Avon Pre-Earnings: Cost-cuts, Sales Representative Count Critical For Growth

Avon Products (NYSE:AVP) is scheduled to report its second quarter results on August 1, 2013. The company is a dominant player in the multi-billion dollar cosmetics market with annual revenues in excess of $10 billion and competes with other beauty and personal care players such as L’Oreal (PINK:LRLCY), Revlon (NYSE:REV) and Estee Lauder (NYSE:EL).

Avon generates more than 85% of the sales from outside the US, and hence, unfavorable currencies have had deep impacts on its financials. Revenues declined by 9% from $2.856 billion in Q2 2011 to $2.592 billion in Q2 2012 of which unfavorable currencies contributed to 8% of the declines. The company has seen tepid growth in revenues in the last few quarters on a constant $ basis due to lower average orders and a declining representative count for the company.

See Our Full Analysis for Avon Products

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High Operating Expenses Squeeze Margins

Avon reported total revenues of $2.484 billion in Q1 2013. Operating expenses were approximately 93% of the total revenues and the operating profit was $172.1 million. However, the company registered a net loss for the second quarter in a row due to a $73 million loss on extinguishment of debt. Due to the huge debt that Avon has on its books, interest and other expenses as a percentage of the operating profit have increased from 30% in Q3 2012 to 57% in Q4 2012. The prepayment of a part of the debt has marginally softened interest and other expenses to 42.88% of operating profits in Q1 2013. High operating expenses combined with a huge debt continue to burden Avon as profit after tax margins have been in the red for the past two quarters.

In a bid to return to profitability, Avon has decided to sell its loss-making Silpada Designs business. We believe that reducing operating expenses and gradual extinguishment of debt would improve operating and net income margins for the company in the long-term. Margins would be boosted further as Avon’s $400 million cost savings program as well as its Representative Value Proposition (RVP) program start to bear fruit.

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Weak Currencies And Declining Representative Count Curb Growth

Latin America is Avon’s largest market, contributing more than 45% of the total revenues generated. Latin American revenues in Q1 2013 were flat in comparison to the prior-year period due to weak currencies and the devaluation of currency in Venezuela. On a constant $ basis, sales have grown 7% on a constant $ basis backed by an increase in the representative count and an increase in the average order. In February 2013, the Venezuelan government devalued the currency by approximately 32% which has impacted Avon’s operating profit and net income by $13 million in Q1 2013. The company expects a further impact of $37 million on operating income and net income from its Venezuelan operations due to this devaluation.

Europe, Middle East and Africa contributed close to 30% of the revenues for Avon. Revenues grew 1% in Q1 2013 over the prior-year period and 3% in constant $ terms due to an increase in sales representatives for Avon in the region. Regional revenues benefited from an increase in active representatives in Russia and South Africa, offset by a slowdown in the UK and decreased average order in Turkey.

North American operations continued to post losses due to the Silpada Designs business, a decrease in representatives and lower average order. Revenues from the region in Q1 2013 declined 15% on a reported and a constant $ basis from a prior-year period. In the Asia-Pacific market, reported revenues declined 10% while constant $ revenues declined by 12% due to lower average order and a reduction in active representatives.

While global factors such as weak currencies shrank revenues for Avon, constant $ revenues have been affected due to a decline in representatives from 6.5 million in 2010 to 6.3 million in 2012, and lower average orders. Avon initiated a Representative Value Proposition (RVP) program which includes Sales Leadership program, focus on enhanced incentives and optimum discount structure, increased sales campaign frequency, improved commissions and new web enabled e-business tools to improve the earnings opportunity for its representatives. We expect the benefits from the $121 million investment in developing the RVP program to kick in, contributing to an increase in the number of active representatives for Avon and higher average orders and leading to higher revenues.

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However, external factors like weak macro-economic situations, government restrictions and currency devaluations would impact revenues for the company due to its large exposure to international markets.

We will update our $20.44 price estimate for Avon Products after the company files its financials with the SEC.

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