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Analyst Blog

On Sep 11, 2013 we downgraded global beauty company, Avon Products Inc. (AVP - Analyst Report), to Neutral, based on the company’s declining revenue trend in North America and currency devaluation in Venezuela, which pose a threat to its near-term growth.

Why the Downgrade?

Estimates for Avon, have been declining ever since it reported fiscal second-quarter results on Aug 1. Avon’s second-quarter revenues of $2,508.9 million missed the Zacks Consensus Estimate of $2,573.0 million. However, adjusted earnings of 29 cents per share surpassed the Zacks Consensus Estimate of 26 cents.

Following the second-quarter results, the Zacks Consensus Estimate for 2013 has gone down 5.2% to $1.09 per share in the last 60 days. The Zacks Consensus Estimate for 2014 has also declined 3.6% to $1.34 per share over the same period. The company also currently carries a Zacks Rank #3 (Hold).

Causes of Concern

Over the last three years, Avon has witnessed a decline in revenues in North America, especially the U.S. mainly due to decrease in active representatives, partly offset by larger average order. Total revenue from this region in 2009, 2010, 2011 and 2012 was $2,293.4 million, $2,193.5 million, $2,064.6 million and $1,906.8 million, respectively. Management remains concerned about the downward trend in revenues, and has been constantly striving to stabilize the situation.

Moreover, due to rising fiscal deficit and pressure on the Forex market, the Venezuelan government devalued its currency in February this year. This will help Venezuela to partially reduce its fiscal deficit, but at the cost of high inflation in the economy. Avon, which generates approximately 5% of total revenue and 14% of operating profit from the country, may face challenges in maintaining profitability if the Venezuelan government restricts pricing decision of the companies to offset the possible rise in raw material prices.

In the backdrop of the challenging scenario in the Americas, we do not see any significant catalyst that could drive the company’s shares in the near term.

Still Prefer the Sidelines

Though Avon has been encountering challenges on various fronts, we prefer to remain on the sidelines. This is due to the strategic measures outlined by Avon focusing on accelerating top-line growth, trimming down costs and improving working capital. As part of its strategy, Avon decreased its quarterly dividend substantially and aims to slash costs by $400 million through 2016. We believe that Avon’s turnaround strategies are paying off, as is evident from its improved operating results in the last 3 quarters.

The company’s also closing operations in some underperforming markets mainly in Europe, the Middle East & Africa region. We believe these actions should help Avon streamline operations by improving focus on high-priority markets and activities, as well as enhance efficiencies

Other Stocks That Warrant a Look

Other stocks worth considering in the retail sector include Citi Trends, Inc. (CTRN - Analyst Report), Kirkland's Inc. (KIRK - Analyst Report) and PCM, Inc. (PCMI - Snapshot Report). All of these carry a Zacks Rank #1 (Strong Buy).

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