Friday, April 28, 2006

Someone Please Give Avon a Makeover

Anyone realize how many blemishes this cosmetic powerhouse hides from our sight? Here's a couple of notes concerning Avon Products (AVP), which reports earnings later today.

Overview Avon manufactures and markets beauty-related products globally. The firm has three segments ranging from cosmetics and skincare to apparel, accessories, and decorative gifts. Avon operates in 60 countries and pulls in over $8B in annual sales through its 5M employees.

The Bear Case Avon's calling, but we're not listening. Margins are falling. Sales are flat. Headcount (# of Avon sales reps, who are being lured away by rivals) is declining faster than Mary Olsen's weight. Analysts are swearing EPS in 2006 will crumble from 2005 numbers. Sephora just hooked up with JC Penny -- the cosmetic retailing space is consolidating; what this will mean for Avon is still up in the air. Insiders own less than 1% of the stock -- we think they need to eat more of their own cooking before anyone takes them seriously. CEO Andrea Jung sold most of her stock in 2004 (check out the rockstar-esque summer Jung had 2 years ago), so the motivation to do the house cleaning may not be entirely there. Finally, because 65% of AVP's sales come from abroad, the firm is inherently susceptible to wild currency swings.

The Bull Case Avon was recently approved by the Chinese government to continue direct selling in China. The Chinese market for Avon is huge, especially because its US market is going nowhere fast. As a result, last November, Avon announced a major reorganization plan to trim down supply chain inefficiencies and hopefully rake in as much as $500M in pre-tax savings. Finally, we have to admit that Avon's low startup cost business model is attractive as it enables reps to hit the ground running without the firm selling the farm to fund Ms. Avon's first pitch.

Our Case You can't out a band aid on a ten inch wound. We're pessimistic about Avon's growth opportunities and with the competitive landscape so threatening, we'd need a massive discount to fair value before powdering our noses with this stock. Avon is a play on the China boom, right? C'mon -- who isn't in China? If you'd like to put your money to sleep for 18 months, invest in Avon. But if you want to make some dough in this white hot market, invest elsewhere. Hint, hint: look at Parlux Fragrances (PARL) - - the junkies we speak to down in Battery Park swear Avon'll snap them up inside a quarter.

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