Avon Slowly Getting Dolled Up

What started last quarter with more attractive sales growth appears to be trickling down to the bottom line. Beauty products direct seller Avon Products (NYSE: AVP  ) isn't out of the woods yet on its restructuring plans, but today's earnings release suggests the company is on the right path.

The market clearly liked the results, sending the shares soaring more than 10% so far today as quarterly sales and earnings beat expectations. However, full-year 2006 results saw an unspectacular 6% sales improvement in local currencies, and diluted earnings fell 41% as higher spending and restructuring charges continued to weigh on results. Free cash flow fell just more than 11% year over year, but still came in at about $640 million, or $1.42 per diluted share.

That's an expensive price-to-free cash flow multiple of almost 27, but Avon is in the midst of wringing costs out of its corporate structure and right-sizing itself to spend on initiatives that will increase sales. I would characterize 2006 results as a mixed bag based on top-line trends.

Latin America represented the largest geographic region for 2006, and sales there grew an impressive 17% in local currencies. But North America, the second most important region, managed to grow only 1%. European growth remains stuck in the mid-single digits, while Asia and the Pacific shrank 6% -- a worrying sign, as the region is supposed to be a key growth area. China growth was flat as Avon transitions to a direct selling model that was recently approved again in the country.

So where do we go from here? Avon concedes that 2007 will qualify as "the early years" in its "multi-year turnaround." It continues to target $300 million in total savings by 2009 and saw a $100 million improvement for 2006. But there is work to do on a number of fronts, including juggling regional preferences in the traditionally fickle and ultra-competitive beauty products industry.

Avon is unique as one of the only direct sellers of makeup and other items, but it still has to compete against smaller, nimble players such as Bare Escentuals (Nasdaq: BARE  ) and Revlon (NYSE: REV  ) . Then there are consumer-goods giants such as Procter & Gamble (NYSE: PG  ) and Unilever (NYSE: UN  ) (NYSE: UL  ) that possess enviable market clout and many years of experience selling on a global scale.

Avon's management is actively repurchasing stock and is even issuing debt to ensure shareholders see tangible benefits as operating results remain in flux. The 2.1% dividend yield also offers some consolation until Avon returns to its former glory of consistent growth and increasing cash flow generation. However, if and when that might happen remains uncertain, and the shares look expensive on a number of metrics, especially after today's run-up. Unless the stock takes a tumble or operational fortunes improve markedly, Avon will remain on my watch list.

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Fool contributor Ryan Fuhrmann has no financial interest in any company mentioned. Feel free to email him with feedback or to discuss any companies mentioned further. The Fool has an ironclad disclosure policy.


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