Avon Products (AVP) continued to struggle operationally in the fourth quarter and the near-term outlook is weak. As I have stated earlier, the direct selling firm makes for a perfect activist target given its discount to intrinsic value, poor execution, and doubted management. Compared to Estée Lauder (EL), Avon is more undervalued but fails to close the gap primarily due to managerial missteps and weakening fundamentals.
From a multiples perspective, Avon is significantly cheaper than Estée Lader. It trades at a respective 16.1x and 11.1x past and forward earnings with an impressive (although doubted) dividend yield of 4.8%. Estée, on the other hand, trades at a respective 26.6x and 20.9x past and forward earnings. To put this under greater context, consider that Estée is valued at slightly more than its historical 5-year average PE multiple versus just 80% for Avon.
At the fourth quarter earnings call, Avon's Chairman, Andrea Jung, emphasized challenges ahead as she advanced a turnaround story:
In terms of 2012 and how we are operating the business in the near term, our priorities are improving top line performance, cost management and cash generation. After a challenging 2011 where full year revenues were up 1% in constant dollars, the priority is restoring revenue growth. Direct selling is a momentum business. However, sustainable growth will take time, and there are still factors of macroeconomic weakness and internal volatility over the next several quarters.
The negative impact of commodities, foreign exchange and wage inflation will also continue to pressure results. In a year of transition, therefore, we're not planning for margin recovery in 2012. In terms of cash generation, we continue to focus on working capital improvement. And as you read this morning, we announced the dividend for 2012, which maintains the current level at $0.92.
But it has been traditionally difficult to turn around a direct selling firm given the nature of it being momentum-driven. And by the time that the company will have returned to normalcy, it is likely that the economy will have fully recovered by then - leaving Avon investors shorthanded in stock appreciation. During the forth quarter, adjusted EPS of $0.39 was 25% below consensus as operating profit fell 31% y-o-y. The organic top-line further fell 1% y-o-y and gross margins were 20 bps below consensus. Management has emphasized that it will attempt to mitigate its cost base through headcount reductions, but SG&A trends have been disappointing. Moreover, management has hinted that savings are unlikely to be as significant as they were in the past.
Consensus estimates for Avon's EPS forecast that it will decline by 4.9% to $1.56 in 2012 and then grow by 10.3% and 8.1% in the following two years. Of the 15 revisions to estimates, 14 have gone down for a net change of -9.2%. Modeling a 3-year CAGR of 4.3% for EPS and then discounting backwards by a WACC of 9% yields a fair value figure of $23.95, implying 26.5%.
Estée Lauder trades at a premium, but faces significant risks in its own right. Although the company has successfully weathered a poor economy, top-line momentum is uncertain and will have to be driven by greater advertising. Global economic growth has been weak and Estée Lauder is highly dependent on mature department stores. The firm's attractive portfolio brands will resonate in a recovery, but the core fragrance segment is underperforming domestically while rising input costs narrow margins.
Consensus estimates for Estée Lauder's EPS forecast that it will grow by 21.1% to $2.24 in 2012 and then by 14.7% and 16% in the following two years. Assuming a bearish multiple of 18x and a conservative 2013 EPS of $2.52, the rough intrinsic value of the stock is $45.36, implying 19.2%. This is likely only in the event of a double dip - a recovery will keep multiples elevated around 24x.