Avon Q4 2014 Earnings Preview: Latin American Problems Might Weigh On Earnings

Avon Products (NYSE:AVP), the direct selling company of  beauty, household and personal care products, is set to release its fourth quarter earnings on February 12th. Avon experienced a weak 2014, so far. For the first nine months of 2014, Avon’s total revenues declined by around 11% on a year-over-year basis to $6.5 billion. The company seems to be on a downhill trend, having posted its last profit back in 2011. Avon’s direct selling model through representatives is losing market share to retail outlets and online shopping.

In 2014, Avon was adversely impacted by both macroeconomic as well as micro economic factors. Externally, the grim economic environment weakened Avon’s performance in 2014, especially in the Latin American region, which contributes to over 50% of Avon’s revenues. Internally, the company underwent major management restructuring and attrition of its representative base.

In this article, we discuss the various trends that might impact the company’s fourth quarter earnings. We will update our price estimate for Avon after the earnings release.

See Our Complete Analysis for Avon Products Here

Avon’s Fails To Hold Its Ground In Latin America (Its Most Important Sales Region)

• Brazil: Avon’s Single Largest Market

Latin America contributes to over 50% of Avon’s annual revenues. Within the Latin American region, Brazil is Avon’s single largest market. Brazil is the third-largest beauty market in the world.  This market has had a 10% annual growth rate for the last 17 years, up until 2013, when the growth rate in 2013 was 4.9%. ^[1] Direct selling contributes to approximately 70% of Brazilian market sales in the skincare, color and fragrance categories. These factors fueled Avon’s erstwhile growth in Brazil.

Reasons For Sales Decline In Brazil:

• At present Brazil’s economic environment is grim and has still not recovered, as it was expected to do post the World-Cup.
• Consumer spending has dampened due to grim economic conditions and high household debts.
• Competition in the personal care market through direct sales as well as retail is intense.
• The product pricing was not suitable for an economy where consumer price sensitivity for luxury goods, like cosmetics, was high.

However, the management believes that Avon’s Brazilian business will grow in 2015. In 2014, the company has forged strategic alliances with KORRES, a Greek skincare brand, and Coty, a French beauty and personal care company, to provide a boost to the Latin American, and specifically to the Brazilian, market. The details of the partnerships are discussed later in this article.

• Mexico: Avon Plans To Improve Retention Rate

Sales in Mexico suffered in the first half of 2014, due to attrition in the representative workforce and an unsuitable portfolio price mix. The product portfolio and pricing have since improved,  resulting in an  increase in average orders in Q3 2014, though the representative retention is yet to improve significantly. Avon plans to improve the retention rate by helping representatives navigate the first 6 campaign cycles. Earlier, this plan had resulted in significant improvements in representative retention in the UK.

Avon Receives Boost In Sales From The Weak Russian Economy

Avon Products’ Russian sales received a significant boost in the second half of 2014, on the back of the depreciating ruble and the economic weakness in Russia. According to Avon country chief Elena Starkova, the sales grew by both volume and value. Due to the weakening Russian economy, many people are seeking additional jobs by selling door-to-door products, and Avon’s business model of direct selling has helped them and has in turn increased Avon’s labor pool in Russia by over 10% (as per December 2014 data). Around 4.3 million Russians are employed by Avon’s direct selling model now. The ruble depreciated by around 43% against the U.S. dollar in 2014, mainly due to two reasons:

1. the decline in the price of oil, Russia’s biggest export product;
2. the U.S. and European sanctions over President Vladimir Putin’s incursion into Ukraine.

According to latest government data, the Russian economy contracted for the first time in five years in November 2014, while real incomes dropped 4.7%, ushering in a recession. Avon’s sales in Russia were also boosted when it introduced the “anti-crisis” consumer basket, after anticipating the economic slowdown. The package includes the bare minimum products required by women for personal care, at the lowest possible prices, such as shampoo for 59 rubles (89 cents) and skin cream for 79 rubles. ^[2]

Avon’s Representative Base Experienced Major Decline

Avon’s sales structure is dependent on active representatives. The North American base of active representatives is in a gradual decline. This is adversely affecting Avon’s product sales in that region. Avon had nearly 470,000 representatives in 2009, which declined to 314,000 representatives by the end of 2013. Going by the rate of decline in representatives in North America, Avon’s active representative count by 2014 end could stand at about 258,000. This continued double-digit decline in active representatives is likely to weigh on sales and put margins under pressure going forward.

