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Investment Overview for Avon Products (NYSE:AVP)
Number of Active Sales Representatives: We currently forecast the number of active sales representative 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 rep count and resulted in a 2% fall in representative base in 2013. We expect Avon's representative count to reach about 6.16 million in 2014 and before seeing an upside to cross 6.45 million by 2020. There could be a 12% downside to our current Trefis price estimate if the sales force were to continue to decline to reach 5.5 million by 2020.
EBITDA Margin on Beauty Products: The strategic lapses for Avon in the latter half of 2013 also negatively impacted margins. Overall, EBITDA margins declined close to 40 basis points over 2012. We currently forecast the EBITDA margin on beauty product sales to increase by about 30 basis points in 2014 to reach 9.3%. We expect margins to reach close to 14.4% towards the end of the year as Avon struggles with severe executional challenges in its turnaround strategy. There could be a 35% upside to our current Trefis price estimate if the margins were to expand to 20% by 2020 instead.
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 jewelery, 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 6.2 million direct sales representatives and about $10 billion in annual revenues in fiscal 2013, 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 15% of sales come from North America while Latin America contributes about 49%. Europe, Middle East and Africa together amount to 29% 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, 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 relatiohships. These factors have resulted in a much sharper decline in active representatives during the latter half of the year.
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 severe than guided and expect Avon's turnaround strategy to take longer than guided.
Increased investments in advertising and representative value proposition (RVP)
Avon has significantly increased its advertising spending over the last four years leading up to 2011 as the key strategy to support new product launches and recruit new representatives. It has also initiated a Representative Value Proposition (RVP) program to improve the reward and effort equation for its representatives. RVP includes the Sales Leadership program, a focus on enhanced incentives and optimum discount structure, increased sales campaign frequency, improved commissions and new web-enablement e-business tools to improve the earnings opportunity for its representatives.
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- 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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