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AVP AT A GLANCE

P/E ► 19.9 AVG EV/EBITDA ► 13.9 HIGH ROA ► 12.2% AVG ROE ► 70.1% HIGH Debt to Equity ► 6.67 VERY HIGH Current Ratio ► 1.72 AVG Interest Coverage Ratio ► 10.1 AVG

 

 

 

 

 

 

Avon (NYSE:AVP) makes beauty and personal care products, including various types of cosmetics - lipstick, eyeliner, mascara, basically anything that would make a wonderful Mother's Day gift - apparel and accessories, and home and decoractive products. AVP's products face intense competition, from companies like Estee Lauder Companies (EL) and Revlon (REV), in all of its markets from both global and regional mid-end brand personal care products. To combat competition and improve brand recognition in US and global markets, AVP launched a Turn-around Plan in 2005 that included strategic initiatives to reduce costs, increased advertising spending, improve product quality, and improve sales profitability. AVP expects an annualized savings of $430 million when the plan is completely implemented in 2011-2012 as well as improved market share and increased sales performance. ^[1]

While the majority of AVP's competitors distribute their products to resellers such as department stores, drugstores, or cosmetic stores, AVP sells its products solely through its direct-selling channel of independently-contracted Active Sales Representatives and through its online website. ^[2] However, AVP's direct-selling business model is at risk for incurring more costs due to Representative dissatisfaction and global legal restrictions. In 2004, four Avon Representatives filed a class-action lawsuit against AVP, charging AVP for charging Representatives unfairly for products and refusing refunds of unsold products. ^[3] In 1998, China banned direct-selling and did not reinstate AVP's license for direct-selling until 2006, resulting in large revenue losses for AVP as it could not longer use its main business model in the Chinese market during this time. ^[4] Due to AVP's reliance on its direct-selling business model, earning potential and satisfaction of its Representatives and maintaining its business model are essential for AVP's success in global markets.

Company Overview

AVP produces and sells consumer packaged goods worldwide through its direct selling boutique store channel and its online channel.

Business Segments

Avon's revenues come from three main categories:

• Beauty (72% of net sales): cosmetics, fragrances, and personal care products;
• Fashion (18% of net sales): jewelry, watches, apparel and accessories;
• Home (10% of net sales): home products and decorative products. ^[5]

AVP's revenues from 2008 consists of a large majority of Beauty products, which makes up 72% of the company's sales, while the other 28% of sales comes from Fashion and Home products. ^[5]

Emerging Markets

AVP continued to expand its business worldwide in FY2008, especially in emerging markets such as Brazil, China, Colombia, Russia, Turkey, and Venezuela, aiming for high market share and brand recognition in these markets. ^[6]

The above graph shows a breakdown of AVP's total revenue from FY2008 by region. During FY2008, the fastest growing markets were emerging markets in Latin America and China. ^[6]

Business Growth

FY 2008 (ended January 31, 2008)^[6]

• AVP's net income rose 65%, from $531 million in FY2007 to $875 million in FY2008. The significant rise in net earnings was due to lower costs associated with AVP's restructuring and PLS initiatives. ^[6]

• Net sales was $10.7 billion in FY2008, up 8% from net sales of the prior-year quarter. Of this 8% increase, 4% came from pricing and product mix adjustments, 1% came from an increase of product units sold, and 3% from currency exchange benefits. ^[6]

• Operating profit for FY2008 was $1.3 billion, and operating margin was 12.5% of net sales. This is a 370 bps increase from the previous year, during which operating margin was 8.8%. The increase in profit margins was again due to lowered costs. ^[6]

Q3 2009 (ended September 30, 2009)^[7]

• AVP's net income slipped 29.9% year-over-year, from $221 million in Q3 2008 to $155 million in Q3 2009 due to recessionary pressures from the economics downturn in 2008, restructuring charges, and a strong dollar. ^[8]

• Net sales was $2.5 billion in Q3 2009, down 3.6% from net sales of the prior-year quarter. However, on a local-currency basis, net sales actually increased 7% -- foreign exchange pressure from a strong dollar pressured growth downwards by 11%. In addition to problems with the strong dollar, sales in North America fell by 8% as well.

