Upside and Downside Risks to Avon's $31 Value


Avon Products ( AVP ) has had a volatile 12 months with its stock price touching a high of around $36 in the fall to a low of around range of $26 in March. We value Avon with a $31 Trefis price estimate of its stock at roughly a 10% premium to its current market price, which is still hovering at the lower end of its 52-week range. Here we take a closer look at the potential upside and downside risks to our otherwise optimistic outlook on Avon's stock. Avon competes beauty and personal care companies like Estee Lauder (NYSE:EL), Revlon (NYSE:REV), L'Oreal (PINK:LRLCY) all of which distribute through third-party retail outlets vs. Avon's direct selling business model.

~30% upside scenario | $40 Trefis price estimate for Avon's stock

1. Number of Sales Representatives (+10%)

Direct selling has served as an alternate and an additional source of income for many during recessionary times. With the U.S. unemployment rate hovering at over 9% as of June 2011, the job market still has a long way to go before it recovers to normal levels, and this could encourage more people to sign up as sales representatives.

We currently estimate Avon's sales force will grow from 6.5 million as of 2010 to 8.75 million over our forecast horizon. In a scenario where there is a drawn out macroeconomic recovery, we expect a steeper rise in the number of sales representatives to almost 9.5 million by the end of our forecast period leading to a 10% upside to our current $31 Trefis price estimates of Avon's stock.

2. EBITDA Margin (+20%)

Despite bypassing operating expenses such as retail space rentals and retailer margins which are associated with selling via brick-and-mortar stores, Avon still has to incur hefty expenses in printing brochures amounting to over $472 million in 2010 advertising to the tune of $400 million and accepting returns of unsold or obsolete products worth almost $131 million. This feeds through to lower EBITDA margins of close to 12%.

We currently forecast the EBITDA margin to rise to 13.3% in the coming years predominantly due to fewer promotional pricing activities and a recovery in spending on higher priced cosmetics. In a scenario where EBITDA margins rise further than our expectations facilitated by the recent restructuring programs ushered in 2009 to around 16% - this leads to almost 20% upside potential.

~20% downside scenario | $24 Trefis price estimate for Avon's stock

1. Number of Sales Representatives (-10%)

Avon leveraged the poor employment status of the U.S. economy during the recessionary 2008-09 by expanding its sales force from 5.4 million in 2007 to 6.2 million in 2009. This however led to lower sales per sales representative, which in turn attracts fewer reps to sign up.

Hence, in the future, if Avon is more conservative on expanding its sales force, and the number of sales representatives only rises to 8 million by 2017 vs. the 8.75 million we estimate, there could be 10% downside to our current estimates.

2. EBITDA Margin (-10%)

Since much of the growth shall be sourced from emerging markets in Asia and Latin America behind more competitively priced products often through promotional or discounted pricing, this could weigh on profit margins. If this deteriorates EBITDA margin below our forecasts, there could be downside to our forecasts. In a scenario where margins reduce to around 10%, this leads to 10% downside to our current $31 Trefis price estimate of Avon's stock.

View our detailed analysis for Avon's 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 , PG



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