These Two Factors Could Lead To 40% Decline In Our Valuation For Avon Products

Avon Products (NYSE:AVP), the direct selling company of beauty, household, and personal care products, experienced a rough year in 2014. The company’s sales declined by 12%, to $8.6 billion, as it faced a weak economic environment and underwent restructuring in its operations. Avon faced a grim economic environment, especially in the Latin American region (which accounts for over 50% of its revenues) and North America (which accounts for more than 10% of its revenues). Internally, the company underwent major management restructuring and attrition of its representative base. Avon has been on a downhill journey since 2011 (its last profitable year) as its direct selling model is losing market share to retail outlets and online shopping.

Our current price estimate of $8.14 for Avon Products is at a more than 10% premium to the current market price. In this article, we list down key scenarios which can lower our valuation for the company by almost 40%.

See Our Complete Analysis for Avon Products Here

1. Lack Of Sufficient Demand From Brazil And North America (~25% Downside)

Brazil

Brazil’s bleak economic scenario dampened Avon’s sales in 2014. The company earns more than 50% of its revenue from Latin America and, within the Latin American region, Brazil is Avon’s single largest market. Brazil is the third-largest beauty market in the world.  This market witnessed a 10% annual growth rate in the last 17 years, up until 2013 when growth slowed down to 4.9%. ^[1]

Avon’s direct selling model has seen significant success in Brazil. Direct selling contributes to approximately 70% of sales in the skincare, color and fragrance categories in Brazil. These factors fueled Avon’s erstwhile growth. However, recently consumer spending in Brazil has declined on account of grim economic conditions and high household debt. Additionally, competition in Brazil’s personal care market has turned aggressive. Avon’s introduction of the premium color line  LUXE in Q3 2014 suffered the backlash of these factors. The product pricing was not suitable for an economy where consumer price sensitivity for luxury goods, like cosmetics was high.

In 2014, Avon forged strategic alliances with KORRES, a Greek skincare brand, and Coty, a French beauty and personal care company, to boost sales in Latin America, specifically Brazil. These measures, coupled with Latin America’s economic recovery, could reignite Avon’s sales growth in the region, going forward.

North America

In 2014, North America experienced a 17% constant dollar decline in revenues and a 18% decline in its active representative base. North America accounts for over 10% of Avon’s net sales. Avon’s product sales in North America had been hit due to a drop in the representative pool. Avon had nearly 470,000 representatives in North America in 2009, which declined to 258,000 representatives by the end of 2014. The company’s representative base declined by 18% annually in North America in 2014.

Avon’s direct selling model’s success lies in having a steady pool of representatives to promote and sell its products. This continued double-digit decline in representatives is likely to weigh on sales. The recovering North American economy and subsequent creation of full-time jobs are expected to pile on additional pressure on Avon’s representative base because Avon representatives are usually non-contractual workers.  Avon has been taking aggressive measures to recover its lost business in North America. There were simultaneous improvements in the commercial marketing process in areas of product mix, pricing, and merchandising execution. Also, as reported in the Wall Street Journal, Avon might be contemplating the sale of its North American business. ^[2] Under both these scenarios, Avon has a chance of recovering its losses and becoming profitable.

Primarily due to the lack of demand in its two most important regions, the beauty products sold per executive declined by over 7% in 2014, to reach $1080. Assuming that its new alliances and restructuring efforts in these two regions would help revive sales, we currently forecast the beauty products sold per executive figure to rise marginally this year and grow at approximately 1% thereon for the rest of our review period. However, if the number of beauty products sold per executive continues to decline in the future and fall below $850 by the end of our forecast period, there will be an approximate 25% decline in our valuation for Avon.

Declining Pool of Avon Representatives (~15% Downside)

Avon’s direct selling model is based on its active representative base. As of 2014, the company had a representative base of 5.96 million, reflecting a 4% year-on-year decline. Avon competes with prominent color cosmetics and skincare companies, who sell through retail outlets, standalone shops as well as through digital media. The dependence on active representatives for most of its sales and the current attrition of representatives is causing a major dent on the company’s sales.

As mentioned above, Avon’s active representative base in North America declined by 18% in 2014 due to employees opting for full-time jobs as against the contractual job that Avon offers. In Latin America, it declined by 4% on a year-on-year basis, primarily due to low retention of new recruits in the first six campaign cycles. Similarly, the  representative base in Asia-Pacific declined 7% year on year over the same time period. In 2013, the company reorganized its sales force, which disrupted  its sales representatives pool. Over the long term, digital channels such as e-commerce are likely to cannibalize sales from the direct-selling channel for Avon, leading to a reduction in its representative base.

Currently, Avon is trying to create additional channels through its active representatives, such as the social seller. This gives the representative the ability to use his or her own e-store and do online selling. Avon is also trying to complement its direct selling model with a retail approach. For example, in Poland, representatives and sales people run their own retail stores for Avon’s products. Avon plans to roll out this model to other geographies in the future. ^[3]

Owing to the decline in demand for contractual jobs in America and internal restructuring that disrupted the sales force, Avon’s active representative base declined by 4% in 2014 to reach 5.96 million. Assuming that Avon’s efforts in creating more sales opportunities for representatives will help attract new representatives and improve representative retention rates, we currently forecast the rate of decline in Avon’s active representative base to gradually fall and then grow marginally to reach around 5.5 million by the end of our review period. However, if Avon’s strategy to revive its representative base fails and the number continues to decline at the current 4% rate for the rest of our review period to reach 4.5 million by the end, there will be a 15% downside in our valuation for Avon.

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1. Multinationals Target Brazil’s Beauty Industry for Growth Despite Drop, GCI Magazine, June 2014 [↩]
2. Avon exploring sale of North America business: WSJ, Reuters, April 14, 2015 [↩]
3. Avon’s Q4 2014 Earnings Call Transcript, Seeking Alpha, February 12, 2015 [↩]