What seemed like great news such a short time ago is turning out to be a difficult period of transition for Avon (NYSE:AVP).
Back in April, the world's leader in direct cosmetic sales was granted permission to resume door-to-door selling in China after the country banned such practices approximately seven years ago. Investors expected to be rewarded by all those Avon ladies pushing their wares in the company's typical fashion.
However, what's been customary for Avon in the rest of the world is going to take some getting used to for a populace unaccustomed to the practice of door-to-door selling. Add to that the concern of China's Avon boutique owners that they'll lose out to the direct sellers, and Avon's getting more than it bargained for.
Avon's unexpected struggles in China weren't helped by other regions, which also failed to perform as well as expected. It was a quarter that appeared nearly flawless at first glance, but a closer look reveals several blemishes. For the second quarter, Avon generated earnings of $328.6 million, or $0.69 per share, which was an increase of 41% from last year. Looks good, right?
Unfortunately, $0.20 per share of that was the result of a tax benefit. Not exactly something the company can count on for future growth. Revenues were up a modest 6% (2% in local currencies) to $1.98 billion, which was slightly below expectations. The company provided a plethora of excuses for the slower-than-expected sales growth, pointing to the unexpected decline in China, lower-than-anticipated growth in Central and Eastern Europe, and delayed expansion into Russia.
The U.S. market also continues its unimpressive performance with revenues falling 6% and operating profit tumbling 14%.
As a result of its unexpected struggles, Avon lowered its third-quarter guidance to between $0.34 and $0.36 per share versus the $0.37 per share it earned in the third quarter of last year. For the full year, Avon reduced its earnings outlook to a range of $2.03 and $2.08 per share. While that range is well above the $1.77 per share it earned in 2004, it's inflated by the $0.20-per-share tax benefit this quarter.
Since the news was reported last week, Avon's stock has fallen nearly 16%, reaching lows it hasn't seen in a year and a half. In my humble opinion, that's a bit much. While the company is not likely to grow much in the U.S., I do believe it will do very well elsewhere, particularly in China -- and sooner rather than later. It's had great success thus far in China despite being forced to improvise its sales tactics. Once the people become accustomed to direct sellers, and if the boutique owners grow to believe there's still room for them in the market, sales should rebound significantly. A forward P/E under 15 and expected annual operating cash flow of $900 million don't hurt, either.
Fool contributor Mike Cianciolo hesitantly admits to using certain Avon products (they make stuff for men, too), but he doesn't own shares of Avon.
