Avon Calls, China Opens The Door

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Avon Products (AVP) has something to smile about this week. The New York-based cosmetics company is being granted the right to resume direct selling in China, a market where door-to-door sales have been banned since 1998. This could be the first in a series of concessions given to door-to-door merchants, a structure China initially became leery of because of proliferating multilevel marketing schemes at that time. Confined to selling through retail shops for the past eight years, Avon has lost its early lead in China.



But the Middle Kingdom still offers plenty of opportunity. Avon CEO Andrea Jung has said China could one day add $1 billion a year to the top line. Avon certainly has a long way to go in building up its presence in the country. While there are five Avon representatives for every 1,000 Brazilians and 2.5 for every 1,000 Russians and Americans, the company has only 0.4 reps per 1,000 in India and zero in China.



COMPETITORS' GAINS.

"China continues to be one of the company's long-term major growth opportunities," says Avon spokesman Victor Beaudet. "It's really critical."



The formal reopening of one of its most important selling channels has been a rare bit of good news in an otherwise frustrating 12 months for Avon investors. The bad times started last April when early reports of China's plan to open up to direct selling caused retailers stocking Avon products to stop ordering out of concern over the new competitive threat.



But before 2005 was out it had become clear that Avon's problems extended beyond China. It reported performance shortfalls everywhere from Eastern Europe to the U.S., and the share price, which was trading at $45 last April, dropped as low as $25 in October and November.



MORE "SUPER HITS"?

Addressing the Consumer Analysts Group of New York on Feb. 24, Jung tried to shed more light on a worldwide downturn that seemed to have caught management almost by surprise. Cuts in advertising and promotional spending -- including a 50% decrease in the U.S. in 2005 -- had been the wrong move at a time when competitors like Procter & Gamble (PG) and L'Oreal were spending plenty and gaining sales.



At the same time, price discounts were hurting profits without generating additional sales. Some 80% of Avon's beauty sales were done at a discount in 2005, up from 65% in 2000.



To tackle these problems -- and remedy the lack of communication that made them come about in the first place -- Jung is set to fire 20 to 30% of Avon's middle management by this summer and will reduce 15 layers of management down to seven or eight. She's also boosting her ad budget by 50% and channeling a bigger share into "super hits" and new introductions.



"NOT COMPELLING."

Some smart money is betting that Jung has hit on the right formula. Among those buying the stock in the past few months: Fidelity, T. Rowe Price, and Capital Guardian. But Wall Street in general has been slow to forgive.



Of 15 analysts tracked by Bloomberg Financial Markets, 10 rate Avon a sell or a hold. Goldman Sachs (GS) analyst Amy Low Chasen is among those who haven't been convinced. On Feb. 27, she reiterated her hold recommendation despite the positive news from Beijing, citing a "lack of near-term visibility and valuation that is not compelling."



By Chasen's estimate, the stock -- which closed at $28.99 on Feb. 27 -- is still trading at a 47% premium to the overall market based on her 2006 estimated earnings, and a 32% premium on 2007 estimates.



TARGETING SPA FANS.

Avon's best shot at winning over skeptics such as Chasen would be to prove that some of its newest introductions can become "super hits" on the scale of blockbusters of years past, such as Skin-So-Soft and Anew. One area of promise: products that are cheap at-home versions of high-priced procedures -- from chemical peels to Botox substitutes -- usually available at a dermatologist office or spa. The latest in this line is "Avon Anew Clinical Eyelift," which is due to launch in the U.S. this quarter and go global later in the year.



Connie Brown, an Avon representative in Lake Charles, La. is pushing these so-called clinical products as she goes about rebuilding her business in the aftermath of Hurricane Katrina. She's a fan of the $32 chemical peel, a bargain compared to the $300 to $400 she says a dermatologist would charge. In January, Brown sold nearly $6,000 worth of Avon products, $2,350 more than the year before. This month, she expects a 50% jump. "It's blowing me away," she says.



If Avon, which does 60% of its business outside the U.S., could get that kind of momentum going in China and other developing markets, it would be blowing away investors, too.