Can Avon Products Really Turn Around?

Recent news from Avon Products hasn't been pretty. Legal problems, currency issues, and weak results in key regions have punished the stock but the company may be able to turn things around. Is it worth taking a chance on Avon?

Can this beauty-products maker overcome its problems?
Avon Products is a well-known beauty-products company with more than 6 million active independent representatives selling products directly to customers worldwide. The company posted lackluster results in its latest quarter. Revenue declined 2% compared to the prior year on a constant currency basis thanks to a 3% drop in the number of sales reps and a 7% decline in products sold.

The company's legal predicament may dwarf quarterly results, however. In 2008, Avon voluntarily contacted authorities about a lack of compliance with the Foreign Corrupt Practices Act. Currently trying to resolve government investigations, the company made an approximate $12 million settlement offer earlier this year.

Authorities countered with a proposal, though unspecified, that was deemed to be significantly greater. Though most likely affordable, a sizable penalty would rob Avon of resources better used elsewhere.

The company's Asian business could certainly use the help. Recent quarterly sales in that area declined 22%, from 2012. China revenue dropped a stunning 69%. While Avon is overturning regional management, it still expects Asian weakness over the next several quarters.

The company also ran into a major issue in Venezuela. A 32% devaluation in that country's currency cut year-to-date operating profits by $45 million. A one-time $51 million write-off was also taken with an additional $5 million earnings hit anticipated for this year.

Avon does have opportunities though. Its North American business could be revitalized. A lack of selling representatives pushed quarterly revenue down 19% year over year but the company aims to restore its sales presence. The U.S. market should be lucrative and it seems reasonable that results would be improved with proper management guidance.

Avon is also implementing a company-wide $400 million cost-savings program. This aggressive initiative is designed to meaningfully increase operating margins by 2016.

Given the difficulties, the company's share price has been surprisingly resilient. Assuming Avon matches 2012 profitability metrics, its cash earnings, basically net income plus non-cash charges such as depreciation and amortization adjusted for expected capital expenditures, would be roughly $360 million on estimated revenue of $10.1 billion. The company's shares, currently trading at a hefty 20 times those earnings, suggest the market may have already priced in some portion of a successful turnaround.

Other, more predictable, beauty-product candidates
Though any good news from Avon would likely deliver a trading bounce, avoiding the stock is understandable given the uncertainty. Luckily, other companies in the beauty-products space might be worth a look.

Sally Beauty , a large retailer and distributor of professional beauty supplies, could be interesting. The company performed solidly in its latest fiscal year ended in September. Net sales were more than $3.6 billion, an increase of 2.8% from 2012, and net earnings came in at a slightly lower $261.2 million, the drop mainly due to higher costs for expansion.

The company's ability to generate cash and use it in a shareholder-friendly way is its real attraction. Sally Beauty produced $310 million in operating cash in 2013 and had more than $200 million in free cash flow, or operating cash less capital expenditures, annually over the last three years. Management has also not been shy about using this cash to repurchase shares. Approximately $510 million worth of common stock was bought in 2013 after $200 million was purchased in the previous year.

Assuming sales of roughly $3.6 billion with cash earnings of $282 million, Sally Beauty shares trade at about 16.2 times cash earnings. Though not exactly a bargain, the valuation looks intriguing given management's skill at employing free cash for shareholder benefit.

Elizabeth Arden may also be an attractive consideration. It offers a portfolio of prestigious beauty brands available in more than 100 countries. In its most recent quarter, the company reported steady sales of $343.6 million, basically flat year-over-year. Adjusted income per diluted share was $0.22 compared to $0.44 per share in 2012. The drop was primarily due to higher non-cash depreciation and amortization expenses.

The lack of sales growth was somewhat disappointing given annual increases of 9.5% in fiscal year 2013, ended in June, and 5.3% in 2012. But the company's invigoration of its namesake Elizabeth Arden brand was impressive. Quarterly net sales of Elizabeth Arden products increased 12.3% over the prior year on a constant currency basis.

Based on expected sales of approximately $1.4 billion and cash earnings of $65 million, Elizabeth Arden trades at a relatively fair 16.7 times those cash earnings, but with some upside possibilities. The company's portfolio of brands has the potential to deliver unexpected growth. Celebrity fragrances based on names like Taylor Swift, Nicki Minaj, and Usher or designer fragrances like Juicy Couture, Alfred Sung, or BCBGMAXAZRIA all have a chance to catch a fashion trend and deliver a surprising sales bump.

Avon Products isn't very alluring. Between operating woes and legal troubles, the company hasn't had much good news to report lately. Its share's, though, seem to be anticipating some better times ahead.

Companies like Sally Beauty or Elizabeth Arden might present an equally bright future. Suited to investors who want exposure to the dynamic beauty-products sector, with less uncertainty than a holding in Avon would incur, they could offer respectable returns with much less volatility.

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