Avon Products (NYSE:AVP) has declined 95% since peaking at $46 in 2004 due to declining revenues and margin compression as which has been exacerbated by a declining EV / EBITDA multiple.
The recent deal with Cerberus Capital Management has several benefits including: (i) will allow management to focus on its international business, (ii) will increase cash on hand by $335m, (iii) will increase EBIT by $60m to $70m (the North American EBIT loss) and (iv) will give AVP access to the extensive restructuring experience from one of the premier distressed private equity investors on Wall Street.
According to the AVP investor day presentation on January 21, 2016, the international operations are growing revenues at 3% on a constant currency basis.
The company announced a new 3 year restructuring program with cost savings of $350m which should drop straight to EBITDA, net income and free cash flow. This should be a catalyst for higher EBITDA multiples.
Personally, I think the USD will peak in 2016 for a variety of reasons. This should meaningfully impact AVP which post divestiture of its North American business has essentially 100% of its revenues internationally (primarily in Latin America, Europe and Asia) but a lot of its corporate overhead in USD.
According to the AVP investor day presentation on January 21, 2016, average FX rates in the 10 markets where AVP is primarily does business have declined 45% against the USD significantly eroding AVP's profitability.
Overview of Cerberus Capital Management Transaction
The table below summarizes the terms of the recently announced transaction with Cerberus Capital Management (CCM).
The current capitalization shows net debt to adjusted LTM EBITDA at 6.7x and EV / EBITDA at 5.2x run rate 6/30/2016 adjusted EBITDA. The adjustments include removing one-time restructuring charges as well as EBITDA associated with the North American business that was spun off as part of the transaction with Cerberus Capital Management.
Leverage levels are high at this stage and the current bond prices reflect this. AVP recently priced a $500m bond issue at 7.625% due 08/2022 which is currently trading at 103 or a yield at around 7%.
Publicly Traded Comparables
The table below shows various publicly traded comparables including direct selling competitors as well as other cosmetics and personal care companies.
The table below shows proforma historical revenues and EBITDA excluding the North American business as well as restructuring costs. For the period ending 6/30/2016 LTM, AVP generated $5.8BN and $304m in adjusted revenue and EBITDA respectively. Again the adjustment excludes one-time restructuring charges as well as the revenues and EBITDA from the North American business.
Click to enlargeAdjusted EBITDA (adjusted for restructuring expenses) have ranged from the current 5.2% in fiscal year 2015 to as high as 16.2% in 2008. Likewise, the adjusted EV / EBITDA multiples have ranged from 7.3x to nearly 18.0x.
Assuming AVP will be able to grow EBITDA in the coming years due to the successful implementation of the recently announced $350m restructuring program and (ii) weakening of the USD, I expect both higher EBITDA and EBITDA multiples.
I have modeled a 3 case scenario (low, base and high) with different assumptions. Each case starts with the $5.8BN LTM 6/30/2016 revenues ex North America and then applies an EBITDA margin and EBITDA multiple to arrive at enterprise value, equity value and per share equity value.
EBITDA margins have been modeled at between 10% and 14%. There are several reasons why I believe margins will expand in the coming years:
- AVP announced a new restructuring program which aims to save $350m over the next 3 years. It is true that AVP has had several restructuring programs in the past but unfortunately their impact was counterbalanced by declining revenues and a surging USD.
- AVP should benefit from a weaker USD once the dollar rally falters. My personal opinion is that the USD will peak sometime in 2016 when the market realizes that the story line that has driven the USD higher (Fed hiking cycle amid a strong US economy) is proven to be an illusion. The fact that commodities are already at multi decade lows and will probably rally at some point also underpins this belief.
- Many of AVP's primary markets are in deep depressions. Brazil for instance is experiencing the worst recession in the past 70 years with double digit inflation, 9%+ unemployment, a plunging currency and deep economic contraction. Eventually these markets will resume their secular growth which should benefit AVP's top and bottom line.
- Finally and most importantly, AVP seems to have finally fixed fundamental problems of the past with declining # of representatives and a declining top line. The top line of the business with revenues growing at 3% in constant currency terms and # of representatives also increasing for the first time in 2 years (see AVP investor day presentation January 21, 2016).
In the base case I assume a 12% EBITDA margin which is average for the historical period (from 2007 to current) and a 10x EBITDA multiple which yields a share price of $9.89 (61.7% upside from current levels) and $9.08 (48.4% upside) assuming conversion of the Cerberus Capital Management preferred stock.
The high case obviously has higher margins, multiples and thus per share equity value. The low case has 10% EBITDA margins and an 8x EBITDA multiple which implies an approximately a $4.60 share price.
As previously discussed AVP has experienced a near 95% decline in share price. The fall has taken the form of a double zig zag or 2x ABC corrections. Typically, in an ABC correction wave A equals wave C in length. For the 2nd zig zag the equality measure comes in at $2.21 which is where the low came in. I acquired shares at $2.50 in January 2016 as I stated in my article on AVP published at that time.
2 Day Chart
The 2-day chart shows that wave C is complete with 5 completed waves. A strong upturn has commenced since then with shares up more than 170%.
4 Hour Chart
Reviewing the price action since the $2.21 low in January 2016 we see an initial 5 wave bull market from $2.21 to a high near $6 upon which we got a correction in 3 waves that bottomed at approximately $3.50.
This is text book Elliot wave price action and the recent explosive move off on Q2 earnings indicate that a very strong wave 3 is now in effect targeting $8 and $9.
AVP has been in a multi year downtrend due to deteriorating financials. The company recently partnered with Cerberus Capital Management to take an 80% stake in its North American business as well make a $435m investment in AVP preferred stock.
The technical action YTD 2016 has been very encouraging and the quarterly earnings have shown slight improvement.
As a result, I believe AVP bottomed at $2.21 in January 2016 and that this current upturn will be long lasting and material eventually bringing shares to my target of $10. Based on the extent to which margins improve and sales grow higher targets may be possible further out.
In January 2016 I wrote" The technical picture clearly points to a potential bottom in the near term. Once margins improve I expect EBITDA multiples to return to the historical range closer to 8x to 10x. As a result, I expect the AVP share price to reach $10 within the next 2-3 years generating a near 250% return".
The price action and fundamental improvement in earnings have been exactly as expected. I stand by my initial forecast although it is possible we will achieve $10 share price sooner than initially expected.
Disclosure: I am/we are long AVP.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: This article presents the opinions of the author and does not provide individually tailored investment advice. It has been prepared without regard to the individual financial circumstances and objectives of persons who receive it. Investors are recommended to independently complete their own due diligence and evaluate any investment independently as well as to seek the advice of a financial advisor. The appropriateness or legality of a particular investment will depend on an investor’s individual circumstances and investment objectives. The securities, instruments, or strategies discussed in this article may not be suitable for all investors, and certain investors may not be eligible to purchase or participate in some or all of them. The article is not an offer to buy or sell or the solicitation of an offer to buy or sell any security or instrument or to participate in any particular trading strategy.