well as through digital media.
- The dependence on active representatives for most of its sales and the current attrition of representatives is causing a major dent in the company's sales. Over the long term, digital channels such as e-commerce are likely to cannibalize sales from the direct-selling channel for Avon, leading to a reduction in its representative base.
- In North America, Avon’s sales have been hit due to a drop in the representative pool. In 2014, North America experienced 17% constant dollar decline in revenues and an 18% decline in the active representative base. North America contributes over 10% to Avon's net sales.
- Management restructuring
- The company announced corporate restructurings to support its multi-year turnaround plan. The management responsibilities in Latin America have been split into two defined sets of markets which would be overseen by two separate executives.
- There will be changes in the marketing and sales organization, in Avon’s key markets.
- Avon’s Chief Financial Officer, Kimberly Ross, resigned in October 2014. The senior management transition added to the company’s existing set of troubles.
Number of Active Sales Representatives: We currently forecast the number of active sales representatives to decline in the short term. Avon had a total representative count of 6.3 million in 2012. However, strategic lapses in its turnaround strategy, and a reduction and reorganization in its field operations during the latter half of 2013, contributed to a steep fall in representative count and resulted in a 2% fall in the representative base in 2013. Owing to the decline in demand for contractual jobs in America and due to the internal restructurings that disrupted the sales force, Avon's active representative base declined by 4% in 2014 to reach 5.96 million. Assuming that Avon's efforts in creating more sales opportunities for representatives will help attract new representatives, and improve the representative retention rates, we currently forecast the rate of decline in Avon’s active representative base to gradually fall and then grow marginally to reach around 5.5 million by the end of our review period. However, if Avon's strategy to revive its representative base fails and the number continues to decline at the current 4% rate for the rest of our review period, to reach 4.5 million by the end, then there will be a 15% downside in our valuation for Avon.
EBITDA Margin on Beauty Products: The strategic lapses for Avon in the latter half of 2013 and in 2014 also negatively impacted margins. Overall, EBITDA margins declined close to 30 basis points over 2014. We currently forecast the EBITDA margin on beauty product sales to increase by about 20 basis points in 2015 to reach close to 9%. We expect margins to reach close to 15% by the end of our forecast period. There could be over 50% upside to our current Trefis price estimate if the margins were to expand to 20% by the end of our forecast period.
Avon manufactures and markets beauty and non-beauty related products globally and sells these by direct selling through sales representatives. Avon's product categories include:
- Beauty Products consisting of color cosmetics, deodorants, fragrances, skin care, hair care, baby care, as well as bath and shower products.
- Fashion Products consisting of fashion jewelry, watches, apparel, footwear, and accessories.
- Home Products consisting of gifts, decorative products, housewares, entertainment, leisure products, and nutritional products.
Avon is the largest direct seller globally
Unlike most other competitors in the beauty and personal care market (L'Oreal, Procter & Gamble, Unilever, Estee Lauder) that sell their products through third-party retail establishments (drugstores, mass-volume retailers, perfumeries, and department stores), Avon sells its products to the final consumers worldwide through the direct selling channel.
With 6 million direct sales representatives and about $9 billion in annual revenues in fiscal 2014, Avon is the world's largest direct selling organization according to recent rankings by Direct Selling News.
Avon's sales representatives are mostly independent contractors rather than Avon employees. Sales representatives make money by purchasing products directly from Avon at a discount from the published brochure price and then selling them to the final consumers at a higher price.
Avon's direct selling distribution strategy has its pros and cons.
- More competitive prices to the consumers and higher profit margin for Avon: Eliminating middle-men (pharmacies, department stores, etc.) helps Avon avoid the high retailer margins charged by them and the ability to sell products to the consumers at more competitive prices, while earning a higher profit margin. The Average retailer margin for Beauty Care is around 40% of retailer selling prices (the price to final consumer) while the commission paid to Avon's sales representatives is about 25% of the published brochure price.
