Avon Products (NYSE:AVP) has a compelling business model that sells cosmetics, fragrances and related products directly to consumers around the world. Unfortunately, for a number of years now it has wasted its advantage of being able to avoid the fixed costs that come with operating retail stores, but the removal of its CEO offers a renewed opportunity to bring in a leader who can boost profits back to more respectable levels.

Investopedia Markets: Explore the best one-stop source for financial news, quotes and insights.

Recent Results Recap
Avon saw third quarter sales rise a steady 5.7% to $2.8 billion on double-digit growth in Latin America and solid high single-digit growth in Central and Eastern Europe, as well as the Western Europe, Middle East and Africa. Asian growth was modest at 1% with North America the laggard, reporting a top line decline of 7%. Beauty sales grew 8% to make up the vast majority of sales at nearly 73%. This was followed by fashion and home sales at 16 and 9%, respectively, both of which saw sales fall in the low single digits. The other revenue category accounted for the balance of sales.

Operating profits rose a slightly stronger 7.4% to $278.6 million, as SG&A costs increased at a slower rate than sales. This put the operating profit margin at 10.1%, which is above the high single-digit level posted in each of the last two fiscal years. However, higher other expenses sent net income down 1.4% to $164.2 million, or a net profit margin of just below 6%. Share buybacks helped keep earnings per diluted share flat at 38 cents. For the first nine months of Avon's fiscal year, operating cash flow of $234.2 million fell well below the reported net income of $517.5 million. Capital expenditure of $197.4 meant minimal free cash flow of $36.8 million. (To know more about income statements, read Understanding The Income Statement.)

Analysts currently project full year sales growth of almost 5% and total sales of nearly $11.4 billion. The current earnings expectation is $1.83 per share, which would represent year-over-year growth of almost 32%.

Since 2008, Avon's operating margins have experienced a steady decline from about 12.5% to less than 10% in the most current full fiscal year. This has come despite steadily lower sales costs, meaning gross margins have improved. The main culprit to lower profitability has been higher SG&A costs over time. Back in 2004 they dipped below 47% of sales, but ate up almost 53% of sales last year. Free cash flow generation has also been dismal since 2007 and has fallen well below reported net income.

In stark contrast, Tupperware (NYSE:TUP), which focuses on the direct selling of kitchen products but also has a smaller beauty segment, has boosted margins over the years on a steady decline in SG&A expenses. Operating profits stood at 14.3% last year, or more than 43% ahead of Avon's. Free cash flow has also exceeded net income for each of the past two years. Procter & Gamble (NYSE:PG), which also has a sizable beauty segment and boasts operating margins closer to 20%, while beauty pure play Revlon (NYSE:REV) recently reported an operating margin above 15%.

The Bottom Line
Given Avon's direct selling model, there is little excuse for it to be reporting such low margins and free cash flow levels. Its margins are closer to that of Elizabeth Arden (Nasdaq:RDEN), a cosmetic maker that was hit during the latest recession and is still recovering. With a renewed focus on cutting corporate overhead and leveraging the decent annual sales growth into profit expansion, earnings could reach well above $2 per share. The removal of Andrea Jung as CEO offers a great opportunity to find a leader who can execute on the bottom line. At a forward P/E of less than 10, there is ample upside opportunity for investors and they are currently getting paid a generous dividend yield of 5.6%, to wait for a recovery. (For additional reading, check out 5 Must-Have Metrics For Value Investors.)

Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!

At the time of writing, Ryan C. Fuhrmann did not own shares in any of the companies mentioned in this article.

Related Articles
  1. Stock Analysis

    Why did Wal-Mart's Stock Take a Fall in 2015?

    Wal-Mart is the largest company in the world, with a sterling track-record of profits and dividends. So why has its stock fallen sharply in 2015?
  2. Stock Analysis

    Allstate: How Being Boring Earns it Billions (ALL)

    A summary of what Allstate Insurance sells and whom it sells it to including recent mergers and acquisitions that have helped boost its bottom line.
  3. Options & Futures

    Cyclical Versus Non-Cyclical Stocks

    Investing during an economic downturn simply means changing your focus. Discover the benefits of defensive stocks.
  4. Investing Basics

    How to Deduct Your Stock Losses

    Held onto a stock for too long? Selling at a loss is never ideal, but it is possible to minimize the damage. Here's how.
  5. Investing

    Retailers Rebel Against Black Friday: Bad Move?

    The Black Friday creep may have hit a wall as some stores are shutting their doors on Thanksgiving and even Black Friday to give employees the day off.
  6. Economics

    Is Wall Street Living in Denial?

    Will remaining calm and staying long present significant risks to your investment health?
  7. Stock Analysis

    When Will Dick's Sporting Goods Bounce Back? (DKS)

    Is DKS a bargain here?
  8. Investing News

    How AT&T Evolved into a Mobile Phone Giant

    A third of Americans use an AT&T mobile phone. How did it evolve from a state-sponsored monopoly, though antitrust and a technological revolution?
  9. Stock Analysis

    Home Depot: Can its Shares Continue Climbing?

    Home Depot has outperformed the market by a wide margin in the last 12 months. Is this sustainable?
  10. Stock Analysis

    Yelp: Can it Regain its Losses in 2016? (YELP)

    Yelp investors have had reason to be happy recently. Will the good spirits last?
  1. How do dividends affect retained earnings?

    When a company issues a cash dividend to its shareholders, the retained earnings listed on the balance sheet are reduced ... Read Full Answer >>
  2. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  3. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  4. How does additional paid in capital affect retained earnings?

    Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>
  5. What types of capital are not considered share capital?

    The money a business uses to fund operations or growth is called capital, and there are a number of capital sources available. ... Read Full Answer >>
  6. What is the difference between issued share capital and subscribed share capital?

    The difference between subscribed share capital and issued share capital is the former relates to the amount of stock for ... Read Full Answer >>

You May Also Like

Trading Center