Avon’s Cost Savings Program Could Squeeze Profits In The Near Term

Avon Products (NYSE:AVP) is undertaking a restructuring exercise in view of its declining revenues and profitability over the past year. The process which started with Sherliyn McCoy taking over as the CEO ^[1] from outgoing Chairwoman Andrea Jung ^[2] in April this year progressed to the next step with the company releasing the details of initial steps towards its targeted $400 million savings by the end of 2015. The initial steps include a headcount reduction besides an exit from the South Korea and Vietnam markets. It now plans to focus its energies on high priority markets. We expect the costs associated with the restructuring to further reduce Avon’s shrinking margins and have a considerable effect on its Q4 results.

Its direct selling business model differentiates it from its competitors, L’Oreal (PINK:LRLCY), Procter & Gamble (NYSE:PG), Estee Lauder(NYSE:EL) and Revlon (NYSE:REV).

View our detailed analysis for Avon’s stock here

Over the past two years Avon has seen its operating margins shrink from ~10% in 2010 to ~4% for the first nine months of the current fiscal year. With total sales declining by ~10% y-o-y during the past two quarters, and the cost structure remaining similar, the company announced a two pronged strategy of improving top line growth and aggressively managing its cost base during the third quarter earnings call in November. ((Avon Products Management Discusses Q3 2012 Results – Earnings Call Transcript, Seeking Alpha, November 2012)) The plan is to pursue both tactics in parallel.

The initial cost saving measures include a targeted global headcount reduction by approximately 1,500 positions and exiting the under-performing Vietnam and South Korea markets. ^[3] These actions will help the company concentrate resources on high priority markets of North America and boost efficiency at the same time.

The actions are expected to cost in the range of $80-90 million of which approximately $50-60 will be realized in the current quarter. These charges are expected to be comprised primarily of $55 to $65 million of employee-related costs and $20 to $25 million in accelerated depreciation, in connection with these initiatives.

Assuming a Q4 income statement similar to Q3, the added expenses could see its operating margins shrink from ~4% in Q3 to ~2%. The remaining ~$30 million will be distributed over further quarters. Its critical to note that several such measures will be announced over the next three years as the current plans account for just about 20% of the target. However, the effect of the added costs on the later quarters could be minimal if the initial initiatives have the desired effect and the operating margins improve to the historical level of 7-10%.

We have a $17 Trefis price estimate for Avon stock which is 15% above the current market price.

1. Avon names Sherilyn McCoy CEO, replacing Andrea Jung, ABC News, April 2012 [↩]
2. Avon Chairwoman to Quit Earlier Than Expected, The New York Times, October 2012 [↩]
3. Avon Announces Initial Steps of Cost Savings Initiative, Avon Products, December 2012 [↩]