• Operating profit for Q3 2009 was $259 million, and operating margin was 10.1% of net sales. This is a 110 bps decrease from Q3 2008, during which operating profit was $297 million, or 11.2% of net sales. The company attributes the decrease in operating margin to unfavorable foreign exchange.

• Sales in all of the company's product segments were lower compared to a year ago: Beauty by -3.3%, Fashion by -3.1%, and Home by -6.5%.

Trends and Forces

Direct-Selling Model Dependent on Earnings from Active Sales Representatives

In both domestic and global markets, AVP's sales largely come from direct selling through its Active Sales Representatives. The 5.8 million Representatives that AVP employs are independent contractors that receive a percentage commission for their sales but do not enjoy employee benefits. ^[9] The idea behind the direct-selling model is that if AVP can eliminate the middle-man (department and cosmetic stores) and get its products directly to consumers, they will be able to cut costs and increase profits. One of the goals of the 2005 Turn-around Plan to increase the number of Representatives paid off in 2007 when the company had a 13% increase in net sales as a result of the increase in the number of Representatives. ^[10]

Due to its reliance on direct-selling through representatives, AVP not only competes for the end consumer but also for representatives that are knowledgeable about the industry and about beauty products. AVP's dependence on the productivity and profitability of the representative direct-selling model exposes it to cost and litigation risks. In 2004, four AVP representatives filed a class action lawsuit against AVP for alleged "channel stuffing," where AVP supposedly shipped products representatives without an order and held representatives responsible for payment for the unordered shipments. It is likely that AVP will incur future costs through litigation and resolution of the lawsuit, which may include terms that would increase costs and decrease profits for AVP. ^[3]

Multi-year Cost Restructuring Initiative May be Unable to Reduce Costs and Support Increased Advertising

In late 2005, AVP launched a Turn-around plan that included several strategic initiatives to realign costs, improve products, and increase market share through brand competitiveness. AVP expects annualized savings of more than $430 million when the plan is fully implemented in 2011-2012. However, with the global economic downturn and slowing demand for non-essential personal care products, AVP may not be able to achieve its savings target. For example, AVP has dropped its prices so far that at the end of Q2 2009, 70% of its products were prices less than $5.^[11] Falling short of its savings targets would be detrimental to AVP's profitability as it would not longer be able to support its increased advertising spending. In 2008, AVP increased advertising costs by 6% ^[12] which was much lower than the 48% increase in 2007 and 83% increase in 2006 ^[13] - a sign that the company was cutting back due to the economic downturn. to support new product launches and improve brand recognition as part of the turn-around plan. Although AVP does not want to reduce advertising spending, which means success of the turn-around plan is vital to supporting AVP's increased advertising costs as well as costs incurred by AVP's entry and expansion in new global markets, the economic downturn has forced the company to cut back on advertising. In Q1 2009, AVP's focused shifted from advertising to recruiting more sales representatives - the number of representatives increased by 7% during the quarter. ^[14] However, the company plans to further cut costs by cutting 1,200 jobs, or about 2.8 percent of its global workforce, by 2013.^[11]

Direct-Selling Business Model Exposed to Regulations in the Global Market

Avon has become synonymous with the direct-selling business model - the process by which the company hires independent contractors, called Active Sales Representatives, and pays them percentage of commission to sell Avon prodcuts directly to customers. By removing the need for a middle distrubutor, such as a department or cosmetic store, AVP hopes to eliminate costs and increase profits. In 1998, the Chinese government banned direct-selling in response to abuses perpetrated by some corporations. The company's business in the region was crippled in the short-term and strongly disadvantaged in the long-term as the company was forced to abandon its direct-selling strategy and had to open its own retail stores in order to sell products. ^[15] Not until 2006 did China re-licensed Avon for direct-selling, which allowed Avon's revenues from China to increase rapidly from 2006 to 2008. Total revenue from China rose from $212 million in 2006 to $280 million in 2007 to $351 million in 2008. ^[16] Similar situations may arise in Avon's other emerging market segments, which would negatively impact Avon's revenue growth globally. ^[4]

