Avon Products (NYSE:AVP) announced its third quarter earnings Oct. 27, 2011. They weren't what investors were hoping for. As a result, its stock dropped 18% in one day of trading. It's now near a 52-week low, and not too far off its five-year low. In addition to its mediocre results, the company also faces legal troubles with the Securities And Exchange Commission (SEC). There are many reasons why someone might not own its stock, but I'll give you three reasons why you should.


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Legal Problems

Avon's problems began in 2008 when the SEC started looking into possible violations of the Foreign Corrupt Practices Act. Essentially, Avon employees in China made payments to Chinese government officials. Those employees were subsequently suspended and then fired for their actions. The company itself voluntarily contacted both the SEC and the Department Of Justice. While the legal costs have been substantial ($224 million to date), the real damage has been to its stock price. Because it's fully cooperated with government officials, it's likely the ultimate settlement will be for far less than what it's already doled out in legal fees. While it's not something that companies want to go through, Andrea Jung and her, much-maligned, management team seem to have done a reasonable job facing the music. Two investors, who seem to be able to separate the wheat from the chaff, are Yacktman Asset Management, which picked up six million shares in the third quarter, at just under $20 a share, and the Appleseed Fund (APPLX), buying Avon after its big drop in price. I think they'll be rewarded for their contrarian behavior. (To know more about contrarian investing, read: Buy When There's Blood In The Streets. )



Financial Position

So what's all the brouhaha? Avon's third quarter earnings per share were 38 cents, flat to last year, and 8 cents lower than the consensus estimate. It wouldn't be the first time a company missed estimates, and it won't be the last. Jim Cramer, host of CNBC's "Mad Money," makes the case that after $1 billion in restructuring, their margins are actually lower. According to Cramer, Avon has frittered away operating cash flow, leading to a weak valuation of its stock. While Avon is struggling, peers like Tupperware (NYSE:TUP), Herbalife (NYSE:HLF) and NuSkin (NYSE:NUS) are all posting strong results. These are all good arguments. However, the dispassionate investor will consider, that despite all the doom and gloom, its margins through the first nine months of the year held firm. Sure they're not growing, but at least they remained about the same. Furthermore, it managed to increase overall operating profits in the third quarter, despite the North American unit delivering an 85% reduction in operating profits. In the past decade, its best year, in terms of operating margin, was 2004. In the third quarter of that year, its operating profit in North America was $77.8 million on $578.6 million in revenue for a 13.4% margin. Considering its North American and Latin American segments are hugely underachieving, a 340 basis point difference in operating margins isn't a whole lot to make up. It might require a management change, but business isn't nearly as dire as some portray it.



Dividend

Avon is what you might call a dividend contender. That's a company that isn't quite eligible to be a Dividend Aristocrat, those companies that have increased their annual dividend for 25 consecutive years. Avon is very close to entering the special club, by having increased its annual payout for 22 years in a row. There's almost no chance it's going to cut the dividend now that it's so close. The fact remains, Avon, in the past decade, has never earned less than $430 million. Regardless of the questions that exist about its business, the dividend in 2012 will be near $1 a share. Any good news, whether it be improved financial performance or an end to its legal troubles, will result in a fast-moving stock to the upside. A dismissal of Andrea Jung would also juice its stock. Until then, patient investors can take the 5% yield, and wait for better days ahead. (If you want to know what companies are Dividend Aristocrats, read: 10 Dividend Aristocrats. )



The Bottom Line

Risk-to-reward. It's what investing is all about. I think those willing to look beyond the immediate storm clouds, will ultimately reap financial gain from Avon Products.


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At the time of writing, Will Ashworth did not own shares in any of the companies mentioned in this article.



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Tickers in this Article: AVP, TUP, HLF, NUS

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