Avon's Cosmetic Dilemma: This Pig Is Wearing The Wrong Lipstick

Avon (AVP) beat the drum and reported Q2 revenue to be up 12%. Then they slip in that Q2 net income in the second quarter 2007 was $113 million, or $.26 per share, compared with $151 million, or $.33 per share in the year-ago quarter. So in terms of real money, they are falling behind.

Avon is desperately attempting to restructure by exiting unattractive product lines. Traditionally a direct sales company, "Avon Calling," they are rolling the strategic dice with a huge advertising spend. They are also attempting to execute on product simplification.

Andrea Jung CEO claims to be pleased with the results. Q2 advertising increased a whopping 74% to $93 million. But global revenues are up only 12%. North American revenues are flat so the ad campaign is rather ineffective. Ms. Jung continued with "Given the success we are seeing in our business, we decided to increase our full-year advertising investment to $375 million, 50% above 2006's level, versus our earlier plan of a 35% increase."

Essentially Avon and Ms Jung are doubling down on a less than adequate pair. When you increase advertising at these percentages you should see return on your investment. The ad spend is so high investors are actually losing money and earnings are down.

Look at the balance sheet fundamentals. Cash is down by $1 Billion. Inventories are up by $100 million. Debt maturing within one year equals cash on hand. Stock repurchases in Q2 totaled $280 million. The strategy is not having the necessary results. When will investors decide the dividend is in danger?

The pig is using the wrong lipstick.

AVP 1-yr chart: