Avon Products (NYSE:AVP) is a dominant player in the multi-billion dollar cosmetics market with revenues in excess of $10 billion. Incorporated in 1916, Avon is the largest direct selling organization in the world with an active representative count of approximately 6.3 million in over 100 countries. The company competes with other players in the beauty and personal care industry such as L’Oréal (PINK:LRLCY), Revlon (NYSE:REV) and Estée Lauder (NYSE:EL).
In the recent quarter ended June 30, the company reported net sales figures of $2.46 billion with an operating profit margin of 8.2% and net income margin of 1.39%. Avon’s top line has been declining steadily due to lower average orders and declining representative count. However, by cutting costs and exiting under-performing markets, Avon has been gradually improving margins.
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Avon’s Business Summary
Avon primarily conducts business by the sale of beauty, fashion and home products. It manufactures beauty products from its manufacturing facilities and sources fashion and home products from third-party suppliers. The company derives a majority of its revenue from outside the U.S. and has significant foreign exchange risk due to adverse currency fluctuations. A brief discussion on individual segments has been covered below:
Beauty products: Avon manufactures and sells various color cosmetics, fragrances, and skin care & beauty products through its large network of representatives globally. The segment accounts for more than 70% of Avon’s net sales.
Sales from the beauty products segment stood at $1.78 billion in Q2 2013 compared to $1.85 billion from a similar period in 2012. Weak sales in North America and Asia Pacific offset the partial strength seen in a few Latin American and European economies. Here’s how products within the segment trended for Q2 2013:
|Product Type||Reported Revenue Change||Constant $ Revenue Change|
Despite having a 2% increase in constant dollar revenues resulting from higher average orders, reported revenues for the segment were down 2%. With its vast exposure to international markets the decline in revenues due to currency fluctuations is inevitable. For fiscal 2013, we expect beauty product sales to decline due to lower average order and an unchanged representative count. In the long-term, we expect beauty product sales per representative to improve due to favorable pricing of products and an increase in representative count for Avon.
Fashion products: Fashion products manufactured by Avon consist of fashion jewelry, watches, apparel, footwear, accessories, and children’s products, which the company sources from third-party suppliers for direct sale. The segment accounted for 16.8% of the sales in Q2 2013 compared to 17.1% in Q2 2012. In the recently concluded quarter, sales stood at $415 million, down from $430 million and $511 million in Q2 2012 and Q2 2011. Although overall representative count for Avon remained the same, lower orders resulted in lesser revenues from the segment.
In constant dollar terms, sales were marginally down while currency variations trimmed revenues from the segment by 2%. We expect fashion product sales to pick up momentum following an increase in representative count due to the Representative Value Proposition (RVP) initiative, offsetting the continued decline in average order with a lower price mix in the segment.
Home products: This segment of products include gift and decorative products, housewares, entertainment and leisure products, children’s products and nutritional products. These products are again sourced from third-party suppliers and sold by Avon representatives on behalf of the company. Sales from this segment have contributed 10.7% of the reported net sales in Q2 2013, up from 9.3% in Q2 2012 due to higher pricing of products.
On a constant dollar basis, sales grew 17% for Q2 2013. Including unfavorable currency fluctuations, revenues for the segment stood at $264 million for the quarter, up 13% over Q2 2012. For fiscal 2013, we expect strong growth in home product sales per representative due to higher pricing. Going forward, we expect an increase in active representative count to further boost revenues in the segment.
Key Drivers Impacting Business
Larger Representative Base and Higher Orders to Drive Top Line Growth
Retaining its existing representatives and further expanding its base is key to Avon’s success as a business. Total representative count has declined by approximately 200,000 between 2011 and 2013, which has impacted revenue generation. The company’s net income has declined since 2008 due to lower average orders and fewer representative.
To grow its representative count and improve order rates from its customers, the company created a Representative Value Proposition (RVP) program. The program focuses on sales and marketing training opportunities for its representatives along with providing new web-based platforms for its representatives. Successful implementation of the program could see the following benefits for Avon:
- Better order realizations from a representative due to better sales and marketing practices.
- Higher order rates, particularly from the online channel, leading to greater inventory turnover.
- Expansion in representative base following the improvement in earnings opportunities for existing representatives.
We expect top line expansion going forward following the two pronged strategy that Avon is pursuing through RVP, which leads to higher order rates and an expansion in active representative count as depicted in our chart below.
Cost Savings Scheme to Improve Bottom-line
Avon’s ambitious $400 million cost savings scheme so far included consolidating manufacturing facilities and exiting under-performing markets such as South Korea and Vietnam. These actions have helped the company concentrate resources on high priority markets of Latin American and EMEA and boost efficiency at the same time. Margins have improved over Q1 and Q2 2013 and further savings and restructurings in operations would improve margins and subsequently, bottom-line.
However, as the North American economy continues to strengthen with increasing disposable incomes and lower unemployment rates, Avon’s strategy for the region remains critical for long term sustainability of operations. Its plan to sell the loss-making Silpada Designs business has been an encouraging development. Additionally, a turnaround in retail operations in China is important for Avon’s success in the Asia Pacific region. We expect sales from these regions to continue declining in the short-term, offsetting an increase in overall margins for Avon Products.
We have revised our price estimate for Avon to $23 to factor in trends from its recent Q2 2013 earnings.