February 19, 2015 Avon Products Inc. Current Recommendation Prior Recommendation Neutral Date of Last Change 02/19/2015 Current Price (02/18/15) $9.10 Target Price $8.25 SUMMARY DATA UNDERPERFORM 52-Week High $15.47 52-Week Low $7.47 One-Year Return (%) -37.10 Beta 1.43 Average Daily Volume (sh) 14,107,682 Shares Outstanding (mil) 435 Market Capitalization ($mil) $3,955 Short Interest Ratio (days) 8.04 Institutional Ownership (%) 95 Insider Ownership (%) 0 Annual Cash Dividend $0.24 Dividend Yield (%) 2.64 5-Yr. Historical Growth Rates Sales (%) -4.1 Earnings Per Share (%) -19.3 Dividend (%) -32.4 using TTM EPS 12.1 using 2015 Estimate 14.9 using 2016 Estimate 11.8 Zacks Rank *: Short Term 1 3 months outlook 5 - Strong Sell * Definition / Disclosure on last page (AVP-NYSE) SUMMARY We downgrade our long-term recommendation on Avon to Underperform, after a dismal fourth-quarter 2014 performance, wherein both top and bottom lines declined year over year. The company s performance has gradually subdued due to continuous loss of active representatives, declining volume, unfavorable foreign currency translations and reduced margins in mature markets like North America. Additionally, over the last five years, Avon has witnessed a declining revenue trend in North America, especially in the U.S., mainly due to a decrease in active representatives. Going forward, the company expects its 2015 sales to bear a significant negative impact from ongoing foreign currency translations. Further, weakness in the emerging markets as well as regulatory and cash flow issues are the other negatives. Risk Level * Above Avg., Type of Stock Large-Growth Industry Cosmetics&Tltrs Zacks Industry Rank * 170 out of 267 ZACKS CONSENSUS ESTIMATES Revenue Estimates (In millions of $) Q1 Q2 Q3 Q4 Year (Mar) (Jun) (Sep) (Dec) (Dec) 2013 2,484 A 2,509 A 2,323 A 2,667 A 9,764 A 2014 2,142 A 2,189 A 2,138 A 2,341 A 8,851 A 2015 1,865 E 1,907 E 1,895 E 2,194 E 7,861 E 2016 7,981 E Earnings Per Share Estimates (EPS is operating earnings before non-recurring items, but including employee stock options expenses) Q1 Q2 Q3 Q4 Year (Mar) (Jun) (Sep) (Dec) (Dec) 2013 $0.26 A $0.29 A $0.14 A $0.34 A $1.02 A 2014 $0.12 A $0.20 A $0.23 A $0.20 A $0.75 A 2015 $0.08 E $0.15 E $0.16 E $0.22 E $0.61 E 2016 $0.77 E Projected EPS Growth - Next 5 Years % 9 (Note: Qtly. fig. may not add up to annual fig. due to rounding off) 2015 Zacks Investment Research, All Rights reserved. www.zacks.com 10 S. Riverside Plaza, Chicago IL 60606
OVERVIEW Headquartered in New York City, Avon Products Inc. directly sells cosmetics, fragrances, toiletries, jewelry, and accessories. The company markets around the world through more than 6.0 million independent sales representatives and is the world s largest direct seller. The company s products are classified under the following categories: Beauty, Beauty Plus, Beyond Beauty, and Health and Wellness. Beauty products include cosmetics, fragrances, and toiletries under the brand names of Avon Color, Anew, becoming, Skin-So-Soft, and Advance Techniques Hair Care, among others. Beauty Plus consists of jewelry, watches, apparel and accessories. Beyond Beauty products include: home products, gifts and decorative items. Health and Wellness products include vitamins, exercise equipment and other related items. The company provides its operational results under 4 reportable segments Latin America; Europe, the Middle East & Africa (EMEA); North America; and the Asia Pacific. Management is currently focused on expanding the direct selling business in the emerging markets. The company s direct selling model is a competitive advantage, particularly in the developing markets as it allows the company to quickly penetrate the market and even access remote communities without large capital investment. REASONS TO SELL Dismal Q4 Performance and Outlook Pulled Down Estimates: Avon s performance has gradually subdued due to continuous loss of active representatives, declining volume, unfavorable foreign currency translations and reduced margins in mature markets like North America. The company reported dismal fourth-quarter 2014 performance, wherein both top and bottom lines declined year over year. Going forward, the company expects its sales for 2015 to bear a significant negative impact from ongoing foreign