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Avon Is Cheap and Could Be a Great Turnaround Opportunity
Posted by: roydamico (IP Logged)
Date: January 6, 2012 04:35PM
Avon Products (AVP) is a multilevel marketing company, selling products in more than 60 countries and territories. Avon's product mix consists of beauty, fashion and home.
Avon is cheaper than all of its competitors. It trades at a respective 10.7x and 10x past and forward earnings. In addition, Avon also offers a significantly high dividend yield of 5.05%. Net debt currently stands at $2.2B, or 28.5% of market value, and free cash flow generation is struggling more than some competitors with lower yields.
Avon offers the best value for the investors. Thanks to its high yield and low valuation, Avon has one of the best combinations of high recurring cash flow business and a big potential turnaround opportunity.
Unfortunately, operations have not been doing well in Brazil, the firm's largest market. These operations have not shown signs of enhancement and sales dropped 3%. Despite this headwind, Avon has operated in the Brazilian beauty-care market for more than 50 years and knows these consumers well.
Third quarter results were not good and confidence was lost. The results were very disappointing. To make things worse, management no longer expected to meet sales growth in 2011 and reassessed its long-term financial and operational targets. Furthermore, there is no expectation that the company will raise its dividend or repurchase stock during the next five years. All together, this caused investors to be more skeptical. Last but not least, the global beauty-care firm continued to be challenged in its home market, as sales in North America plummeted 8% from the year-ago period and the adjusted operating margin contracted 450 basis points to just 1.9%.
Third-quarter sales increased just 1% year over year in constant currency. The adjusted gross margin fell 60 basis points to 64.0%, while the adjusted operating margin contracted 20 basis points to 10.3%.
However, there is a good point. The firm has announced that it is shifting its representative structure in its struggling domestic market to more closely mirror its structure in Mexico and it is investing to improve the potential compensation incentives for its representatives. These changes will be materialized in 2012.
The results that Avon has shown in the third quarter greatly affect valuation by investors. Indeed, fair value estimate for Avon has dropped to $25 per share implying forward fiscal-2012 P/E of 15 times, enterprise value/EBITDA of 9.2 times, and a free cash flow yield of 4.4%.
There is no faith the company will get on the right track. Sales growth has been forecast at 3.0% in 2011 and 4.5% on average through fiscal 2015, ultimately driven by new product introductions that will be attractive for consumers. In addition, there is no certainty that the restructuring efforts will yield margin improvements in the next five-year period.
Given the very high degree of uncertainty in the global beauty care firm's business, a larger margin of safety around the fair value estimate is now needed.
These poor results and weak performance are closely related to management. After 12 years at the helm, CEO and chairwoman Andrea Jung, 51, will be stepping down from her post as CEO in 2012, and the company is looking outside the business to fill the top spot.
This is not surprising, especially when the management team has not been able to set Avon on a more stable path after the series of missteps at the global beauty care firm.
Fortunately, there is hope that things will change. Avon's newly appointed CFO Kimberly Ross and head of Latin America Fernando Acosta have both just come on board in the past few weeks.
By looking at my FAST Graphs chart, I can see that AVP price traded above the earnings justified valuation price (orange line). That changed in the past two years, when AVP started trading below its FAST Graphs justified valuation. Also, AVP has a P/E of just 10 when its normal P/E has always been more than 20x.
I find AVP a very compelling opportunity for patient investors.