Avon Products (NYSE:AVP) reported its second quarter results on August 1, 2013. Net sales grew marginally to $2.46 billion over Q1 2013, but declined approximately 3% in comparison to Q2 2012. The unfavorable currency impact continued to affect Avon as it generated more than 83% of its sales from outside the U.S. during the quarter. Excluding currency fluctuations, net sales grew marginally by about 2%.
Geographically, the U.S. and Asia Pacific continue to be the weak links in the business as sales shrunk by 12% and 10% q-o-q, respectively, on constant dollar terms. However, the weakness in sales in these regions were clearly offset by constant dollar growth rates of 7% and 5% over Q2 2012 in its larger markets of Latin America and EMEA regions.
Slowing sales prompted management to take up cost cutting measures in 2012, and the results of the $400 million cost saving program continued to impact the recent Q2 results. The cost of sales as a percentage of net sales declined from 39.5% in Q3 2012 to 37.9% in the current quarter while SG&A expenses as a percentage of net sales in the same periods decreased from 56.2% to 55.6%. While sales were largely flat, the lower costs and expenses resulted in operating margins improving from 0.36% in Q4 2012 to 8.2% in Q2 2013.
Following the recent debt refinancing in the first half of 2013, interest expense as a percentage of operating profit shrunk from 25.75% in Q3 2012 to 15.4% in the current quarter. Going forward, we expect continued reductions in interest expense as the company refinances its outstanding long-term debt. The company has also paid huge amounts in income tax in the last three quarters largely related to the divestment of its Silpada business. We expect tax rates for the company to come down to 35% in the long term, now that the deal has gone through successfully.
Avon’s product sales in the U.S. have been subdued despite the recent divestment of the loss-making Silpada business. In constant dollar terms, net sales declined by 12.4% y-o-y and 6.4% q-o-q to $380.3 million due to lower active representative count in the region. The number of active representatives in North America declined by 13% over Q2 2012 which contributed to a 14% reduction in beauty product sales and a 9% reduction in fashion and home product sales.
In a bid to turn around the ailing North American business, the management hired Pablo Munoz from Tupperware as head of the region’s business. The company has new skincare products in the pipeline for the North American market and is coming up with a new brand positioning to better market the products. Although we don’t expect an immediate turnaround for the company, we see a gradual improvement in business performance with new product launches driving top-line and cost savings, lower interest expenses contributing to a better bottom-line.
Sales in the Asia Pacific region continue to remain weak, shrinking by 9.3% y-o-y and 1% q-o-q to $198.1 million. The retail store formats for Avon in China continued to post weak sales as units sold decreased 12% q-o-q which contributed to a 28% reduction in constant dollar revenue. The management guides that the decline in net sales from the Asia Pacific region will accelerate in the second half of 2013 due to lower representative count and operational inefficiencies.
However, we expect strong sales from Avon’s larger markets of Latin America and EMEA to continue to offset the decrease in sales in North America and Asia Pacific in the short term.
On a segment basis, beauty product sales continue to be tepid while sales from higher priced fashion and home products continue to drive net sales. We are updating $20.44 price estimate for Avon Products to reflect these trends and the recent Q2 2013 results.