currency translations. Further, adjusted operating margin is expected to fall up to one point in reported dollars due to foreign currency impact. These negative factors triggered a downward trend in the Zacks Consensus Estimate for 2015 and 2016 over the last 30 days. Declining Revenue Trends in North America: Over the last five years, Avon has witnessed a declining revenue trend in North America, especially in the U.S., mainly due to a decrease in active representatives, partly offset by large average order. Total revenue from this region has declined considerably from about $2,293.4 million in 2009 to nearly $1,203.4 million in 2014. Management is concerned about this rapid decrease and hence, has been constantly striving to stabilize the situation. Equity Research AVP Page 2
Adverse Impact from Currency Devaluation in Venezuela: Due to rising fiscal deficit and pressure on the Forex market, the Venezuelan government devalued its currency in January. This will help Venezuela to partially reduce its fiscal deficit but at the cost of high inflationary situation in the economy. Avon, which generates approximately 5% of its total revenue and 14% of operating profit from the country, may face challenges in maintaining profitability if the Venezuelan government restricts pricing decision of the companies to offset a possible rise in raw material prices. Avon is facing a similar situation in Argentina. Risk of Operating in Overseas Markets: Avon s financial performance may get substantially affected by its significant presence in the international markets, which exposes it to the risk of unfavorable foreign currency translations, economic or political instability and other governmental actions on trade and repatriation of foreign profits. Competitive Pressure: Avon faces competition from various products and product lines both domestically and internationally. The beauty and beauty-related products industry is highly competitive and the number of competitors and degree of competition in this industry varies widely from country to country. Worldwide, Avon competes against products sold to consumers by other direct-selling and direct-sales companies and through the Internet and against products sold through the mass market and prestige retail channels. RISKS Leading Global Beauty Company: Avon Products is a leading global beauty company, with annual revenue of over $8 billion in 2014. As the world's largest direct seller of beauty and related products, the company markets its products to women in over 100 countries through over 6 million independent sales representatives. The company also derives a substantial portion of its revenue from high-growth emerging markets, which offers a significant future upside potential. Stringent Focus on Cost Management Likely to Bring Turnaround: Avon is continually working on its long-term target of bringing down costs. In a recent move toward this direction, the company has started lowering its headcounts globally. Apart from this, Avon shut down its operations in some underperforming markets like South Korea, Vietnam, and Ireland. Moreover, the door-to-door cosmetics seller stopped the global rollout of the software supplied by SAP under its SMT project in December last year, after it failed to impress the company s sales representatives in Canada. The company expects the restructuring actions taken so far to realize approximately $400 million of annualized savings (before tax). We believe these actions will help Avon to streamline operations by focusing more on high-priority markets and activities, and also to enhance efficiencies. RECENT NEWS Avon Misses Q4 Earnings Estimates on Currency Headwinds Feb 12, 2015 Avon Products Inc. reported adjusted earnings of $0.20 per share from continuing operations, which fell short of the Zacks Consensus Estimate of $0.25 and declined 41.2% from $0.34 posted in the year-ago quarter. The company s bottom-line results were mainly impacted by foreign currency transaction costs and translation adjustments. Further, on a reported basis, the company posted a loss of $0.75 per share from continuing operations compared with a loss of $0.16 in the year-ago comparable quarter. Equity Research AVP Page 3
