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Investment Overview for Avon Products (NYSE:AVP)
WHAT HAS CHANGED
Avon Products has been consistently performing poorly. The company's sales declined by ~20%, to $6.2 billion in 2015.The active representative base grew by 1% for 2015. Avon’s adjusted operating margin was 5.7% down by 360 basis points. The decline was due to Brazilian IPI taxes, Brazil’s VAT credits, and the foreign currency impacts on Avon’s performance.
In 2015, Avon had been on the lookout for a buyer for all or parts of its business, which it finally found in December in Cerberus Capital Management. Cerberus invested $435 million into Avon and carved Avon’s North American division into a separate entity by investing another $170 million in it. In January 2016, Avon entered into a strategic collaboration with Hewlett-Packard for hybrid infrastructure information. The agreement is expected to enhance Avon’s global IT infrastructure, where Hewlett-Packard will help Avon by identifying cost-effective tools and processes in order to boost the beauty company’s operational efficiencies. This will improve Avon’s adaptability to the ever-changing dynamics in the beauty industry. We expect these changes to significantly revive the company’s performance in the coming years.
- Avon is struggling in most of its important regions
- Brazil – the largest revenue contributing country for the company– has been more than partly responsible for Avon's bleak performance. The company’s revenues declined by 44% on a constant dollar basis in Brazil primarily due to the decline in average orders. Beauty spending is currently very weak in Brazil on account of its economic challenges. Brazil’s IPI taxes (industrial product related taxes in Brazil) are putting additional pressure on the margins.
- Currency headwinds are dampening Avon's sales even further
- Currency headwinds have been a major dampener for Avon (especially in Latin America from where it derives around 50% of its sales).
- New developments in 2015
- Avon re-positioned its brands in 2015 with a new theme titled Beauty for a Purpose which received a positive response across the globe. The company is planning to build further upon the theme this year. Also, the social media and digital reach of the company grew considerably last year and it is currently rolling out upgraded service models in key markets.
- In January this year, the company entered into a strategic collaboration with Hewlett-Packard to identify cost-effective tools and processes in order to boost its operational efficiency. This move might help Avon in adapting better to the dynamic beauty industry. As a part of this partnership, the company, along with other such enhanced technological upgrades, also intends to cut its global headcount.
- Avon’s biggest highlight for the year probably came in December 2015, when private equity management firm, Cerberus Capital Management invested $435 million into the company and carved out Avon’s North American division into a separate entity by investing another $170 million in it. Avon sold 80.1% of its North American business to Cerberus. The company had been striving to make a turnaround post the deal.
- Avon’s Three-Year Road Map To Improvement
- The three-year plans broadly entails investing in growth areas, cutting costs, and better recovery from financial stress. With respect to the first point, Avon will ramp up investments in the new brand positioning in its important markets. There will be a detailed pricing list in place in the company’s top ten markets. The company is currently striving to develop its top 40 brands. For better representative retention, the company has launched an improved on-boarding program. The service model for the company is undergoing changes and there is a three-year plan for the same. Some of the countries where these changes have been set in motion include Poland, Turkey, the U.K., and a few markets in the EMEA. The implementation will be completed in its major markets over 2016.
- Also, in Brazil there is a upgradation of the service model which involves a better order management system and key digital tools that will enhance the business management aspect of representatives and sales managers. The company is in the pilot testing stage of pickup points, where buyers can get their merchandise, and on-demand delivery for the top sellers.
- In the cost cutting aspect, the company plans on $350 million of cost cutting over the next three-year period. For building up its financial resilience, the company will increase investments in services with the suspension of dividends, better repayment of debt, and improved operational efficiency.
- Management restructuring
- Avon announced some management changes which became effective since January 1, 2016. John Higson, formerly in charge of the EMEA and Global field operations, also has Latin America under his purview, with the combination of EMEA and Latin America. Fernando Acosta, formerly heading Northern Latin America and Global Marketing, was made in charge of brand marketing and innovation aspects, including the company's move towards social selling. Jim Scully, the Chief Financial officer, also assumed the role of Chief Operating Officer. His responsibilities include enterprise strategy, infrastructure, and global supply chain.
Number of Active Sales Representatives: 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. However, in 2015 with its changes and restructuring moves, the representative base increased by 1% to 6.02 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 Avon’s active representative base to gradually grow to almost 7 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 4% rate (like 2014) for the rest of our review period, to reach 4.5 million by the end, then there will be an over 50% 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. The margins remained dampened in 2015 as well. Overall, EBITDA margins declined close to 330 basis points over 2015. We expect margins to reach over 10% by the end of our forecast period. There could be over 100% 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 $6 billion in annual revenues in fiscal 2015, 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 and 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 offerings, 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
Avon sold its 80% stake in North America to Cerberus Capital. According to its 2015 annual report, Latin American contributed to around 53% of its revenues. Europe, Middle East, and Africa together amount to ~37%, while Asia Pacific contributed the remaining 10%.
- 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: currently, almost all of Avon's business is 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 is expected to have started
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 accounted for over 50% of Avon’s revenues), and North America (which had earlier accounted 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.
In 2015, Avon had been on the lookout for a buyer for all or parts of its business, which it finally found in December in Cerberus Capital Management. Cerberus invested $435 million into Avon and carved Avon’s North American division into a separate entity by investing another $170 million in it. In January this year, Avon entered into a strategic collaboration with Hewlett-Packard for hybrid infrastructure information. The agreement is expected to enhance Avon’s global IT infrastructure, where Hewlett-Packard will help Avon by identifying cost-effective tools and processes in order to boost the beauty company’s operational efficiencies. This will improve Avon’s adaptability to the ever-changing dynamics in the beauty industry. We expect these changes to significantly revive the company’s performance in the coming years.
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.
How Does Trefis Modelling Work?
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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