by Will Ashworth | January 9, 2013 12:53 pm
Multilevel marketing has been in the press a lot lately, thanks to Bill Ackman accusing Herbalife (NYSE:HLF) of operating an illegal pyramid scheme in December. Prior to Ackman’s charge (not exactly a new revelation), I happened to recommend that investors buy Avon Products (NYSE:AVP), itself a big player in the MLM world. Since then Avon’s stock is up 9% compared to 5.4% for the SPDR S&P 500 (NYSE:SPY).
It’s on a roll.
The question is whether it can continue its end-of-the-year momentum, especially given the bad publicity shining brightly on the entire industry. I believe it can.
First, let’s consider its stock price for a moment. Despite a 9% run in less than two months, it’s still trading at levels not seen since March 2009 and before that, February 2000. Its price-to-sales ratio of 0.6 is one-quarter its multiple a decade ago and half that of the S&P 500.
One of my favorite valuation metrics — enterprise value to EBITDA — shows quite a gap between then and now. At the end of 1999, Avon’s enterprise value was $9.4 billion — 14.9 times EBITDA. Today, its enterprise value is $8.9 billion and just 10 times EBITDA. Avon has had just one year of positive returns in the past five. Any good news from CEO McCoy is bound to move the needle.
Avon reports fourth-quarter earnings on Feb. 11. Analysts estimate 2012 revenues of $10.71 billion with 76 cents in earnings per share. Looking back at its 1999 fiscal year, revenues were $5.3 billion with EPS of $1.17. On a per share basis, it delivered higher profits in 1999 than what’s expected in 2012. On a dollar basis, however, it should earn $25 million more than in 1999.
Clearly, operating margins were much higher back then, but gross margins are a different story altogether, at an identical 61.5% for both periods. The culprit at Avon is a bloated infrastructure. Its selling, general and administrative costs as a percentage of revenues in 1999 was 49%. Today they’re at 57%, costing shareholders $900 million annually, or a little more than $2 per share.
Not surprisingly, Avon announced in December initial steps for reducing costs by $400 million annually by the end of 2015. Part of its plan includes cutting its global work force by 1,500 people. While never a popular move, especially when jobs are so hard to come by, cuts had to be made. If not, the 40,000 or so currently on Avon’s payroll would also be at risk. CEO McCoy comes from an organization where operating margins as a norm were well above 20%. At this point, I’m sure she’d be happy just returning Avon to double digits.
Some interesting investors have gotten on board the Avon bus since Andrea Jung stepped aside for McCoy last April, including Ken Fisher, whose Fisher Investments took a small $6.6 million position in the third quarter of 2012. Given that Fisher manages many billions, that’s certainly not news, but it does indicate that someone in the know thinks McCoy has a chance of righting the ship.
Perhaps more interesting is the $35 million investment Jamie Zimmerman has made in Avon beginning in the second quarter of 2012. Zimmerman is the founder of Litespeed Management, which Bloomberg ranks as the 21st best-performing hedge fund (assets of more than $1 billion) in 2012. Zimmerman focuses on businesses that are down but not out. That definitely describes Avon.
At the end of the day, Avon’s success will come from reducing its overhead while simultaneously forging ahead in the markets where it does well, like Asia and Latin America. If it does both of these, the current run-up is only the very beginning of a long bull run.
As of this writing, Will Ashworth didn’t own any securities mentioned here.
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