Third quarter results that Avon Products (NYSE:AVP) reported on October 31 were dispirited, with the turnaround strategy undertaken to revive business performance failing to gain traction. Revenues saw a steep decline, impacted by currency volatility. Weak top line performance resulted in a net loss of $5.5 million for the quarter. Avon’s stock price fell by more than 20% yesterday in response to these concerning results.
Q3 Fiscal 2013 Overview
Revenues dropped a steep 7% to $2,323 million for the quarter compared to 4% in Q1 and 2% in Q2. The decline in reported revenues accelerated in Q3 due to adverse currency fluctuations in various emerging markets. Excluding currency variations, constant dollar revenues showed a 1% decrease in Q3 in contrast to a 2% increase in Q2. The decrease in constant dollar revenues in Q3 was primarily due to a 3% reduction in the Active Representative count. Additionally, unit volumes continued to inch lower, with a 7% decline this quarter arising from challenges in the company’s strategic execution.
Executional challenges also crippled the company’s ongoing efforts to contain costs. Cost of sales as % of revenues increased by 20 basis points to 37.5% in Q3 compared to a 60 basis points reduction in Q2,. SG&A expenses as % of revenues witnessed a higher increase of 3% in Q3 over Q2. This resulted in a 38% decline in operating profits, aided by the deterioration in top line and an increase in operating expenses.
Near Term Outlook For Top Line Looks Bleak With Severe Challenges In Strategy Execution
Avon has been suffering problems with sustainable top line growth and curbing costs since the start of 2012. Its top line has been constantly impacted by a steady reduction in its active representative count as well as lower unit sales. To bolster top line growth, management commenced a Representative Value Proposition (RVP) Initiative earlier this year to attract new talent into its representative program and help existing representatives achieve greater earnings opportunities with enhanced sales & marketing tools and the provision of a web-based order platform instead of the paper-based model for quicker order realizations.
To curb operational expenses and return the company to a profitable trajectory, Avon’s management planned an ambitious $400 million Cost Savings program. The program entails various headcount reductions and exits from under-performing markets and the adaptation of newer systems such as an ERP system and an SCM system. Since the initiation of the Cost Savings program, operating profit margins have steadily improved in the first half of 2013, reaching 8.1% in Q2 from the abysmal 0.4% seen in December 2012. However, operating margins dropped back to 2.9% due to a steep decline in revenues for the quarter. The cause for this deterioration in margins in Q3 was revenue deleverage and higher transportation costs globally. Going forward, we expect margins to decline in the near term due to an increase in costs resulting from the challenges that arose this quarter.
The active representative count, which is critical for Avon’s business performance and prospects of growth, reduced by 3% during the third quarter due to a global fallout in the company’s hiring and training system as well as a disruption caused in order booking due to the roll-out of Avon’s Service Model Transformation (SMT) in Canada.  The SMT program was initially taken up on a global scale in 2009 but its roll-out was suspended due to lack of sufficient adaptation of the technology. Earlier this year, Avon narrowed down the roll-of the SMT platform for the U.S. and Canada. However, a severe disruption following the adaptation of the new order system impacted the daily processes of Avon’s representatives, leading to a reduction in active representative count and also a significant reduction in order bookings.
Additionally, organizational restructuring within the U.S. led to employee relationship disruptions, which impacted sales from the region. Avon faces similar challenges with its representative organization within the Asian markets, particularly China. The retail store format for Avon in China continues to see sharp declines in demand in Q3 which led to closure of a few company operated beauty boutiques in the region. The North American and Asia Pacific markets continue to be weak links in the business, with approximately 20% decline in constant dollar revenues from each region in Q3. The management states that it is now considering alternative approaches for the roll-out of its SMT platform into other markets.  Going forward, we believe that Avon could face some downward pressure in sales generated per representative due to challenges in pertaining to order bookings.
While we are positive on an improvement in margins in the coming quarters for Avon resulting from the strict measures to reduce costs further, we are pessimistic on the company’s ability to grow its top line in the near term. We believe the current challenges in strategy execution and amount of disruption in terms of representative organization within the U.S. and Asia Pacific are substantial, and a steady decline in active representative count could further deteriorate the company’s financial position going forward.
We have updated our price estimate to $21 for Avon Products to reflect the recent Q3 FY2013 results.Notes:
- Avon Products Management Discusses Q3 2013 Results – Earnings Call Transcript, Seeking Alpha, October 2013 [↩] [↩]