Total revenue for the quarter declined 12% year over year to $2,341 million from $2,667.2 million. However, the top line surpassed the Zacks Consensus Estimate of $2,328 million. On a constant currency basis, total revenue improved 5% year over year. During the quarter, the global beauty company registered an increase of 8% in price/mix, while Active Representatives fell 4% and total units slipped 3%. Average orders were up 9% in the quarter. Avon registered declines of 14% and 13% in its Beauty Products and Fashion & Home segment revenues, respectively. On a constant dollar basis, sales at Beauty Products rose 5%, while Fashion & Home revenues inched up 1%. Adjusted gross margin contracted 40 basis points (bps) year over year to 60.8% on account of negative currency translation effects, primarily in Latin America and Europe, Middle East & Africa as well as higher supply chain expenses. This was, however, partly offset by an encouraging mix and pricing, prompted by inflationary pricing in Latin America. Adjusted operating margin improved 110 basis points (bps) to 9.3%, mainly driven by VAT credits in Brazil and gains from the company s ongoing cost saving initiatives. Regional Performance In the quarter, Avon s revenues in Latin America fell 15% year over year to $1,051.8 million, while it rose 10% on a constant-dollar basis owing to the acknowledgement of Value Added Tax (VAT) credits in Brazil along with an increase in average orders, offset by a reduction in Active Representatives. Units sold and Active Representatives were down 6% and 5%, respectively, year over year. In North America, sales skidded 12% year over year to $326.9 million, mainly due to a fall in Active Representatives and units sold, offset slightly by improved average order. On a constant dollar basis too, revenues were down 11%. Units sold for the region dropped 10% year over year, while Active Representatives slipped 16%. Regional Beauty sales declined 10%, while Fashion & Home sales were down 13%. Avon s revenues of $772.9 million in Europe, the Middle East and Africa fell 11% year over year. However, on a currency neutral basis, revenues increased 5% mainly driven by higher average orders, 1% increase in Active Representatives and 3% rise in units sold. However, revenues were slightly affected by the closure of the France business. The Asia-Pacific division s revenue fell 2% to $189.4 million. Conversely, constant dollar revenues increased 2%, mainly due to higher average orders. The region marked a 5% decline in Active Representatives, while units sold inched down 1% year over year. Full-Year Synopsis For 2014, the company s adjusted earnings came in at $0.75 per share, down 26.5% from 2013 and short of the Zacks Consensus Estimate of $0.79. Revenues for the year fell 11% to $8,851.4 million, while constant dollar sales were flat compared with the last year. The company s top line surpassed the Zacks Consensus Estimate of $8,845 million. Other Financial Details Avon exited 2014 with cash and cash equivalents of $960.5 million, long-term debt (excluding current maturities) of $2,463.9 million and shareholders equity of $289.8 million, excluding non-controlling interest. Equity Research AVP Page 4
Moreover, in conjunction with the earnings release, the company announced a quarterly dividend of $0.06, payable on Mar 2, 2015, to shareholders of record as on Feb 23. 2015 Outlook For 2015, the company projects a modest improvement in revenues on a constant-dollar basis. However, given the January foreign currency spot rates, management expects 2015 total revenue to bear nearly 12 percentage points negative impact from foreign currency translation. Additionally, the company anticipates adjusted operating income for the year to be significantly impacted by foreign currency transaction costs and translation adjustments. However, on a currency neutral basis, adjusted operating income is expected to improve modestly due to higher prices and more cost containment efforts, which should offset majority of the foreign exchange headwinds. Nevertheless, adjusted operating margin is expected to fall up to 1 point in reported dollars due to foreign currency impact. VALUATION Avon s current trailing 12-month earnings multiple is 12.1x, compared with the 26.2x industry average and 19.3x S&P 500 average. Over the last five years, Avon s shares have traded in the range of 9.3x to 23.6x trailing 12-month earnings. Moreover, the stock is trading at a discount to the industry average, based on forward earnings estimates. Our target price of $8.25, 13.5x 2015 EPS reflects this view. Equity Research AVP Page 5
