2 Beauty Retailer Stocks to Buy, 1 to Avoid

Choose wisely between these three beauty retailers with two distinct business models.

Apr 15, 2014 at 11:57AM

Avon Products (NYSE:AVP) and Nu Skin (NYSE:NUS) are based on the multi-level marketing (MLM) business model. However, MLM schemes are not without their share of controversies due to the compensation plans involved, sometimes taking them closer to what are known as Ponzi or Pyramid schemes.

The beauty and personal care segment is considered to be recession-proof, though, especially when looking at the historical growth of companies like Ulta Salon, Cosmetics & Fragrance (NASDAQ:ULTA) and Sally Beauty Holdings. However, Avon hasn't been able to perform well despite adopting the MLM model, which thrives upon the recruitment of associates and the ability of the company to retain them. Let's take a look at the underlying business of Avon and how it holds up against its peers.

Avon's woes
Avon's MLM plans haven't been working in its favor ever since it went that route in 2005 , and this has been evident from its stock performance. In its fourth quarter of fiscal 2013, it continued to witness a decline in the North American business and this has been dragging down the company. Fourth-quarter revenues declined 10% year over year, primarily as a result of a 5% decline in active representatives.

In addition, a 10% decline in units and unfavorable currency movements also added to Avon's woes. Due to a declining top line, Avon's earnings per share declined from $0.36 in the year ago quarter to $0.34. Going forward, unfavorable currency movements are going to negatively impact its performance.

Avon's implementation of Service Model Transformation (SMT) on a pilot scale in Canada was found to be highly disruptive and counterproductive. This resulted in a severe decline in both revenue and active representatives, and the company had to finally discontinue the implementation of SMT  as a part of its cost control attempt.

Going forward, Avon is going to bolster its personal care, fashion, and home segments, which have performed well. The third-quarter launch of Encanto, a higher-end hand and body line, performed well in Brazil. In addition, the fragrances segment also benefited from the fourth-quarter launch of Instinct.

Avon also announced a strategic alliance with KORRES, a premium all-natural product line that will be marketed in the Americas. Avon has also decided to exit non-performing markets. With these initiatives, Avon hopes to turn things around in the long run, but has failed to provide any timeframe. The company is also still clueless about how to turn around its steep 50% year-over-year decline in revenue from China.

The Chinese problem
Avon is facing trouble in China due to government intervention. Its peer, Nu Skin, which was having a dream run in China, is under the microscope for alleged Pyramid Scheme operations, which are illegal in the country. As such, it is no surprise that Nu Skin has now lost momentum and crashed from an all time high of $140.50 at the beginning of this year to $84.46 at the time of writing.

Despite the headwinds in China, however, Nu Skin continued its third-quarter growth momentum into the fourth quarter, delivering all-around growth in all geographies . Its annual revenue growth was a staggering 49% year over year. The company declared a 15% increase in dividend, marking the 13th year of dividend increases.

Despite Chinese investigations, Nu Skin is still confident of achieving a 20% to 24% growth in revenue in the first quarter of fiscal 2014. It has voluntarily elected to suspend business promotional meetings as well as the engagement of new sales people in China as a part of complying with regulatory authorities there.

Old but gold
At Ulta Salon, business is going on as usual as the company is not in midst of any allegations that are common with multi-level marketing operations. On the back of continued momentum of its e-commerce business, it reported strong fourth-quarter results. Company-wide comparable store sales, or comps, grew 9.2% year over year on top of 8.6% growth in the year-ago quarter . The e-commerce channel contributed 82.5% to comps growth.

Ulta opened 11 new stores during the fourth quarter and new store productivity remains strong. Going forward, Ulta plans to open 100 new stores in 2014 to keep the top-line growth momentum intact. 40% of these new openings will be in new markets, thus expanding Ulta's market penetration. In addition, it has a strong loyal customer base of 13 million which will also drive growth going forward.

Bottom line
MLMs might work, as we saw in the case of Nu Skin, or they might not, as in the case of Avon. As such, conservative investors would be better off investing in a traditional business such as Ulta Salon. Those with a higher appetite for risk should definitely consider Nu Skin, however, as the company is seeing strong growth and expects the positive momentum to continue despite weakness in China.

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Prabhat Sandheliya has no position in any stocks mentioned. The Motley Fool recommends Ulta Salon, Cosmetics & Fragrance. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

4 in 5 Americans Are Ignoring Buffett's Warning

Don't be one of them.

Jun 12, 2015 at 5:01PM

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David Hanson owns shares of Berkshire Hathaway and American Express. The Motley Fool recommends and owns shares of Berkshire Hathaway, Google, and Coca-Cola.We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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