- Proximity to consumers : Direct selling enables the company to be in closer contact with the final consumer of its products. This helps in better understanding the consumer requirements and provides a quicker response to evolving trends and preferences. As a result, selling & advertising spending is more efficient and has a better return, R&D is more focused, and inventory is better managed.
- Added competition for acquiring sales representatives and associated costs : Before competing for final consumers, Avon has to compete for sales representatives by incurring high advertising expenses for attracting talent and thereafter incurring costs related to training sales representatives about the company, product offering, and direct selling techniques. Ensuring and increasing the earnings potential for sales representatives over time is crucial for attracting and retaining direct sellers.
Highly diversified global business
Only around 14% of sales come from North America while Latin America contributes about 48%. Europe, Middle East, and Africa together amount to 30%, while Asia Pacific contributes the remaining 8%.
- Strong presence in emerging economies : The beauty and personal care industry in emerging economies in Asia, Eastern Europe, and Latin America has a much higher growth rate compared to North America and Western Europe. For instance, China, Thailand, and India have a double digit year-on-year growth rate projections compared to less than 3% for the US over the 2013-2016 period. Avon stands to benefit from a stronger presence in these economies.
- High exposure to foreign exchange rate fluctuations: Over 85% of sales are not in US Dollars. The production is also spread outside the US so even costs are exposed to exchange rate fluctuations. Hence, Avon's earnings (reported in US Dollars) are dependent on macroeconomic events and exchange rates.
Turnaround to take longer than guided
Avon's business suffered from continued losses in 2011 and 2012. The company reported a sharp decline in sales and earnings. The total number of Active Representatives also declined in the major markets during the year. However, the impact of the trend was mitigated by sharp growth in Latin America.
Avon suffered heavy setbacks in its turnaround strategy in 2013. The company's attempt to cut costs by shifting to a new order management system did not bode well with its existing representative base during the pilot launch in Canada in early 2013. Additionally, its headcount reorganization in North America led to severe disruption in its employee-representative relationships. These factors have resulted in a much sharper decline in active representatives during the latter half of the year.
Avon experienced a rough year in 2014, as well. The company’s sales declined by 12%, to $8.6 billion, as it faced a weak economic environment and underwent restructuring in its operations. Avon faced a grim economic environment, especially in the Latin American region (which accounts for over 50% of Avon’s revenues), and North America (which accounts for more than 10% of its revenues). Internally, the company underwent major management restructuring and attrition of its representative base.
The business has also been suffering due to SEC investigations for possible violation of the Foreign Corrupt Practices Act. We expect the extent of the disruption caused from the executional lapses to be more severe than guided and expect Avon's turnaround strategy to take longer than guided.
Avon's Restructuring Initiatives(RVP)
Avon launched a new product positioning theme in May 2015. Avon is trying to upgrade its direct selling model to a more social selling structure, whereby its active representatives can sell through the digital media. Avon is also transforming its business model into a social selling model with the aid of mobile, digital, and social media.
As per its Q1 2015 earnings call, Avon plans on improving its supply chain efficiencies, including contract terminations, as well as global headcount reductions, which may result in annualized pre-tax savings of approximately $50 million to $55 million as part of Avon's $400 million cost savings initiative.
Currently, Avon is reducing its footprint in the Asia-Pacific region, particularly China, where it operates under a beauty boutique model compared to its traditional direct-selling model due to intensifying competition from local and Korean cosmetics manufacturers.
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How do we get the historical numbers for this chart?
Trefis has a team of in-house Analysts who gather historical data from company filings and other verifiable sources. When historicals are available, we explain how we got them at the bottom of the Trefis analysis section below.
Who came up with the Trefis forecast for future years?
The Trefis team of in-house Analysts considers a variety of factors when projecting any forecast. The rationale for our projections is explained in the Trefis analysis section below.
How does my dragging the trendline on the chart impact the stock price?
- We use forecasts for business drivers to calculate forecasted Revenues and Profits for each division of the company.
- We then use forecasted Profits in a Discounted Cash Flow (DCF) model to obtain the Price Estimate for the company.
See more on: DCF Methodology
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