The year 2013 was very disruptive for Avon Products (NYSE:AVP), with various strategic challenges resulting in sharp contractions in margins and revenues. Revenues for the company came in well short of our FY13 estimates. Additionally, margins continued to fall steeply as the company found it difficult to maintain operating margins due to falling revenues. During the period between February 2013, when Avon reported its Q4FY12 results, to February 2014, when it recently reported its Q4FY13 results, Avon’s stock has lost as much as 14% during the one-year period. In view of the heightened magnitude of Avon’s executional challenges the company faced in 2013, we have reduced our Trefis price estimate to $15 from our earlier estimate of $20.
Recap Of Fiscal 2013
Avon showed strong recovery and alleviated concerns on revenues and margins during the first half of fiscal 2013 with the implementation of its two-pronged strategy. Revenue decline for the company reduced to (-3.4%) on a year-on-year basis in the first half of FY13, from (-6.5%) in FY12, following the implementation of the Representative Value Proposition (RVP) initiative. Operating profit margins too witnessed considerable expansion, from 5% in FY12 to 7.5% in H1FY13 as Avon exited under-performing markets of Vietnam and South Korea, and relocated its manufacturing facilities to reduce excessive operational expenses. Reduced revenue decline and margin expansion resulted in a 31% appreciation in Avon’s stock value during the February-August 2013 period.
However, Avon encountered severe set backs in its turnaround strategy during the latter half of 2013. Employee restructuring in North American field operations, along with the rollout of Avon’s Service Model Transformation (SMT) module in Canada, resulted in a sharp contraction in the company’s active representative base. In North America, Avon reduced its existing headcount and further simplified the selling structure to a One Simple Sales model that involved redistricting its representatives. And this impacted critical representative-customer relationships.
The roll-out of the SMT module in Canada resulted in severe disruption and decline in Avon representatives, as employees found it difficult to adopt the new order management system. These initiatives resulted in a 9.3% year-on-year decline in revenues during the second half of 2013. In addition, operating profit margins plummeted to 1% for H2FY13, much lower than what Avon registered in H1FY13. A 32% decline in Avon’s stock value followed the steep decrease in revenues and margins witnessed during the latter half of 2013.
Executional Challenges Should Strain Revenues And Margins In 2014
Our revised price estimate for Avon underpins various lapses the company needs to address to revive its business performance. Being a direct-selling organization, Avon relies solely on its representative base for top line growth. While Avon’s total representative count expanded by 1% during H1FY13, the restructuring and headcount reorganization activities resulted in a 3% and 5% decline in rep count during Q3FY13 and Q4FY13. The Latin American market, which generates close to 50% in revenues for Avon, also witnessed a decline in representative count during the second half of 2013 after posting an expansion in the first half. However, the North American and Asia-Pacific markets had the biggest falls in rep count during the second half due to their inherent weaknesses. We expect these regions to continue under-performing heavily in 2014 which should weigh on the company’s overall top line in 2014. We have a revenue forecast of $9.72 billion for Avon in 2014, which represents a 2.4% erosion compared to FY13 revenues.
According to our calculations, Avon’s EBITDA margins continued their downward trajectory and declined to 9% in 2013, from 9.4% in 2012 and 13.7% in 2011. In absolute terms, the company’s Earnings before Interest, Tax, Depreciation and Amortization (EBITDA) decreased from $1.55 billion in 2011 to $1 billion in 2012 and reaching $895 million in 2013. Much of this decline is attributable to the company’s inability to contain costs in a declining sales environment. Avon’s GAAP operating profit margin, which includes non-cash charges such as D&A and other non-recurring expenses, declined from 9.9% in 2009 to 7.6% and 4.3% in 2011 and 2013 respectively. We believe the decline in margins for the company have bottomed out and expect the company to post a 30 basis point expansion in operating margin in 2014. There should be a further downside to our price estimate if Avon’s turnaround strategy takes longer than anticipated and margins inch lower going forward.