Recommendation: HOLD Estimated Fair Value: $13 $25

Transcription

1 Recommendation: HOLD Estimated Fair Value: $13 $25 1. Reasons for the Recommendation Positive Outlook The beauty industry has a positive growth outlook for the next 3 years in key developing countries. Fortunately, the cosmetic industry is a mature market in five of the six countries Avon operates in. A large part of Avon s revenue comes from Latin America and it is currently expected to be a high growth region for the upcoming years. Brazil, which accounted for more than 20% of Avon s total revenue in 2011, is currently a developing country experiencing high growth. The higher growth rate from Brazil has boosted Avon s overall expected growth in Brazil s growth rate declined due to internal system errors in 2011, which was adequately address by the end of Brazil is expected to resume its high growth in The internal system error caused sales representatives to place any new orders. The new management team is looking to capitalize on growth in key countries and restore investor confidence in With the departure of former CFO Charles Cramb, Avon s board of directors brought in Kimberly Ross, who is experienced in cost cutting and streamlining processes to make a company run more smoothly. Since joining the company in December 2011, Ross has already made significant contributions that will impact Avon for the upcoming years. With the recent announcement of Avon s new CEO, Sherilyn McCoy, Avon is expected to make an announcement soon regarding the company direction in The new company direction will potentially provide a boost to investor confidence. The overall contribution from McCoy will remain uncertain until the announcement is made. New expansions plans from McCoy can boost future cash flow for Avon. On the other hand, any questionable decisions could also hinder growth in the future. The recent buy-out offer from Coty confirms the upside potential of Avon. There is a high possibility Coty will raise the buy-out price from the previous offer of $ Avon s stock price, after the offer, rose to the range of Coty s offer. Avon rejected the offer at $23.25 and said the price was too low for what Avon is truly worth. A second offer will potentially increase the stock price, and subsequently a higher buy out price,. Coty s original offer was under the current intrinsic value estimated for Avon. Avon s current stock price is still lower than the target price and has room to grow. Risk Factors New CEO Sherilyn McCoy is going through a transition stage, so it could take additional time for her to understand the details of the company and determine a new direction for 2013 and beyond. As investors keep a close eye on what the new CEO will bring for Avon, she continues to raise questions about the future direction of the beauty giant. Previous CEO, Andrea Jung, has already decided the operation strategy for the rest of The bribery allegation against Avon continues to cloud their operating plan overseas. Avon s China bribery case is the one of the most important reasons that contributed to the fall of its stock price. The bribery caused growth in the Asia Pacific region to be hindered significantly. It is difficult to predict if there is any potential for a settlement or if penalties will be assessed against Avon, and how much. The pg. 1

2 expansion plan for the Asia Pacific region will be a high priority for the McCoy and will most likely be seen in the next year. 2. Company Analysis Strength Avon is the world s leading retail cosmetics giant with strong brand recognition and loyalty. With 6.4 million direct selling representatives across 113 countries, Avon can reach a very broad market. Avon currently operates in one of the fastest growing emerging markets, Brazil, which has particularly high growths potential for beauty products. Avon contracted nearly 6.5 million direct selling representatives worldwide, but only employed little over 40,000 people on its books. The contracted representatives purchase Avon s products at a discount and resell them regionally, which reduces the need for Avon to incur additional employee costs. Weakness Avon heavily relies on its direct door-to-door selling representatives to market products and generate revenue. Year over year, revenue generated has been heavily influenced by the number of representatives in operating countries. Given the nature of the business model, representatives have a relatively high turn over rate. The utility of Avon s training program and compensation program is the key to retaining its direct selling representatives to sustain revenue year over year. Opportunity Not one single business in the cosmetics industry has distribution channels setup to operate in every country in the world. The Internet provides an opportunity to capture more business in areas where Avon does not have distribution channels. By offering international shipping, Avon has the potential to capture more customers without capital expenditures or hiring more employees to expand in countries they currently do not have direct selling representatives in. Threats Avon currently faces severe competition in a few key high growth countries. One of the key emerging markets Avon currently operates is Brazil. The biggest competitors in Brazil are Natura and Estee Lauder. Last year, Avon s competitors were able to capture more market share in Brazil. Also, Estee Lauder was able to grow 20% in revenue in the America s. In addition to the strong competition, the recession caused major drawbacks to growth in emerging markets across the world. 3. Industry Analysis The Cosmetic () industry manufactures and markets beauty related products. Products include color cosmetics, fragrances, skin care, and personal care. Avon faces very high competition in the Cosmetic industry worldwide. Primary competitors include Estee Lauder and Proctor & Gamble in terms of market share and segment revenue. Due to the different marketing and distribution channels of both competitors, Avon does not directly compete by utilizing the same method of marketing their cosmetic products. Avon pg. 2

