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Shares of Avon Products (NYSE:AVP) jumped up on Tuesday morning after the beauty product company received an upgrade from analysts at Wells Fargo (NYSE:WFC).

Analysts at the bank see more upside potential for the struggling beauty products company. While I agree with the conclusions, I see a lack of catalysts triggering a nice run-up in the short to medium term.

Wells Fargo's Upgrade

Analyst Chris Ferrara upgraded Avon Products from "market perform" to "outperform". Ferrara raised the price target from $21-$23 to $25-$26, which implies that shares of Avon might have some 28% upside potential from their current levels.

Ferrara believes that management's turnaround initiatives are starting to gain traction, while Wall Street's expectations are low. Full year earnings for 2013 are now seen around $1.13 per share, while earnings could increase to $1.37 per share in 2014, ahead of consensus estimates.

There is still a long way to go, but real progress has been made. EBIT margin expansion is expected to outpace market expectations in the coming years. Furthermore Avon has potential for real operating leverage as a result of high fixed costs, and the fact that three quarters of sales are being generated in developing markets.

Valuation

Avon Products ended its second quarter with $873.2 million in cash and equivalents. The company operates with $2.90 billion in total debt, for a net debt position of $2.03 billion.

Revenues for the first six months of the year came in at $4.96 billion, down 3% on the year before. Net earnings fell by 79% to $18.2 million after Avon reported net earnings of $31.9 million in the second quarter.

At this pace, annual revenues could come in around $10.5 billion. I don't expect spectacular earnings for this year, although the second half should be better than the first half, especially on a GAAP basis.

Trading around $20 per share, the market values Avon Products at $8.7 billion. This values equity in the business at 0.8 times annual revenues and 18 times adjusted earnings at $1.13 per share.

Avon Products currently pays a quarterly dividend of $0.06 per share, for an annual dividend yield of 1.2%.

Some Historical Perspective

Investors have seen terrible returns over the past decade. Shares have steadily fallen from highs of $45 in 2004 to lows of $15 in 2012. Shares have rebound to $20-$25 this year, which still results in big losses for long term shareholders.

Between the calendar year of 2009 and 2012, Avon Products has increased its annual revenues by a cumulative 5% to $10.7 billion. After reporting earnings of around $500-$600 million in recent yeas, Avon reported a net loss of $42 million over the past year.

Investment Thesis

Shares in Avon Products have finally seen some upside this year after years of struggling operations and the failed takeover of Coty in the spring of last year. Shares have risen from $15 in January to highs of $24 in May, before seeing a 15% correct to current levels at $20 per share. Note that Coty (NYSE:COTY) itself actually went public back in June of this year, in a public offering which is not beautiful.

Management has made some real improvements in recent times, although a lot of one-time charges continue to impact GAAP earnings. In the second quarter alone, Avon took a $17 million charge related to inflation in Venezuela, and a $12 million settlement charge related to the Foreign Corrupt Practices Act investigations. The pre-payment of $500 million in notes also resulted in a $17 million charge, while restructuring charges cost another $8 million.

While second quarter GAAP earnings totaled just 7 cents per share, coming in at $32 million, adjusted earnings came in at $0.29 per share, or around $125 million.

So perhaps the recent 15% pullback might provide a nice entry opportunity as management seems to make progress in stabilizing revenues and boosting margins again. With shares trading around 0.8 times revenues and 18 times non-GAAP earnings, they trade at a significant discount to Coty. After witnessing a 10% pullback from their public offering levels, shares of Coty trade around 1.3 times annual revenues and 20 times earnings.

Back in April of last year I last took a look at Avon Productsprospects following the news hat Coty made a $10 billion offer for Avon, which was rejected by the board of directors.

The offer price of $23.25 was declined as the board believed it could create more value in a stand-alone basis. While shares have traded above this level so far this year, it still does not prove the board is right, especially with shares around $20 at the moment. Management's steps to boost margins going forwards should be able to create more value for shareholders in the coming years, at least that is the promise.

The company has made adjustments to its outdated business model in order to rejuvenate revenue growth. Instead of opting for the quick cash of selling the business, management is trying to create more value, supported by its board. Based on these improvements, operating leverage, and prospects for sales growth, Wells Fargo sees more upside potential.

I agree that relative valuation multiples look fair, especially in combination with expected earnings improvements and margin expansion in the coming years. A $25-$26 price target looks fair, after the recent pullback. At the same time I don't see a catalyst for a massive jump in the short run.

I remain on the sidelines for the moment, with a long bias.

Source: Avon Products - I Remain Cautiously Optimistic As Analysts Turn Bullish