Avon's A Buy Following Goldman Upgrade On Recent Weakness

Goldman Sachs is adding Avon Products (NYSE: AVP) to the Americas Conviction Buy List to take advantage of recent weakness. The firm is very confident in their $2.20 2008E (ex-charges) since cost savings should accelerate next year. 2Q (reported July 31) was weaker than street expectations primarily due to management's bias to spend now for earnings acceleration in 2008 and 2009. The risk/reward for AVP is very attractive at currently in their view, with 32% potential upside, and although investments in advertising and RVP are likely to remain high near term, margins should recover over the coming quarters. Plus, sales growth has already begun to benefit from the spending.

GSCO believes the earnings recovery that they forecast in 2008 and 2009 will be the catalyst for the shares to move higher. Once investors gain comfort that management does not plan further major increases in advertising and RVP, they should regain comfort with estimates, and the firm believes the stock will look very attractive. Also, management significantly stepped up share repurchases in 2Q, which they believe could continue over the coming quarters and support the shares. Target remains at $45.

Notablecalls: AVP stock is down over 10% since missing consensus expectations two weeks ago. Avon spent an additional $71 million in the quarter toward ads and an incentive program for its representatives, which was the main driver for the shortfall. Avon also said it would ramp up ad spending an additional 15% in 2007. The co is in the middle of a multi-year restructuring that includes cutting jobs, eliminating less profitable products and aggressive advertising. Investors are fearful that the high level of agressive advertising is here to stay (and may go up from here!) as competition is getting fiercer in the sector.

GSCO's call helps to soothe the fears regarding advertising expenditures, saying management is not planning any further hikes. Margins have a good chance of recovering as the funds put to work in advertising in past quarters will be starting to bear fruit. Generally, Avon is considered a smart advertiser, putting their dollars to work where very good rates of return are seen.

Currently, the market is pricing in further hikes and little in terms of margin recovery. That's the disconnect traders can take advantage of, according to Goldman.

I like this one and I'm going to call it Actionable here. Be prepared to pay up early on but don't overpay! I think there could be couple of days of upside in store following the call.