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Beauty stocks at bargain prices
Problems have blemished the looks of cosmetics giants Avon and Estee Lauder. But their shares might prove attractive at reduced prices.
By Michael Brush
Judging by the unsightly stock charts at two of the worlds leading cosmetics companies, you might think that women around the world are swearing off mascara.
Sales at Avon Products (AVP, news, msgs) -- best known for its "ladies" going door-to-door -- were well below expectations last quarter in Europe, Russia and China. Its U.S. sales were down 6%.
Estee Lauder (EL, news, msgs) has fared better in moving product. But the company had to pour so much money into marketing that profits and earnings growth have sorely disappointed Wall Street.
The financial blotches at the beauty-mongers have spooked investors. At $33 a share, Avon is down 25% from its highs of this year. Estee Lauder is off 16%, trading recently at $38.
But vanity isn't dead, and neither are these stocks. Both companies were hit by a series of missteps and problems theyll be able to fix, say value investors who snapped up shares during the sell-offs.
The Avon Lady's China problem
The world's leading direct seller of beauty products, Avon, markets its cosmetics and body-care products through nearly 5 million reps who sell door-to-door, at lunch hour in the office and at in-home parties.
As a company that gets well over half its sales outside the U.S., Avon has been a great way for investors to play rapidly growing economies in places like China, Russia and Eastern Europe. Avons success in emerging markets helped drive a turnaround that saw annual sales grow to nearly $8 billion in the past 12 months from $5.3 billion in 1999.
Recently, though, those emerging markets have been a source of problems. The nastiest surprise for Avon shareholders last quarter came from China, where Avon sells beauty products through boutiques and department stores because the government -- until recently -- had a ban on door-to-door sales.
The Chinese government worried that direct-sales programs led to pyramid schemes, with sales reps toiling for next to nothing while the lucky few at the top get rich.
China had a change of heart in April, when it lifted the ban on direct sales. It sounded like good news for Avon, but the company's boutique owners in China questioned whether they still had a future. They stopped restocking their shelves with Avon products. The result: Avon's second-quarter sales in China fell 20%, compared with 38% growth in the prior quarter. Investors, troubled by the sharp reversal, ditched Avon shares.
Related news and commentary on MSN Money
But their fears are misplaced, says Sophia Collier, a portfolio manager whose Citizens Value Fund (MYPVX) has been buying shares in the recent sell-off. "This is a little early to start saying China is not working," she says, noting that the company's management team is the same one that produced the earlier turnaround. "Management has a great record of creating very strong emerging-market success stories from nothing, in country after country."
One thing that will help: Avon remains the only company allowed to sell cosmetics door-to-door. That's just one reason Avon is about to see a return to rapid, yet sustainable, growth in China. The market could eventually be worth $1 billion in annual sales, the company says. Avon had $220 million worth of sales in China last year.
Pockets of weakness
In Central and Eastern Europe, Avon plans to rekindle growth by advertising more, introducing new products and putting out more products at lower price points. "I think they still have a lot of opportunity in Eastern Europe," says Morningstar analyst Lauren DeSanto, who is bullish on the stock. Growth is slowing, but that doesnt mean it wont be robust. Theyve hit pockets of weakness in different global markets around the world, and theyve been able to over come it.
As for the U.S., Avon hopes to reverse sales weakness this fall with a big boost in advertising, new products, a campaign called Beautify America designed to energize sales reps and a frequent buyer program. Management is going to bear down and get the right products out there and reinvigorate the troops, says Collier.
There are two other reasons to like Avon at $33. The company generates an impressive $900 million a year in cash and is using part of it to fund a share-buyback plan Avon just increased by $500 million.
Can Ford drive a revival?
Estee Lauder has a knack for creating and sustaining premium brands, but the company looks like it needs a makeover itself. Its two top brands -- Estee Lauder and Clinique, which account for about 60% of sales -- are showing signs of fatigue. To sustain growth, Estee Lauder hiked marketing and research spending in the first quarter of 2005 to $975 million, a 9% increase compared with the same quarter a year before. That hurt results last quarter, when earnings fell well short of analysts' expectations, and the stock took a hit.
We think that it was just a bump in the road, says Michael Church of Church Capital Management in Yardley, Pa. This is a great brand with nice growth prospects. Churchs money management firm bought shares in the recent sell-off. When a stock like this gets this cheap, we jump all over it.
Estee Lauder recently hired Tom Ford, the man who reinvigorated the Gucci apparel brand. Ford will launch and market a Tom Ford for Estee Lauder brand of cosmetics this fall. Next, Estee Lauder will introduce a line of fragrance under Fords name. Will these new product lines succeed? Given Estee Lauders track record as a brand launcher, dont bet against them.
Overblown consolidation concerns
Some investors fret that department-store consolidation spells trouble, as Estee Lauder gets about 40% of its sales through North American department stores. But Church says that Estee Lauder only gets around 1% of its sales from the stores that Federated Department Stores (FD, news, msgs) and May Department Stores (MAY, news, msgs) may close as they merge. That is not going to kill Estee Lauder, says Church.
The company has a plan here, too. It has created new brands to sell through Kohl's (KSS, news, msgs) department stores, called American Beauty, Flirt!, good skin and grassroots.
Estee Lauder's sales at high-end department stores like Nordstrom (JWN, news, msgs) and Neiman Marcus (NMG.A, news, msgs) have stayed solid. This suggests that Estee Lauder's results may come in stronger than expected when it reports results Aug. 16, says Church.
Some analysts are wary because the Lauder family holds 86% of the voting power at this company, which means regular shareholders have little say. But research also shows that family-run companies have a good shot at beating the competition.
Church thinks the family control of the company is one reason last quarters earnings miss is nothing to worry about. He believes Estee Lauder was only sacrificing near-term results -- by spending on promotion and development -- for better performance down the road. Good or bad, they are not as concerned with hitting estimates every quarter, says Church. They are more concerned about long term.
Stock picks
With this column, I'll add Avon to my Company Focus stock-pick portfolio for tracking, and we'll see how it does from here.
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