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Avon: World-Leading Direct-Selling Business with Consistent Growing Dividend for More Than a Decade

January 25, 2012 | About:
In the industry of nutrition and personal care products which involves networking marketing, nearly all the companies are trading at high valuation level such as Nu Skin Enterprises (NUS), Herbalife (HLF). Both are trading at 18-22x earning multiple and very high book value multiples, with 6.4x for NUS and nearly 14x for HLF. Just a little more than six months ago, Avon Products (AVP) was trading at the same high level. But since then, it has experienced a down-trending stock price, when it plunged from the $30 level to $16 per share in November 2011, and now it is staying at $18.3.

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Dated back much further, 10 years ago, it started the year 2002 at around $23 per share. Since then, it experienced the fluctuation ups and downs along the years in the range of $15.7-$45 range. The bottom of 2009, AVP has dropped significantly from nearly $45 in August 2008 to only $15.7 in March 2009. Along this time, AVP has paid out its increasing dividends very consistently. In 2002, the total market capitalization of AVP was around $11 billion. Ten years later, AVP total market cap has been reduced to $7.9 billion, the drop of more than 28%. And in the same period, fundamentally, we see the contrast view. AVP revenue has grown from $6 billion to nearly $11 billion; the EPS jumped 54.4% from $0.9 to $1.39, meaning the net income topped $606 million.

Business

A brief on AVP’s business: AVP is a long-standing global manufacturer and marketer of beauty and related products, beginning operations in 1886, and was incorporated in New York in 1916. AVP has been selling its products via special channel, unlike most of its competitors which sell products through third-party retail establishments such as drug stores and department stores. That channel is direct selling.

Currently, AVP has sales operations in 64 countries and territories, and the sales are conducted through around 6.5 million active independent representatives. The sales rep earn a profit by purchasing products directly from the company at a discount from a published brochure price and selling them to the customers, the end users. Currently, no single representative accounts for more than 10% of the net sales. So basically, the direct customers of AVP are its sales reps, and one of the keys to AVP's success is the growing sustainable sales rep base. AVP sells three categories of products including Beauty, Fashion and Home Care. Its Beauty category makes more than 70% of its net revenue, then Fashion, making nearly 20% of its sales.

AVP's business is quite seasonal; a large part of yearly revenue is coming from the fourth quarter, accounting for 30% of the revenue and 30-40% of total yearly operating profit because the fourth quarter is the holiday season.

In terms of geography, the main source of revenue and profit is coming from Latin America, then North America. Asia Pacific and China accounted for quite a small contribution of the total company’s performance (Asia Pac and China altogether makes 9% and 7.7% of the total revenue and profit respectively). I heard several investors are worrying about the domination of China on AVP’s performance, and when China cuts back the demand, AVP's performance would be adversely affected. That is basically not true. Not for China, but on the American region, especially Latin American.

Financials

In terms of financials, AVP has managed to demonstrate consistent performance over a 10-year period, with increasing revenue, net income and positive operating and free cash flow in that previous period.

USD million 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
Revenue 5,995 6,228 6,876 7,748 8,150 8,764 9,939 10,690 10,383 10,863
Operating Income 842 904 1,039 1,226 1,149 761 873 1,339 1,018 1,073
Net Income 430 535 665 846 848 478 531 875 626 606
CFO 755 565 745 883 896 796 590 748 782 689
Free Cash Flow 600 449 583 652 689 621 311 368 485 358


Financial health is not very great, and AVP has taken up a lot of debts on its balance sheet, with the short and long-term debt accounting for more than 42.5% of the total assets of the company, whereas cash and cash equivalents only accounted for more than 12.5%. Even with the market capitalization at only $7.89 billion, adjusting for the cash and total debt, the enterprise value of AVP stays at around $10.24 billion, equivalent to the share enterprise value of around $23.8 per share. If we combine the total profitability and the financial structure, we might expect a great return on equity but a much lower return on assets of AVP. Indeed, even though the return on equity is triple digit and lowest of 36%, the return on assets ranged from 5-20% over a 10-year period.

Management

AVP has been under the leadership of Ms. Andrea Jung since 1999 as the CEO and since 2001 as both CEO and chairman of the board. She alone owns more than 1% of the $8 billion company. And collectively, all directors and the executive management team possess only 1.75%. The biggest shareholders are BlackRock (5.77%), Capital Research Global Investors (10.5%) and Capital World Investors (5.4%). However, AVP just announced the stepping down of Jung as CEO and that that spot would be filled by outsider, but Jung would remain to be the company’s chairman. The separation of CEO and chair of the board would help to increase the company’s corporate governance, and the fact that Jung stays on the board as chairwoman can retain the representative, as she interacts quite well with them.

