Avon Products (NYSE:AVP) is scheduled to report its third quarter results on October 31, 2013. We expect positive growth in constant dollar revenues this quarter, impacted by a growth in representative count and higher order rate in its larger markets. However, we expect order rates and representative count to decline in Avon’s smaller markets. Additionally, as Avon derives approximately 85% of its revenues from outside the U.S., the recent volatility in EM currencies will have a significant impact on reported revenues this quarter.
H1 FY13 Recap
Top line in the first half of 2012 stood at $5.167 billion compared to $4.992 billion in 2013. Reported revenue growth continued to decline in the first half of 2013 due to adverse currency fluctuations. Additionally, constant dollar revenues grew a meager 1% due to a 1% increase in representative count. Overall order rates remained flat, with an increase in Latin America and EMEA regions offset by a heavy decline in Asia Pacific and North American markets. Avon initiated the Representative Value Proposition (RVP) initiative to plug the decline in order rates and have better order realizations due to better sales and marketing practices.
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Focused efforts such as exiting markets in Korea, Ireland and Vietnam to reign in costs bore fruit as operating margins more than doubled in the first half of 2013, from 2.94% in 2012 to 7.5% in H1 FY13. The company also sold its loss-making Silpada Designs business in 2013 to have a more streamlined portfolio, and refinanced a part of its debt to reduce its interest payment obligations. However, higher interest rates completely offset the decrease in outstanding debt, leading to higher interest expenses in the first half of 2013. The devaluation of the Venezuelan bolivar by 32% also impacted net income margins negatively in H1 FY13, with one-time increases of $34 million in other expenses and $17 million in income taxes from a write-down in monetary and tax assets. Net income margins in the first half of 2013 declined from 1.71% in H1 FY12 to 0.36% in H1 FY13.
In the third quarter, we expect Avon’s operating margins to strengthen further due to the focused efforts from management to reduce operating expenses. On the net income front, we believe the decline seen in the first half due to one-time expenses to have bottomed out and expect profit-after-tax margins to expand, despite high interest rates contributing to an increase in interest expenses.
Strong Currency Headwinds To Have Significant Impact In Q3; RVP Remains Key For Top Line Revival
Geographically, the Latin American market is Avon’s biggest market with a revenue share of about 48%, followed by the EMEA region at 29%. The domestic U.S. market contributes 15% of revenues while the smaller Asia Pacific region makes up the remaining 8%. The large share of revenues from overseas markets mean that an adverse currency fluctuation in these regions could potentially cut down growth prospects for the company. During the July – September period, emerging market currencies saw steep declines due to concerns of tapering in the Fed’s QE program, and Avon’s heavy reliance on these markets could continue to negatively impact top line results this quarter.
In constant dollar terms, revenues grew by a meager 1% in H1 FY13 over H1 FY12. Strong demand for beauty products in Latin America and a revival in demand from the EMEA region due to a recovering economy, coupled with a slight increase in representative count in these geographies, contributed to a 7% and 4% increase in constant dollar sales. However, business performance remained weak in the U.S. and Asia Pacific regions, with declining representative count and lower order rates, which resulted in a 13% and 11% decline in constant dollar sales respectively.
In order to address the issue of declining order rates, Avon is planning a shift from the paper-based order model to an omnichannel experience by leveraging the use of various social and digital media channels. The company expects this shift in the consumer proposition model to support an increase order rates and lead to higher order turnover. Additionally, the company is targeting an improvement in its consumer service through the Representative Value Proposition (RVP) program and by providing more relevant and locally positioned products.
The Representative Value Proposition (RVP) program includes various incentives, business tools and training programs to expand its representative base. 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 organically grow constant dollar sales at a faster pace.
Operating Margins To See Further Expansion On Strong Cost Saving Measures
Avon has a two-pronged strategy to increase top line growth as well as cut down operating expenses. To increase representative count and reduce attrition rate, the company initiated the RVP program. The company also announced an ambitious $400 million cost savings initiative in Q4 FY12 to reduce operating expenses and grow to a low double digit operating margin level by 2016. So far, Avon has exited its business from Korea, Ireland 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.
We will update our $23.17 price estimate for Avon Products after the company files its financials with the SEC.