Large Presence in Global Market Exposes AVP to Currency Fluctuation Risks

78% of AVP's sales revenues come from markets outside of the United States, making the company very sensitive to currency fluctuations and the strength of the dollar. ^[16][A weakening of the dollar against foreign currencies would allow AVP products to become more competitively priced in global markets, thus positively affecting sales revenue from foreign markets; however, a weak dollar would also mean higher costs for products manufactured overseas. For example, in Q3 2008, AVP's operating profit in Central & Eastern Europe was 13% lower due to negative impacts from foreign exchange on costs. ^[17]

Competition

As a retailer of personal care products, AVP faces intense competition from other mid-end personal care product retailers. Most of its competitors use a reseller model and distribute its products to retail stores such as Walgreens, Wal-mart, Macy's, etc., while others also sells products through the direct-selling channels. Almost all competitors also advertise and sell products through an online channel.

Major Competitors

• L'oreal (LRLCY) - is a global cosmetics company that makes products for skin care, hair care, hair coloring, make-up, and styling products.
• Estee Lauder Companies (EL) - makes skin care, makeup, fragrance and hair care products.
• Revlon (REV) - makes cosmetics, women’s hair color, beauty tools, fragrances, skincare, anti-perspirants/deodorants and personal care products.
• Bare Escentuals (BARE) - makes cosmetics, skin care and body care products.
• Elizabeth Arden (RDEN) - makes fragrance, skin care and cosmetics products.

References

1. ↑ Reuters "Avon Announces Final Initiatives of the Restructuring Program Under Its Turnaround..." 8 Jan 2008
2. ↑ AVP SEC Filing 2008 10-K, Pg. 7
3. ↑ ^{3.0 3.1} Legal News Watch "California Court Reinstates Class Action Lawsuit Against Avon" 25 May 2005
4. ↑ ^{4.0 4.1} Business Net "China Game.(China's direct-selling ban)" June 1998
5. ↑ ^{5.0 5.1} AVP SEC Filing 2008 10-K, Pg. 8
6. ↑ ^{6.0 6.1 6.2 6.3 6.4 6.5 6.6} AVP Fourth Quarter and 2008 Results Press Release
7. ↑ ^{7.0 7.1} AVP Q3 2009 Report, pg. 3
8. ↑ Yahoo! Finance "Stronger dollar weighs on Avon Products in 3Q" 29 October 2009
9. ↑ AVP SEC Filing 2008 10-K, Pg. 6
10. ↑ Beauty Packaging Overview of AVP
11. ↑ ^{11.0 11.1} Yahoo Finance "Avon Products 2nd-quarter profit drops" 30 July 2009
12. ↑ AVP SEC Filing 2008 10-K, Pg. 21
13. ↑ AVP SEC Filing 2008 10-K, Pg. 18
14. ↑ Marketing Daily "Avon Reports Sales Gains, Shifts Ad Spending"
15. ↑ Asia Times "Watch out China, the Avon Lady may come calling" 20 Feb 2004
16. ↑ ^{16.0 16.1} AVP SEC Filing 2008 10-K, Pg. 29
17. ↑ AVP SEC Filing 2008 3rd Quarter 10-Q, Pg. 12
18. ↑ AVP 2008 Annual Report
19. ↑ LRLCY 2008 Annual Report
20. ↑ EL 2008 Annual Report
21. ↑ BARE 2008 Annual Report
22. ↑ REV 2008 Annual Report
23. ↑ RDEN 2008 Annual Report