In terms of insider trading, the insiders have sold out significant stocks out at the price range of $28-$39 per share in the past three years from 2008 to 2011.

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Valuation

Relative valuation

AVP has dropped to the bottom range in 2009, whereas its P/E valuation is the lowest in five years, and it is equivalent to the valuation in the first half of 2005. The P/CF is 12.8x, not ridiculously low compared to the P/CF three-year average of 15.8x, and the price to free cash flow is at 28.5x.

GuruFocus has done a marvelous job for investors for the comparison convenience. As we can see, AVP has is the largest of its four competitors. However, it has a market value just a little bit more than HLF, which has only $3.3 billion in revenue. The valuation of AVP seems to be the cheapest out of four in all measures. Last but not least is the constantly increasing dividend which is now yielding 5.1%, four times that of of HLF and NUS.

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Dividend Discounted Cash Flow

The advantage of AVP stock is the constantly increasing dividends years over year. Since 2001, it paid out $0.38 dividends per share, and until now, in fiscal year 2010, the dividend paid out was up to $0.88 per share, with the annualized growth rate of 8.76%. Now we conservatively assume the dividend growth rate for the next five years will stay around only 8%, and then it will grow to infinity at the rate of only 1%, with the discount rate of 10%.

Year 1 2 3 4 5 6
Dividend FV 0.95 1.03 1.11 1.20 1.29 65.30
Dividend PV 0.86 0.85 0.83 0.82 0.80 36.86
Share value 41.02


So the enterprise share value would be worth around $41 per share with those assumptions above. If we set the target enterprise value per share at $41, AVP would be destined to have potential share appreciation of 72% to the current price.

In the inverse dividend discounted cash flow, the current price would set the growth rate for the next five years at 6.5%, a discount rate of 10% and an infinity growth of 1%.

Risks

Networking marketing businesses in a lot of countries require license with strict scrutiny from the government overseeing the business operations. So the change in the legal framework regarding direct selling businesses certainly affects the business performance.

In addition, AVP’s representatives do not always sell its products exclusively.The issue of orders delay and incorrect orders might frustrate its representatives, due to the restructuring execution of its global supply chain since 2009. The weaker of Latin American currencies would translate into weaker revenue for the company.

Altogether, the result was that the company reported declining sales in 7 of the last 11 quarters in the Latin American region, the main source of AVP’s revenue. The loss of loyal and ambitious representatives would cause the company fundamentals to erode very rapidly, as they are the direct customers and the only marketing and sales channels for AVP.

Conclusion

Even with the short-term fluctuations in its operations due to the impact of restructuring the global supply chain plan since 2009, I think over the long run, AVP will still be one of the leading companies in the direct selling industry. AVP has taken quite a high level of debt burden; however, with the spreading out of maturity and growing operating cash flow, AVP has quite a low probability of solvency risks. Apart from that, AVP was granted license of its direct selling business in the biggest markets in the world, including China in 2008, opening up huge potential for its business. Last but not least, with a consistently growing dividend yielding 5.1% and low valuation in any measures, AVP can fit in an investment portfolio for value investors and income investors.

Disclosure: No position

About the author:

Anh Hoang
Money manager into global equities, especially with US and Vietnam markets. CFA level 3 candidate. Lecturer for Stalla - CFA course in Vietnam

Visit Anh Hoang's Website


Rating: 4.0/5 (13 votes)

Comments

AlbertaSunwapta
AlbertaSunwapta - 2 years ago
How does the mail-order business (aka "online shopping") NOT present a huge threat to direct selling?

Are any of Avon's products like mutual funds - 'they are sold, not bought' ?
ken_hoang
Ken_hoang - 2 years ago
There are two advantages on the direct selling business and it is intertwined with each other. First, it would save manufacturer a lot of marketing and sales cost, instead of doing marketing, advertising etc, it would mainly rely on its Representatives to resell its products. Second, actually the representatives are already the customers of the company, so it was like the registered customers are already in place for the products.

You can see the direct-marketing companies like Herbalife, Nuskin are trading at very high multiples, because of the little reinvestment, light asset they have in the company, generating very high multiples.

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