The reasons behind Avon’s waning representative base are:

• Avon’s reorganization of its sales force in Q2 2013, which resulted in the disruption of its sales representatives pool.
• The recovering North American economy and the subsequent creation of full-time jobs is expected to pile on additional pressure on Avon’s representative base because Avon representatives are usually non-contractual workers.
• Over the longer term, digital channels such as e-commerce are likely to cannibalize sales from the direct-selling channel for Avon, leading to a reduction in representative base. The company launched its consumer-centric e-commerce platform avon.com in the U.S. in Q3FY14 and intends to expand into other key markets in 2015.

Currently Avon Canada is cutting hundreds of jobs at its distribution center in Pointe-Claire. Though Avon refused to divulge a specific figure, the company did admit to having slashed a majority of jobs at the distribution center. The company is outsourcing the jobs to Chicago based Genco, a supply chain management company. In view with its recent poor performance, Avon has decided to take this step in order to remain competitive and reduce operating costs. Genco is a third party logistics provider, capable of supporting Avon’s bi-weekly selling cycle demands by expanding or contracting the supply in accordance with Avon’s varying needs. Last year, Avon mentioned that it was striving to reduce its spending by $400 million by 2016. The latest cuts should contribute to around $50 million to $55 million in annual savings. ^[3]

Restructuring Of The Management

The company announced corporate restructurings to support its multi-year turnaround plan. The management responsibilities in Latin America have been split into two defined sets of markets which would be overseen by two separate executives. In addition to this, there will be changes in the marketing and sales organization, in Avon’s key markets. ^[4]

On January 28, 2015, Avon Products announced the appointment of James S. Scully as Executive Vice President and Chief Financial Officer. He will lead all finance and information technology functions. Prior to assuming his current position, Mr. Scully served as Executive Vice President and Chief Financial Officer, Chief Administrative Officer and Chief Operating Officer at J. Crew, a leading women’s, men’s and children’s multi-channel specialty retailer. ^[5]

Avon’s Chief Financial Officer, Kimberly Ross, resigned in October 2014. The senior management transition added to the company’s existing set of troubles. Although external factors such as volatile currencies have played their part in Avon’s declining sales, internal representative churn and lapsed management strategies across geographies have contributed to significant declines in constant currency sales.

Avon Paid Fine On Account Of Anti Bribery Charges

Avon will pay a fine of $135 million to settle US charges of bribery against its China unit. Avon pleaded guilty to hiding $8 million in gifts, which its employees gifted to Chinese officials, over a period of four years starting from 2004. Avon also admitted to hiding cash, non-business meals, travel and entertainment it provided to obtain business benefits. ^[6] (View SEC filing)

Avon Is Currently Taking Initiatives To Improve Upon Its Lackluster Performance

• The company plans on improving its supply chain efficiencies, including contract terminations, as well as global headcount reductions, which may result in annualized pre-tax savings of approximately $50 million to $55 million as a part of Avon’s $400 million Cost Savings Initiative.
• Earlier in February 2014, Avon entered into an alliance with KORRES, the Greek skincare brand, to develop manufacture and market the latter’s products in Latin America. In May 2014, the company partnered with Coty, a pure play beauty company, to market and sell select Coty fragrances through Avon Brazil’s network of 1.5 million independent sales representatives. The company aims to strengthen its presence in its most important sales region, through these initiatives.
• Avon is reducing its footprint in the Asia-Pacific region, particularly China, where it operates under a beauty boutique model compared to its traditional direct-selling model due to the intensifying competition from local and Korean cosmetics manufacturers.
• Avon ceased operations in Bolivia, in mid-2014, after a series of weak performances in the region. The company aims at focusing on regions with greater growth potential.

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1. Multinationals Target Brazil’s Beauty Industry for Growth Despite Drop, GCI Magazine, June 2014 [↩]
2. Avon Swells Sells In Russia Thanks To Ruble Drop, Business of Fashion, January 2015 [↩]
3. Avon cuts hundreds of jobs on Montreal’s West Island, CBC News, January 2015 [↩]
4. Avon Revises Management Structure in Support of Turnaround Plan, Avon Press Releases, November 2014 [↩]
5. Avon Names James S. Scully Executive Vice President and Chief Financial Officer, Avon Press Release, January 2015 [↩]
6. Avon Settles China Bribery Case For $135m, Yahoo! Finance, December 2014 [↩]