Key Indicators F1 F2 Est. 5-Yr EPS Gr% P/CF 5-Yr High 5-Yr Low Avon Products Inc. (AVP) 14.9 11.8 6.1 7.5 12.1 23.6 9.3 Industry Average 20.4 23.5 9.4 15.4 26.2 N/A 11.0 S&P 500 16.7 15.6 10.7 15.3 19.3 19.4 12.0 The Est (EL) 29.4 24.7 10.6 19.3 27.1 29.7 20.2 Kao Corp. - ADR (KCRPY) N/A N/A 9.9 15.7 30.8 N/A 2.4 Shiseido Company, Limited (SSDOY) N/A N/A 4.9 10.1 28.3 43.0 12.6 Coty Inc. (COTY) 23.4 23.5 10.7 14.4 23.7 30.2 20.2 TTM is trailing 12 months; F1 is 2015 and F2 is 2016, CF is operating cash flow P/B Last Qtr. P/B 5-Yr High P/B 5-Yr Low ROE D/E Last Qtr. Div Yield Last Qtr. EV/EBITDA Avon Products Inc. (AVP) 3.6 11.4 3.6 39.7 8.1 3.1 11.6 Industry Average 4.5 4.5 4.5 35.1 1.0 0.9 32.8 S&P 500 5.3 9.8 3.2 25.5 N/A 2.1 N/A Equity Research AVP Page 6
Earnings Surprise and Estimate Revision History Equity Research AVP Page 7
DISCLOSURES & DEFINITIONS The analysts contributing to this report do not hold any shares of AVP. The EPS and revenue forecasts are the Zacks Consensus estimates. Additionally, the analysts contributing to this report certify that the views expressed herein accurately reflect the analysts personal views as to the subject securities and issuers. Zacks certifies that no part of the analysts compensation was, is, or will be, directly or indirectly, related to the specific recommendation or views expressed by the analyst in the report. Additional information on the securities mentioned in this report is available upon request. This report is based on data obtained from sources we believe to be reliable, but is not guaranteed as to accuracy and does not purport to be complete. Because of individual objectives, the report should not be construed as advice designed to meet the particular investment needs of any investor. Any opinions expressed herein are subject to change. This report is not to be construed as an offer or the solicitation of an offer to buy or sell the securities herein mentioned. Zacks or its officers, employees or customers may have a position long or short in the securities mentioned and buy or sell the securities from time to time. Zacks uses the following rating system for the securities it covers. Outperform- Zacks expects that the subject company will outperform the broader U.S. equity market over the next six to twelve months. Neutral- Zacks expects that the company will perform in line with the broader U.S. equity market over the next six to twelve months. Underperform- Zacks expects the company will under perform the broader U.S. Equity market over the next six to twelve months. The current distribution of Zacks Ratings is as follows on the 1126 companies covered: Outperform - 15.8%, Neutral - 76.0%, Underperform 7.4%. Data is as of midnight on the business day immediately prior to this publication. Our recommendation for each stock is closely linked to the Zacks Rank, which results from a proprietary quantitative model using trends in earnings estimate revisions. This model is proven most effective for judging the timeliness of a stock over the next 1 to 3 months. The model assigns each stock a rank from 1 through 5. Zacks Rank 1 = Strong Buy. Zacks Rank 2 = Buy. Zacks Rank 3 = Hold. Zacks Rank 4 = Sell. Zacks Rank 5 = Strong Sell. We also provide a Zacks Industry Rank for each company which provides an idea of the near-term attractiveness of a company s industry group. We have 264 industry groups in total. Thus, the Zacks Industry Rank is a number between 1 and 264. In terms of investment attractiveness, the higher the rank the better. Historically, the top half of the industries has outperformed the general market. In determining Risk Level, we rely on a proprietary quantitative model that divides the entire universe of stocks into five groups, based on each stock s historical price volatility. The first group has stocks with the lowest values and are deemed Low Risk, while the 5 th group has the highest values and are designated High Risk. Designations of Below-Average Risk, Average Risk, and Above-Average Risk correspond to the second, third, and fourth groups of stocks, respectively. Equity Research AVP Page 8