Avon Products (NYSE:AVP) is the largest direct selling organization in the world competing with global players such as L’Oréal (PINK:LRLCY), Revlon (NYSE:REV) and Estée Lauder (NYSE:EL) in the $400 billion beauty and personal products’ market. The company has been witnessing consistent declines in top line and margins, which has dragged down the company’s stock price. Since its recent Q2 2013 results on August 1, the stock price has declined by approximately 13%.
Our price estimate for Avon Products stands at $23, implying a premium of 15% to the current market price. Although sales for the recently concluded June quarter were down 3.2% y-o-y, we are bullish on the company’s future performance and expect the cosmetics player to do well in the coming years. By cutting costs and exiting under-performing markets, Avon has started to improve margins after their slump to 3% in FY 2012.
In our previous note, we focused on how Avon’s business segments have performed and established the importance on growing its representative sales force to spur top line growth (See: A Look At Avon Products And Its Plans To Spur Growth). Recently, the company revamped its senior management by hiring Ms. Nancy Killefer and Mr. Brian Salsberg from McKinsey’s consumer and retail practice division to oversee Strategic Development and Execution, and Global Strategy, respectively. In this article, we analyze the strategy chartered by Avon across its product portfolio and explain our rationale behind the upside in our forecast.
Improved Consumer Proposition Model & Product Innovations To Boost Top Line Growth
Avon is planning a tectonic shift from the paper-based order model to an omnichannel experience by leveraging the use of various social and digital media channels to provide multiple touch points for the consumer. The new model involves mobile and online ordering channels along with an improved delivery system for the representatives, which is expected to increase order turnover for the company. Additionally, the company is targeting an improvement in its consumer service by providing more relevant and locally positioned products.
By supporting product innovation and launches on a consistent basis, Avon is planning to create further inroads into the upper mass-market category by launching its flagship brand Avon Color in its top markets like Latin America and Europe, the Middle East and Africa (EMEA). The company is also targeting younger consumers in these regions with more contemporary offerings. Though the lack of sufficient reserves poses a challenge for the company, incremental cost savings brought about from the “$400 million Cost Savings Scheme” could provide cash for product innovation and R&D expenses.
Within the skincare segment, the company is currently losing market share due to an obsolete product portfolio comprising of under-performing mass moisturizers and cleansers and declining representative participation. By developing innovative products and competitive mass proposition models involving discounts and by optimizing representative performance through the Representative Value Proposition (RVP) initiative, the company aims to re-capture market share in the skincare segment.
Working Capital Improvement To Increase Investments Into Operations
In addition to a mid single-digit top line growth and low double-digit growth in operating profit, management expects an improvement of $100 million in working capital by 2016. To facilitate this growth, the company is planning to invest between $150 million to $200 billion by 2016, into a robust IT infrastructure for efficient demand forecasting and retire existing infrastructure. New IT infrastructure is also expected to support the transformation from the traditional paper-based sales channel to an omnichannel experience for the consumer.
Investments are also being made towards General Ledger (GL) simplification and ERP substitution to improve inventory recognition and management practices as well as create an efficient supply chain management system. Other improvements to the existing supply chain management infrastructure include improved vendor payment terms which results in an increase in account payable days, higher inventory levels to cater to increase in demand, improved brochure ad promotional material prepaid expenses and an accelerate the use of tax assets.
More working capital could result in higher sales as Avon expands its inventory reserves due to increased accounts payable days. On the other hand, higher inventory levels might lead to greater losses due to obsolescence. We expect the company to maintain sufficient inventory and buffer levels and have factored in trends from Avon’s strategy in our price estimate. We estimate a gradual improvement in sales from the 2012 levels of $10.7 billion to cross $14 billion by 2020, and an expansion in EBITDA margins from 9.56% in 2012 to 17% by 2020. However, if the implementation of Avon’s turnaround strategy fails to gain traction, we could see downside to our price estimate.