Prefer Avon, Estee Lauder as Staple “Dream Deferred,” Deutsche Bank Says

Consumer staples are great to have in a portfolio for periods of market weakness, but when investors are expecting the economy to pick up, not so much. And that, perhaps, explains why Deutsche Bank upgraded Estee Lauder (EL), and listed Avon Products (AVP) as its top Cosmetics, Household & Personal Care pick for 2014, over companies such as Procter & Gamble (PG) and Coca-Cola (KO).

Reuters

Bill Schmitz and team explain their outlook:

On paper, the setup for the broader staples group doesn't look very compelling. Category growth rates remain depressed in developed markets and have slowed in developing markets, with volume growth in the US barely positive across categories despite growing optimism about the US recovery. Offsetting this troublesome dynamic, companies continue to rely on restructuring savings and balance sheet redeployment to support earnings growth, albeit much lower quality without the help from top-line expansion. At the end of the day, organic top-line growth is the industry's best productivity metric and correlates well to operating margins, EPS growth and cash flow generation, with valuation multiples following suit.

Against this backdrop,  Schmitz explains why he upgraded Estee Lauder…

Our upgrade of Estee Lauder is predicated on (i) potentially improving category trends off recent contraction and relatively strong brand health driving volume leverage; (ii) further cost savings; (iii) pristine balance sheet funding growth and EPS accretive deals; (iv) earnings and working capital driven cash flow acceleration and (v) reasonable valuation relative to latent growth. To be sure, back half earnings hurdle is high but company is reinvesting aggressively and strategically, with potential upside from improving trends in Europe and EM. Provided global macro and demographic trends persist, we expect Estee's organic growth to be near the top of the group, justifying an industry-leading EBITDA multiple reflective of the category killer portfolio the company owns.

…and why Avon Products is still their top pick in their coverage:

To be sure, the recovery here is going to be bumpy, but the starting point is severely depressed and there is still more than one way to win with this one. Of course, ongoing success for this emerging markets direct seller of beauty products is predicated on driving positive organic growth trends, and that is undoubtedly the biggest challenge management faces as it tries to right the ship…As the equity story here plays out, we believe there are several milestones that should get investors paid along the way, including FCPA resolution, return of US business to profitability, aggressive non-strategic cost elimination followed by selective reinvestment and much needed upgrade of systems capabilities, including further migration of the business to ecommerce channels which is the clear relative growth driver going forward.

Shares of Estee Lauder have gained 0.3% to $74.29, Avon Products has fallen 1.3% to $16.58, Procter & Gamble has dipped 0.1% to $80.23 and Coca-Cola has dropped 1.2% to $39.66.