Avon Products (NYSE:AVP) reported fiscal 2013 earnings yesterday that were well short of our expectations on the top line as well as the bottom line. Fourth quarter revenues stood at $2.67 billion compared to our estimate of $3 billion. In constant currency terms, quarterly revenues were down 4% from a year ago. The company’s active representative count witnessed a further 5% contraction during the quarter in addition to a 3% decline in Q3FY13. Currency effects further added negativity to these results as reported revenues came in 10% lower that Q4FY12.
Weak revenue growth also resulted in a deep correction in the company’s GAAP EBIT margin. On a year-on-year basis, Avon’s operating profit margin declined from 7.21% in Q4FY12 to (-0.64%) in the recently concluded quarter. In the first half of 2013, the company managed to expand its GAAP EBIT margin to 7.50% from 3.83% in a similar time period in FY12. However, the company reported an operating profit margin level of 4.3% for complete FY13, compared to our estimate of 7.3%, indicating the extent of disruption Avon’s business had in Q3 and Q4.
Avon has lost approximately $3.34 billion in market capitalization since it reported its Q3FY13 results on October 31, 2013 and now has a market cap of approximately $6.34 billion. We currently have a $21 price estimate for Avon Products and are in the process of updating our model to incorporate the latest Q4 results. Given the nature of the company’s earnings in the last two quarters, we expect to see a significant downside in our revised price estimate for Avon.
Fundamentals Look Weak; Turnaround Should Take Longer Than Anticipated
The executional challenges that Avon had in the second half of 2013 is testament to the fact that the company’s fundamentals look weak. Margins nose-dived in the second half due to weak performance in primarily its North American market, which contributes only 15% in revenues. Active representative count in North America fell 17% in Q4 alone, which resulted in a 27% decline in unit volume sales. We believe the field level disruption caused in the North American division, along with the fallout of its SMT program, will continue to weigh on the company’s business performance for several more quarters to come. Furthermore, Avon’s Asia-Pacific division, particularly China, is also under a lot of pressure. Sales from China fell 50% due to shutdown of Avon’s beauty boutiques which closed off that channel.
Additionally, the company’s debt burden is beginning to strain the company’s bottom line. Although Avon has extinguished and refinanced a part of its short term and long term debt, weak cash generation as a result of declining representative base has depressed the company’s Interest Coverage ratio. Avon’s total debt decreased from $3.3 billion in 2011 to $2.7 billion in 2013. However, the company’s interest coverage ratio decreased from 9.2 to 3.5 between the same period despite lower interest payment obligations for the company. Going forward, we expect to see further deterioration in Avon’s financial position as the company continues to address lapses in its turnaround strategy.
Margin Growth Prospects Remain Muted
In a bid to curb operating expenses and boost profitability, Avon’s management planned a $400 million Cost Savings program that entailed various headcount reductions and reorganizations, exiting under-performing markets like South Korea and Vietnam, and replacing legacy ERP and HCM systems. Moreover, the company had also planned a shift in its order processing system from a paper-based model to an online model. A pilot program of the Service Model Transformation (SMT) project was rolled out in Canada. However, the new ordering system resulted in a severe disruption without any meaningful return on its investment. Avon halted and subsequently discontinued the roll out of its SMT project on a global scale to prevent further disruption and recorded a $117 million pretax, noncash write down charge in capitalized software relating to the SMT project. 
Moreover, the declining representative base should reduce unit volume sales for the company going forward. In FY13, units sold decreased 5% while the company’s price mix offset this decline partially with a 4% increase. We believe the increasing inflationary levels in developed markets, where Avon has a very large footprint, played a key role in the expansion of pricing and volume contraction. If inflationary levels remain close to their current levels in these economies, it will be difficult for Avon to restrain unit volume declines. As consumer buying sentiment begins to decline, the gap between unit volume and pricing power will continue to grow, pressuring margins going into 2014 as well.Notes:
- Avon Products Management Discusses Q4 2013 Results – Earnings Call Transcript, Seeking Alpha, February 2014 [↩]