Latin America Adds To Avon’s Top Line Woes In Q3FY14

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Avon Products (NYSE:AVP) reported third quarter results that were in-line with analyst estimates on October 30th. Quarterly sales stood at $2.14 billion, marginally lower than consensus estimates of $2.16 billion. Geographically, sales from the EMEA region continued to improve from the change in strategy, registering sales that were 5% higher on a constant currency basis at $620 million. In reported terms, sales from the EMEA market remained flat due to a 5% currency headwind from depreciating local currencies against the U.S. Dollar.

However, performance from North America continued to remain dull, with the representatives count and sales declining 18% and 15% respectively. Additionally, its largest market of Latin America failed to deliver on management expectations during the quarter, with weaknesses in Brazil, Argentina, Mexico and Venezuela weighing on constant currency sales. Sales from the Latin American market stood at $1.07 billion, 2% higher from a year prior period in constant currency terms. In reported terms however, depreciating currencies resulted in a steep 14% headwind on sales.

In terms of margins, overall gross margins adjusted for certain non-GAAP items declined from 63.1% in Q3FY13 to 62.2% this quarter, primarily impacted by currency fluctuations in EMEA markets. However, operating profits witnessed a strong expansion following prudent cost savings and management realignment from Avon. Q3FY14 operating profit margins, adjusted for various non-GAAP charges, stood at 7.9% compared to 5.4% in Q3FY13. Primarily, the expansion in margins were facilitated by a decline in sales & marketing, general, and administrative expense, which helped boost earnings per share from $0.14 in Q3FY13 to $0.55 in Q3FY14.

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Weak Brazilian Economy, High Representative Attrition in Mexico Weigh on Q3FY14 Latin American Sales

Within the Latin American region, Brazil is Avon’s single largest market. Direct selling penetration is relatively high in Brazil compared to other emerging markets, and this has favored Avon, particularly in the skincare, color and fragrance categories. The direct sales channel in these categories in Brazil accounts for nearly 70% of market sales, making the market attractive and highly competitive at the same time. [1] In the third quarter, organic sales from Brazil remained depressed by approximately 4% in constant currency terms due to a challenging macroeconomic environment. Avon states that the launch of new, premium products in Brazil when consumers were becoming more price sensitive did not help sales, particularly in color cosmetics. [1] However, incremental VAT credits offset this decline of 4% in organic sales from Brazil, leaving overall constant currency sales flat on a year on year basis.

Furthermore, sales in Mexico suffered from continued attrition in its representative base. Sales declined 7% in reported terms and 6% in constant currency terms due to a decrease in Active Representatives for the company. In addition to the decline in representative count, Avon’s performance in Mexico was negatively impacted by its portfolio price mix. [1] While the company has made some progress in balancing its product portfolio for the Mexican market, it states that the decline in representatives is due to low engagement with new recruits in the first 6 campaign cycles. [1] To address this issue of high attrition amongst new recruits, Avon plans to roll-out its strategy for the U.K market, which generated nearly double digit gains in sales last quarter, and expects sales from Mexico to stabilize in Q4FY14. [1]

Representative Engagement in North American Remains Low

For the nine months in FY14, North American revenues declined 19% year on year to $877 million. The decline was primarily a result of low engagement with its independent representative base in the region. Active Representatives, which represent the total number of representatives actively involved in Avon’s field programs, registered an 18% decline in numbers. This sharp fall in the number of representatives the company has in the field has resulted in low unit volumes, which have declined nearly 26% year on year in 9MFY14.

Although the third quarter has displayed marginal improvement in the rate of representative attrition, and a subsequent slowdown in the decline rate in sales, it still remains at worrying levels for sustainable running of the business in North America for Avon. The region continues to operate at a  loss, with 9MFY14 adjusted operating profit margins standing at (-1.7%) compared to (-4%) in 9MFY13. The company has a new management team in place to turnaround the business and has made some progress in curtailing excess costs, and expects to turn profitable in the market by 2015. [1] However, the double-digit decline in sales from the market should have substantial impact on North American operations in the near to medium term.

We are in the process of updating our model to reflect key trends from the latest Q3FY14 earnings for Avon Products.

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Notes:
  1. Avon Products’ (AVP) CEO Sherilyn McCoy on Q3 2014 Results – Earnings Call Transcript, Seeking Alpha, October 2014 [] [] [] [] [] []