By Palwasha Saaim
Trading close to its 52-week low at $16.40 last week, Avon Products, Inc. (AVP) is slowly being downgraded by several investment banks. Amid legal probes by the SEC regarding the bribery lawsuit, the resignation of its auditor Kerry Carr, the termination of its Vice Chairman and finally Avon's refusal of Coty, Inc.'s lucrative merger offer, the company's stock has a bearish outlook. If you own it, hold it at your own risk.
The 125-year old company grew over the years from its Beauty (cosmetics color cosmetics, fragrances, skincare, personal care) product line to Fashion (jewelry, watches, apparel, footwear, accessories) to Home (gift and decorative products, houseware, entertainment, leisure, children's, nutrition). Today, Avon has over 6.4 million representatives in more than 100 countries. But something has gone wrong somewhere.
From FY08 onwards, the company has seen turbulent times. Avon has consistently underperformed for the past four years with revenues, net income, ROE, profit margins and EPS all decreasing over time. It is interesting to note, however, that dividend payout has increased from 39% in FY08 to 77% in FY11. This year's Q1 regular dividend of $0.23 against an EPS of $0.06 indicates a dividend payout ratio of over 380%.
Additionally, capital expenditures have decreased over the same period - $381M in FY08 to $277M in FY11. FY12 Q1 capital expenditures are $45.7M as opposed to FY11 Q1 capital expenditures of $55.3M. With lower retained earnings and less cash on hand to spend on growth opportunities, one can safely deduce that the company has moved its focus away from growth - which is alarming!
What further boggles my mind is why would Avon's management not accept Coty Inc.'s generous offer? Coty Inc. holds brands including Calvin Klein, Chloe, Marc Jacobs, Davidoff, Playboy, Adidas and Rimmel. Coty also has a strategic partnership for the distribution of the perfume lines, including Antonio Banderas, Prada and Shakira in the United States and Canada. With this kind of a world class portfolio, Avon could have been able to provide its shareholders much greater value with the proposed merger.
Whether it was management's hubris or its greed for executive positions, the refusal led the stock to plummet more than a whopping 25%. Avon's justification for the refusal was that Coty, being an 'opportunist', bid lower than what the company was actually worth. It is important to note here that Coty Inc. had disclosed that it was willing to consider a price increase, in addition to the 27% offered premium over Avon's three month volume-weighted average price, if due diligence indicates a greater synergistic value in the merger.
A quick look at the fundamentals further substantiates that Avon is overvalued. Avon has fallen behind analysts' estimates for the last four quarters. Avon has a PEG ratio of 3.3 and P/E ratio of 16.81 with next quarter's growth estimate of -28.9%. The industry's average PEG ratio is 0.89, P/E ratio is 1.85 and next quarter growth estimate is 14.8%. For the personal care products segment, the PEG ratio is 1.85, P/E ratio is 17.41 and next quarter growth rate is estimated to be 50.1%.
If we take a look at its immediate competitors, Revlon, Inc. (REV) has a PEG ratio of 2.09 and P/E ratio of 10.47. Estee Lauder Companies Inc. (EL) has a PEG of 1.69, P/E ratio of 24.07 and next quarter's growth estimate of 12.7%. Reckitt Benckiser Group plc has a PEG of 3.19 and P/E ratio of 13.83 and next quarter's growth estimate of 6.2%. Procter & Gamble Co. (PG) has a PEG of 2.19, P/E ratio of 16.01 and quarterly growth rate of 5.8%. Avon's highest PEG ratio, second highest P/E ratio and a negative expected next quarter growth among its four peers, and also higher PEG an P/E than the industry and sector average, all substantiate that Avon is overvalued.
Now, those holding on to AVP might be thinking whether the company has potential to revive. I see both negative and positive factors in play, albeit more former than latter.
The company generates revenues through direct selling - a sales channel that markets products directly to customers, thus eliminating the middlemen, i.e. wholesalers, advertisers and retailers. However, Avon's new CEO Sherilyn Mccoy doesn't have any direct sales experience from her past career track at Johnson & Johnson (JNJ) and may need time to learn the company's unusual door-to-door sales strategy or better yet, come up with a new sales model to neutralize the down sliding sales.
Among other factors, Avon owes the decline in its revenue to the decrease in the number of Active Representatives involved in direct selling in all regions across the globe where Avon operates, including North American, Europe, the Middle East, Asia Pacific and Africa. Only Latin America saw a growth in active reps.
All income accounts in reported Q1 2012 earnings are lower than what they were in Q1 2011, while all expense accounts are higher. Higher labor costs, increase in allowance for bad debt in Africa, negative impact of foreign exchange, and weak macroeconomic environment in Europe are some of the reasons for the higher expenses that Avon cites.
Some external factors appear to be in favor of Avon. With an increasing number of women joining the work force around the world and thus having their own money to spend, the demand for personal care products are expected to rise. This is evident from S&P's Personal Products Index which has shown an overall uptrend since FY08.
Emerging international markets have seen a rise in the demand for packaged products. Consumers who could not previously afford these products are now a source of revenue generation for many big global corporations. If rightly targeted, these emerging markets can provide better growth opportunities for Avon.
Another positive for the stock is recent hedge fund interest. Perry Capital initiated a $100+ million position in the stock. Billionaire Jim Simons' Renaissance and Robert Atchinson's Adage Capital also significantly boosted its stakes in the stock during the first quarter (see Jim Simons' new holdings).