Since I first explained here how Avon Products (AVP) was undervalued and an activist target, the stock has appreciated by 12.4%. The firm continues to be rated a "hold" on the Street, largely due to investor fatigue over failed management and execution. With Estée Lauder (EL) trading at loft multiples, however, I expect Avon to outperform.
From a multiples perspective, Avon's value is more than 50% cheaper. It trades at a respective 10.9x and 10.8x past and forward earnings with a dividend yield of 5% while Estée Lauder trades at a respective 27.2x and 20.3x past and forward earnings with a dividend yield of 0.9%. Both are more volatile than the broader market by around 30 - 40%.
At the third quarter earnings call, Andrea Jung noted some progress amidst overall dismal performance:
Obviously we're disappointed with our third quarter results and the slower-than-expected pace of recovery. We had a challenging Brazil ERP implementation, which caused greater disruption than we had anticipated, and that was the significant impact on Avon's top and bottom-line.
We have an increased macroeconomic volatility, which further pressured our third quarter revenue results. Though it's not yet reflected in our financial results, we are making some tangible strategic progress, most notably in North America, and I'll talk about that. But given the current operating environment, we no longer expect to achieve mid-single-digit sales growth and 50 to 70 basis points of operating margin expansion in 2011. We're fully assessing our long-range business plan and targeting an operational and financial update to investors in the first quarter of 2012.
North America represents a whole fifth of the business, and in order to drive up domestic demand, Jorge Martinez Quiroga, head of domestic operations, has been given the task of handling promotions. He has a solid track record, having been responsible for the realization of double-digit growth for the Mexico market. Net debt is trending towards a 25% reduction to ~$1.5B by 2013. Brazil is getting increasingly to difficult, especially in light of how O'Boticario, the second largest Brazilian comestics firm, is reportedly implanting a direct selling market plan in the region. The firm has 3,000 stores, which it can use as wholesale shops for distributors.
Consensus estimates for Avon's EPS forecast that it will decline by 2.2% to $1.76 in 2011, decline by 2.3% in 2012, and then grow by 12.8% in 2013. Assuming a multiple of 13x and a conservative 2013 EPS of $1.69, the rough intrinsic value of the stock is $21.97, implying 18.6% upside.
Estée Lauder, on other hand, faces substantial risk from multiples contraction. Much of the reason why the firm trades at a premium is due to its successful navigation during a challenging economy. Management exceptionally mitigated its cost base while meaningfully penetrating geographical markets. The only problem now is that it will need greater advertising to support the kind of top-line momentum that the market seems to be factoring into the stock price. Estée Lauder is exposed to mature department stores, which are particularly vulnerable to lower consumer expenditures. Despite improving domestic employment figures, global economic growth has still been dismal. With that said, the company has established a portfolio of top-line name brands and had has a one-fourth share in the international high-end makeup market. Its exclusive distribution partnership with Kohl's (KSS) further establishes greater visibility.
Consensus estimates for Estée Lauder's EPS forecast that it will grow by 22.2% to $2.26 in 2012 and then by 13.7% and 17.5% in the following two years. If the multiple falls to a more reasonable level of 18x and 2013 EPS turns out to be $2.51, the rough intrinsic value of the stock is $45.18, implying 21.4% downside.