Avon products: significant potential upside in the long term despite short term pressures Avon products is currently

trading below the pre-Coty bid levels. Company is conducting strategic business review and appointed Sherilyn McCoy as CEO replacing long term CEO, Andrea Jung. Avon had rejected Cotys previous bid calling it undervaluing, and said that more value could be extracted by a turnaround than by being bought out, which seems to be the case. Avon has been struggled during the past few years due to issues in key emerging markets including Brazil and China. ERP systems related business disruptions has affected operations in Brazil and corruption issues have affected business in China. But, Avon still is the largest direct selling company and has operations in approx.100 countries with more than 6.4 million representatives. Company successfully implemented restructuring initiatives in the past during 2005-2008 period and was able to improve margins due to product improvement initiatives. With diversified operations, significant exposure to the high growth emerging markets, rightly planned review and restructuring could result in huge upside despite short term pressures. Active sales representative, a key driver for the business, has declined in 2011 to 6.4m from 6.5m due to operational issues. But the company has been taking initiatives to increase earnings opportunity for Avon representatives termed as representative value proposition or RVP. Company has been gradually increasing spending on these initiatives for the past few years. Despite this sales representatives decreased due to operational problems. However, these initiatives are expected to have a positive effect in the long term as the company conducts strategic review and the active sales representative count is expected to recover and increase to 7 million by 2015 and to 8 million by 2018. Avons EBITDA margin was affected as well due to competitive pricing to gain market share in emerging markets and IT issues. However, company has been undertaking product improvement initiatives eliminating less profitable products and reducing overlap in product portfolio. The inventory management is also expected to improve with new IT systems in Brazil. As a result of continued improvements EBITDA margin could improve from 12% currently to 14% by 2015 and to 15% by 2018. Sales per representative also decreased in the recent years due to weak economic conditions and ERP problems in Brazil. But as the operations improve and as new IT systems get implemented in Brazil, the number is expected to increase and could reach $1,500 by 2018. Considering the sales representative increase, EBITDA margin improvement and increase in sales per representative, using Trefis analysis, the stock has a 62% upside to the current market price of $15.73. The restructuring initiatives undertaken, investments in IT and the legal issues could affect margins and could have a negative effect on the share price in the short term. However, with largest sales force in the world and significant growth opportunity in the emerging markets, company is expected to perform well in the long term. Moreover, if the stock remains under pressure in the short term, company could be an attractive takeover target for other companies including Loreal and would provide an exit opportunity at a premium for the shareholders if bear case develops.