Avon Q2 2015 Earnings Preview: A Slight Improvement In Brazil And More Probable Strategic Restructurings Expected

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Avon Products (NYSE:AVP) is slated to release its Q2 2015 earnings on July 30. The company’s performance has been on a downhill slide post 2011. In 2014, its sales declined by 11% to $8.9 billion. In Q1 2015, sales declined by 18% to $1.8 billion. However, in constant dollar terms, Avon’s revenues grew by 1% during the quarter due to growth in Europe, the Middle East, and Africa. Within the Latin American region, Brazil showed signs of recovery. Avon is trying to upgrade its direct selling model to a more social selling structure, whereby its active representatives can sell through the digital media. Though the company’s active representative base declined by 1% on a year-over-year basis, however, there was a sequential quarter-over-quarter improvement in Avon’s representative base for Q1 2015. As of December 2014, Avon had around 6 million active representatives. [1]

Our price estimate of $6.55 is significantly above the market price. We will revise our estimate post the Q2 2015 earnings results.

Avon’s Performance Revival In Its Most Important Sales Region, Brazil

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Latin America contributes to over 50% of Avon’s annual revenues. Within the Latin American region, Brazil is Avon’s single largest market. 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.

In 2014, Avon’s Brazil sales received a setback primarily due to the country’s weak economy, competition from retail channels, and Avon’s improper product pricing mix. Hence, as a recovery measure, towards the end of 2014, the company 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.

In the Brazilian beauty market, fragrance plays a crucial role in the overall product mix, and the launch of Coty products helped Avon in filling the demand gap. Hence, in Q1 2015, Avon witnessed an improvement in sales from this region. Currently, Avon is strategizing on the pricing mix in Brazil and approaching the product price mix in a staged manner in order to regain consumer confidence. [2]

However, Brazil’s IPI tax (one of the basic sales taxes in Brazil) will have an estimated 50 basis point impact on the company’s constant dollar adjusted operating margins for the full year 2015. In Brazil, Avon is a leading player in the color and skincare segments, and these segments would be dampened due to the IPI taxes.

Avon’s Divestiture Of Liz Earle And The Possibility Of Further Restructurings

On June 9, Avon announced the divestiture of Liz Earle, its wholly-owned, UK-based natural skincare brand, that contributed around 1% to Avon’s consolidated revenues and adjusted operating profit in 2014. Liz Earle was acquired for £140 million by Walgreens (NASDAQ:WBA).

Avon will use the proceeds from the transaction for redemption of its $250 million worth 2.375% notes that are due in March 2016. (See Press Release). Additionally, Avon’s weak capital structure is expected to receive a boost as a result of this transaction. Avon’s persistent poor performance and eroding representative base have made it necessary for the company to take some drastic initiatives.

The Sell Off May Help Other Avon Brands To Revive

In view of its sequential improvement in the skincare segment over the last five quarters leading up to Q1 2015, Avon has planned a few additions to its skincare division. The sale of its skincare brand, Liz Earle, might be one of the measures to sacrifice a less popular brand in order to provide better revival options to its other more popular brands. Avon had planned to launch an upper-market product line called Nutra Effects in Q2 2015. A few key additions were slated for its Anew line too. Within the color cosmetics segment, Avon had planned a few product lineups in mascara, lipstick, and eye color. Avon is boosting its color segment with strong advertisements in key markets. [2]

Are More Restructurings Probable In The Future?

Avon is reported to have been exploring strategic alternatives since April 2015. [3] There were rumors of an offer in May, where private equity firm PTG Capital Partners was alleged to acquire Avon for a value of around $8.16 billion, not including debt. However, the claim was refuted by an Avon spokesperson shortly afterward. [4]

In North America, Avon’s sales have been hit by a drop in the representative pool. In Q1 2015, although some cost management initiatives proved effective, the company still faced a serious slowdown. Revenues in North America declined by 17% on a constant dollar basis and the active representative pool also fell by 17%, on a year-over-year basis. The recovering North American economy, and the subsequent creation of full-time jobs, is expected to pile additional pressure on Avon’s representative base because Avon representatives are usually non-contractual workers. In view of its losses, Avon might be contemplating the sale of its North American business, according to a report from the Wall Street Journal. The company has not yet commented on the issue. [5]

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Notes:
  1. Avon Reports Q1 2015 Results, Avon Press Releases, April 30, 2015 []
  2. Avon’s Q1 2015 Earnings Call Transcript, Seeking Alpha, April 30, 2015 [] []
  3. Walgreens Buys UK Cosmetics Brand from Avon, 24/7 Wall St, July 9, 2015 []
  4. Did Avon Finally Get an Offer — and Is It Real? (Updated), 24/7 Wall St, May 14, 2015 []
  5. Avon exploring sale of North America business: WSJ, Reuters, April 14, 2015 []