Avon's 6% Dividend: Whistling Past The Graveyard

| About: Avon Products, (AVP)

Wednesday, Avon Products (NYSE:AVP) declared its regular $0.23 dividend:

NEW YORK, Aug. 1, 2012 /PRNewswire/ -- Avon Products, Inc. today declared a regular quarterly dividend on its common stock of $.23 per share, payable September 4, 2012, to shareholders of record on August 15, 2012.

Given the 6% yield, holders must have shared a collective sigh of relief. Unfortunately, while it's not in writing, the company all-but-promised that it will be reducing it in the near future. During the company's earnings call, CFO Kimberly Ross declared:

Today, we have declared our regular quarterly dividend of $0.23 for the quarter. Going forward, we are focusing on developing a capital structure that will strike the right balance between returning cash to shareholders and reinvesting for sustainable growth. As I said before, the dividend should be funded consistently through our income statement rather than our balance sheet. And as we complete this review, our intention is to bring Avon's dividend more in line with our overall performance and our peer group.

You might want to check the transcript for a broader discussion, though the company didn't really say much more than that the new dividend will take into account payout ratios of peers.

I don't think that this news is really that surprising. Investors who listened to CFO Ross on the Q4 conference call may be disappointed, but she only promised for 2012:

Now moving on to our dividend, which has been a topic of much discussion. We understand the great value shareholders place on the dividend and recognize that its sustainability and consistency lies in paying the dividend with the P&L, not the balance sheet. After careful consideration, we are maintaining our dividend at $0.92 per share for 2012, which is approximately $400 million.

Longer-term investors should not be discouraged, as new CEO Sheri McCoy shared the "bones" of her turnaround plan, declaring that she can "fix" the company. It is likely that she can, though it sounds like the company will have to spend money upfront to do so, particularly in IT.

If you are counting on that fat dividend, don't. It's likely to be cut by more than 50% in my view, which would get the payout ratio down to less than 50%. Closest peer Tupperware (NYSE:TUP) has a payout ratio of below 30%. Looking at cosmetics company Estee Lauder (NYSE:EL), it pays out about 1/4 of its net income in dividends.

With the recent earnings shortfall and a turnaround plan that involves upfront expense and lower price points, my estimate may prove conservative. Before the report, analysts were estimating .94 for 2012 and 1.16 for 2013, but the quarter was light at .20. YTD, the company has earned just .30 on a non-GAAP basis (down from .86 in H1-2011). Based on the cautious commentary on sales and margins and considering probably investments, it would seem prudent to assume that the company earns no more than .70 in 2012 and perhaps $1 in 2013. To make .70, the company would need to earn .40 compared to .78 in H2-11, which would be an improvement relative to the 65% decline in EPS in H1. If the company were to payout 40% in 2013, the annual dividend would drop to .40, while a 50% payout ratio would reduce it to .50 from .92. Even at 50% of the prior analyst consensus for 2013, the dividend would fall to .58 (37%).

Given that the company has stated that it is looking to reduce the dividend and to get the payout closer to that of its peers, investors should expect a dramatic reduction, perhaps more than 50%. Based on consensus forecasts, the company was already paying out almost 100% of projected 2012 EPS before the miss and the cautious outlook. A more reasonable payout would appear to be 25-50%. AVP's balance sheet is reasonably strong (about $2.2 billion in net debt, or 2X projected EBITDA), but, with the sales and earnings in decline, investors are not likely to tolerate continued negative free cash flow. So far in 2012, the cash flow from operations of $41mm has been exceeded by the $88mm in capital spending. Each .10 reduction in the annual dividend will save the company approximately $43mm. If the company lowers the dividend to .40, annual savings would be $225mm.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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