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HG Bonds: Avon Spreads Continue Wider As Morale, Ratings Slide

After drawing another fallen-angel downgrade this month, Avon today was unable to quell mounting investor unease regarding the company’s glacial progress on its mistake-ridden turnaround plan.

After posting third-quarter results this morning, five-year CDS referencing Avon debt increased by more than 9%, rising to the 385 bps area, or the highest reading since early 2013, according to data provider Markit. Avon’s five-year CDS costs started the year near 215 bps, and stood at 325 bps before Moody’s on Oct. 10 cut the rating to junk-territory at Ba1.

Trades in Avon 5% notes due 2023 tested T+400 today, 15 bps wider on the day and roughly 120 bps wider month to month, according to MarketAxess. The notes date to issuance in March 2013 at T+312.5.

Fitch last year cut Avon’s rating to BB, leaving S&P’s BBB- rating the only one of the three still above the high-grade demarcation. Both Fitch and S&P have negative outlooks at present ratings. “Over the next couple quarters, we could consider a lower rating if executional missteps continue and management is unable to gain traction on turnaround efforts such that the company continues to have representative and market share declines,” S&P analysts stated in August.

While Avon today reported a better-than-expected result for earnings per share ($0.23), revenue came in shy of S&P Capital IQ estimates, and many analysts on today’s earnings call keyed on the transitory benefit to the bottom line from VAT credits in Brazil, which is Avon’s largest single market worldwide.

The direct beauty-products marketer’s top-line woes remain linked to dramatic and ongoing declines in its base of active representatives, which famously accelerated after Avon attempted in 2011 to foist an unpopular new sales model on its workforce.

Though it subsequently abandoned the scheme, Avon has yet to stop the slide in that posted year-to-year declines in active representatives. The company’s overall base of representatives fell another 4% in the third quarter, including a daunting 18% slide in the North America base and single-digit declines in Latin America and Asia Pacific.

Moody's this month noted that its decision to cut Avon’s rating to high-yield territory reflected its “concern that competitive and structural challenges associated with Avon's direct selling model are creating pressure on representative levels, revenue and cash flow.”

Meantime, Avon’s gross margin declined to roughly 60.6% for the 12 months through September, more than a point lower from the year-earlier period and marking the thinnest margin in more than 15 years, according to S&P Capital IQ.

When asked on today’s analyst call how Avon was faring in terms of keeping up morale among senior managers through a difficult turnaround period, CEO Sherilyn McCoy said “it's not an easy task, frankly."

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