Rise in Online and Mobile Shopping Can Threaten Avon's Stock

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Avon Products ( AVP ) sells products ranging from color cosmetics and fragrances to jewelry, house wares and even nutritional supplements. Avon is the largest direct selling organization in the world with over 6.2 million active sales representatives that buy products from Avon at a discount and earn a commission on every sale. This is what differentiates Avon from the likes of L'Oreal ( LRLCY ), Estee Lauder ( EL ), Procter & Gamble ( PG ) and Unilever ( UL ), that traditionally sell through third-party retail outlets including department stores and mass-volume retailers like Wal-Mart (WMT) or Costco (COST).

Our price estimate for Avon Products' stock stands at $36.63 , roughly 25% ahead of its current market price. Beauty products make up almost three-fourth of our estimated stock value, while fashion and home products constitute 15% and 10% respectively.

Rise in Online and Mobile Sales

Online sales in the U.S. reportedly grew 12% year-over-year (YOY) in December 2010. Health and beauty retailers reported an even steeper rise beyond 23%. What makes these trends particularly interesting is the portion of sales generated through mobile devices. These gadgets reportedly contributed 5.5% of online retail sales, a sharp increase over November 2010.

While part of this rise is no doubt a function of growth off a small mobile sales base, the report does nevertheless highlight the rising trend of online and mobile retail as a crucial medium for sales. Here we explore the impact this trend might have on Avon Products, which utilizes another alternate sales medium, direct selling via sales representatives.

Avon's Direct Selling Model

Eliminating the conventional retail channel (drugstores, department stores, perfumeries, pharmacies etc) helps Avon avoid the relatively higher retailer margins (in excess of 40%) in favor of the commission charged by sales representatives (which we estimate to be close to 25%). This not only lets Avon offer products at more competitive prices but also helps the company to earn higher profits from the sale.

Direct selling also enables Avon to be in closer contact with the final consumers, which creates better understanding of its customer base and, ultimately, leads to more efficient advertising and research & development spending. Also, since products are shipped from Avon's warehouse or centralized outlets once the order is placed, it favors better inventory management.

The downside of direct selling is that it leads to dependence on sales representatives. Avon has to incur expenses to advertise and attract talent, train the sales representative and retain these employees by ensuring that they make sufficient margins on sales. We believe this partly explains the breadth of Avon's products range. On any given household visit, a sales representative stands a better chance to make a sale with a broader products portfolio.

How Does the Growth in Online and Mobile Shopping Affect Avon's Outlook?

Competitors selling online stand to make higher margins than those selling through retail outlets. However, they cannot sell at explicitly discounted prices for fear of cannibalizing third-party retail sales and spoiling trade relations with retailers. Hence, more promotions (such as Buy Two, Get One Free etc) can be expected on companies' e-commerce websites. This would increase competition for Avon since competitors' promotional offers erode Avon's price advantage.

Further, online and mobile shopping adds an implicit level of competition for Avon, as it offers consumers the same convenience of shopping from home. While Avon does sell online, it hasn't developed a mobile-specific interface yet. With rising e-commerce facilitated by sophisticated user-friendly applications on the iPhone, Blackberry, Android and Symbian, we expect mobile shopping to draw sales sales volume away from Avon until the company can expand its online and mobile presence.

Beauty care products will likely be more affected than fashion items, as consumers still feel the need to physically touch or try fashion products before reaching a final decision on purchasing. Beauty care products, particularly items that the customer has previously purchased, will be more easily transferrable to online sales.

We estimate that annual beauty care product sales per representative will rise from nearly $1,300 in 2010 to beyond $1,900 by the end of our forecast period. However, if online and mobile shopping continue to gain momentum and Avon does not expand its presence in this realm, there could be downside to our base forecasts.

Drag the trend line in the chart above to see how various trends in beauty care sales per Avon representative could affect the company's stock value.

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You can see our detailed analysis of $36.63 Trefis price estimate of Avon Products' stock here .



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , Investing Ideas , Stocks , US Markets

Referenced Stocks: AVP , EL , LRLCY , PG , UL

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