3 also operates in two other business segments: costume jewelry and housewares. The two remaining business segments account for 27% of total revenue in Costume jewelry faces locally owned jewelry competitors. Housewares face chain competition from brands like Tupperware and Newell Rubbermaid in terms of market share and revenue. Level of Competition Avon faces a high level of competition around the world. The two main competitors are Estee Lauder and Proctor & Gamble. These two direct competitors both operate in many countries Avon currently operates in and more. They both utilize retail-marketing channels to reach more customers than Avon s direct selling channel. In Brazil, Avon is not only facing direct competitions Estee Lauder, they also face a very well known local brand called Natura. Natura currently holds more of the market share in Brazil than Avon. Unfortunately, Avon is facing severe competition in Brazil where most of its growth is coming from. Natura surpasses both Avon and Estee Lauder in market share in Brazil due to several competitive advantages. First, Natura focuses on earth friendly products to promote social support from its customers. Second, Natura s most popular product is home bikini wax, which attracts a large amount of Brazilian women to its customer base. Third, Natura gains familiarity in Brazil since it is owned by a Brazilian and utilizes more ordinary Brazilian women to advertise its products rather than hiring super models. Fourth, Natura spends a significant amount on research and development to push out new products faster. Cosmetic Industry Outlook The cosmetics industry is projected to have strong growth as global demand for cosmetic products increases in key developing countries. Brazil is expected to have strong cosmetic growth through 2014 with economists predicting an average growth rate of 6.7%. 1 The overall cosmetic industry is a continuously growing industry and has not yet reached its maturity in a majority of markets worldwide. Consumer Staple Industry Outlook The consumer staples industry is a good sector to own during economically stressful periods. It is not a cyclical sector and produces staples that will have constant demand even in a recession. Consumer staple industry has steadily recovered over the past years since the start of the recession in This sector has recovered from the lowest point during the recession and has surpassed historic peak prices to set new record highs. If another recession starts, Avon will be a very good defensive stock to own in a portfolio. Cosmetic industry customers tend to be very loyal towards their brand of choice. Avon, being the largest direct-selling cosmetic retailer in the world, has a very strong and loyal customer base. 1 pg. 3

4 Appendix A: Inputs into the Discounted Cash Flow Valuation Risk-Free Rate 0.131% Default Spread 0.66% Cost of Debt 1.95% Bottom-Up beta 1.47 Yahoo! Finance Beta 1.46 Weighted average MRP 8.43% Cost of Equity - Bottom Up 12.79% Cost of Equity - Bloomberg 13.70% Weight of Debt 64% Weight of Equity 36% WACC Bottom-Up 8.61% WACC Yahoo! Finance 9.13% Growth Rate 6% *Sources: Avon 10-k, Yahoo! Finance, Google Finance, Bloomberg, Wall Street Journal Market Data, and Survey of Professional Forecasters. Glossary: Bottom-up beta This is calculated by taking a weighted average of the unlevered betas for each business segment, and then re-levered the weighted average unlevered beta using the firm s D/E ratio. Each segment is weighted by revenues from that segment. Weighted average market risk premium This is calculated by taking the market risk premium from each country or region of operation and weighted by the revenues from that country or region. The country risk premiums are from pg. 4

5 Appendix B: Inputs into valuation using multiples Competitiors EV/EBIT EV/Revenue Avon Proctor & Gamble Estee Lauder Nu Skin Revlon Elizabeth Arden Inter Parfums *Source: SEC Avon/Estee Lauder/Proctor & Gamble 10-k reports, Yahoo! Finance, Google Finance, Bloomberg, Wall Street Journal Market Data, and Survey of Professional Forecasters. Historical Multiples TTM P/E P/B P/Sales *Source: Morningstar, Inc. pg. 5