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Avon Downgraded to Underperform

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We have downgraded Avon Products Inc. (AVP - Free Report) , one of the leading global beauty companies, to ‘Underperform’ after the company posted disappointing first-quarter 2012 results. Currently, the stock has a Zacks #5 Rank, implying a short-term ‘Strong Sell’ rating.

The company reported a year-over-year decline in its bottom line along with contraction in margins for the third consecutive quarter. Avon’s adjusted earnings of 10 cents per share for the first quarter of fiscal 2012 fell short of the Zacks Consensus Estimate of 28 cents and plummeted nearly 73% from the prior-year period.The weak quarterly performance resulted from increased input costs, higher labour costs as well as increased operating expenses. Moreover, the company’s net sales inched down 2% reflecting a fall of 1% in total units, partially offset by a favourable price mix.

Moreover,Avon’s North American market continues to remain sluggish with sales falling 4% in the first quarter of fiscal 2012. We believe the company’s initiatives to change the product mix and reposition the business in the U.S. market will involve significant expenditure to support increased advertising and promotional activities, which may exert pressure on margins to some extent.

Battered by continuous wretched quarterly performance and macroeconomic pressures, the company intends to focus on its top-line growth, cost management and cash generation with a lower focus on margin recovery.

Further,we believe Avon has missed the opportunity of reviving itself after Coty Inc. declared its lack of interest in acquiring Avon given the company’s reluctance to enter into discussions since the initial offer was made in March 2012.We believe that the combination would have created an iconic beauty company that would provide new growth opportunities for the merged entity.

In addition, Avon’s financial performance may be substantially affected due to its significant presence in international markets (81% of total revenue in fiscal 2011), which exposes it to unfavourable foreign currency translations, economic or political instability and other governmental actions on trade and repatriation of foreign profits.

Above all,Avon faces competition from various products and product lines both domestically and internationally. The beauty and beauty-related products industry is highly competitive and the number of competitors and degree of competition in this industry varies widely from country to country. Globally, Avon competes with products sold to consumers by other direct-selling and direct-sales companies and through the Internet and against products sold through the mass market and prestige retail channels.The company faces stiff competition from Revlon Inc. (REV - Free Report) .

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