Unloved $10 Stock Poised For A Big Comeback
One of the most interesting changes in the market over the past few years is the resurgence in investor interest for U.S.-led profits. This is in stark contrast to before the financial crisis when many investors passed over domestic stocks for emerging market growth. You couldn't watch 10 minutes of CNBC without hearing how developing world growth would crush the stagnant economies of the United States, Japan and Europe.
The iShares MSCI Emerging Markets (NYSE: EEM ) surged more than 200% in the four years to September 2007, compared with 46% for the S&P 500, and it seemed investor sentiment couldn't get more bullish.
And of course, it didn't. The emerging market fund is down almost 10% since September 2007 against a 36% gain on stocks in the S&P 500.
But have things really changed that much? The U.S. will probably eke out 2% GDP growth this year, according to the IMF, which is still well below the 4.4% growth projection for the emerging world. The United States is still running a nearly $500 billion deficit, and the greenback is more than 10% weaker over the past decade against a basket of peers.
The weakness in emerging market stocks will not last, and investor sentiment could begin to turn as early as this quarter. Weaker currencies mean stronger exports when third-quarter economic numbers come out, and emerging market investors could start to see the light at the end of the tunnel.
Over the longer term, these economies should fulfill expectations for strong consumer growth.
By 2020, Latin America will represent 10% of the global population with a market of 640 million consumers, according to Americas Market Intelligence (AMI). The region's GDP is on track to double in this decade, and AMI cites changing demographics that include "the enhanced role of women in society, and the emergence of a robust middle class."
Few companies are better positioned to take advantage of this than today's pick. This company has a 128-year history and a brand that has represented female empowerment for millions across the globe.
Shares have struggled along with emerging markets. In the past year alone, they are off 40%. But things may be about to change as a corporate turnaround program starts building momentum and stronger growth returns to emerging markets.
Avon is Still Calling
As a child of the 80s, I still remember the amazing reputation Avon Products (NYSE: AVP ) once had in the United States. Just about every woman in my extended family sold the products at one time, and the company has been an icon for female entrepreneurs since 1886.
Poor sales and a steep decline in active U.S. representatives sent investors running for the exits over the past several years, but most investors do not see what I see from my home here in Colombia.
Avon is still red hot in Latin America and much of the emerging world.
In fact, Avon now sees the vast majority of its sales from the developing world, with nearly half coming from Latin America.
The company reported a 6% drop in 2013 sales due to translation from weak foreign currencies. Sales in Latin America jumped 6%, and sales in Europe, the Middle East and Africa increased 2% before the effect of currency weakness. Without currency effects, total sales were only down 1% on the year.
A Longer-Term Turnaround With Near-Term Catalysts
CEO Sherilyn McCoy joined the company in 2012 and announced an aggressive turnaround program in December of that year. While progress has been slower than hoped, the company improved its operating margin by 130 basis points to 7.9% in 2013, and achieved a third of its three-year, $400 million cost-saving goal.
In the most recently reported quarter, sales decreased 8% when accounting for weak foreign currencies, but increased 1% in constant dollars. And earnings of $0.23 per share beat estimates by 35%.
If the company cannot stabilize domestic performance, it may make the segment a target for a private equity buyer. Avon already sold one mature market, Japan, to TPG Capital in 2010 for $89.7 million, and it may eventually do the same with its U.S. segment.
Standard & Poor's recently cut the company's bond rating to non-investment grade. However, I think S&P is late to the game and downgraded the company on issues now in its past. Avon had $667 million in debt maturities this year, which spooked the market for liquidity concerns. Debt maturities start to decrease significantly from here with $350 million due in 2015 and just $218 million due in 2017.
Avon has improved the health of its balance sheet with $826 million in cash and $3.1 billion in current assets that cover liabilities by more than 1.4 times. The company increased free cash flow by $64 million over the past four quarters to $402 million against fiscal 2013.
If emerging currencies strengthen over the next quarter, and I think they will, the company could see a strong revenue increase just on currency translation. Combined with continued progress on the turnaround program, investor sentiment should improve and shares should rally. Over the longer term, I see a lot of opportunity with a sale of the U.S. segment and general growth in emerging markets.
Buying Shares at a Discount or Booking a Quick Profit
Not only does Avon present strong long-term upside potential, but the relatively high volatility in the shares is increasing options premiums , setting it up for one of my favorite options strategies, selling puts .
By selling a put option on a stock, we are agreeing to buy 100 shares per contract at the option's strike price if shares are below that price when the option expires. For accepting the obligation, we are paid a premium, which lowers our cost basis. And if shares are above the strike price at expiration, that premium is ours to keep free and clear.
AVP rallied Friday as BTIG Research reiterated its "buy" rating on the stock. With AVP trading near $10.60 at the time of this writing, we can sell the AVP Jan 11 Puts for a limit price of $0.90 a share ($90 per contract). If AVP closes below the $11 strike price at expiration on Jan. 17, we will be assigned shares at that price. Since we received $0.90 in options premium, our actual cost is $10.10 per share, a 13% discount to the current price.
We want to make sure we have enough money in our account to cover the purchase. This means setting aside $1,010 for every contract plus the $90 we collected from selling the puts.
If AVP closes above $11 on expiration, we keep the premium for a gain of 8.9% in just 68 days. If we were able to make a similar trade every 68 days, we would generate a 48% annual rate of return .
Note: Selling puts is one of the best strategies for generating consistent, market-beating returns. My colleague, Amber Hestla, has earned 54.5% average annualized gains with this strategy on her way to a perfect 71 for 71 track record. You can learn exactly how to make the same trades -- plus details about her first 52 successful trades -- by following this link .
This article originally appeared on ProfitableTrading.com: Unloved $10 Stock Poised for a Big Comeback
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
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