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Li & FungHK$13.06 - SELL
FinancialsYear to 31 December 10A 11A 12CL 13CL 14CLRevenue (US$m) 15,912 20,030 21,624 24,350 26,824Rev forecast change (%) - - 0.0 0.0 0.0Net profit (US$m) 548 681 829 776 971NP forecast change (%) - - 1.0 2.5 2.1EPS (US¢) 7.2 8.4 9.9 9.3 11.6CL/consensus (21) (EPS%) - - 114 93 97EPS growth (% YoY) 23.0 17.5 17.6 (6.4) 25.1PE (x) 23.4 19.9 17.0 18.1 14.5Dividend yield (%) 3.4 4.1 3.7 4.5 5.1ROE (%) 18.6 18.0 16.6 12.6 15.1Net debt/equity (%) 45.8 75.6 42.2 56.2 59.9Source: CLSA Asia-Pacific Markets
Find CLSA research on Bloomberg, Thomson Reuters, CapIQ and themarkets.com - and profit from our evalu@tor proprietary database at clsa.com
Aaron Fischer, [email protected](852) 26008256
Mariana Kou, CFA(852) 26008190
15 November 2012
Hong KongConsumer
Reuters 0494.HKBloomberg 494 HK
Priced on 14 November 2012HK HSI @ 21,442.0
12M hi/lo HK$20.15/11.46
12M price target HK$10.60±% potential -19%
Shares in issue 8,356.6mFree float (est.) 67.5%
Market cap US$14,084m
3M average daily volumeHK$352.4m (US$45.5m)
Foreign s'holding 12.3%
Major shareholdersVictor and William Fung 29.9%
Stock performance (%)1M 3M 12M
Absolute 9.4 4.3 (15.7)Relative 7.8 (1.3) (23.3)Abs (US$) 9.4 4.4 (15.4)
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Nov 10 May 11 Nov 11 May 12Li & Fung (LHS)
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Source: Bloomberg
www.clsa.com
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Still clouded by uncertaintyLi & Fung hosted an analyst day today. The company announced two acquisitions, which was slightly disappointing given the recent issue of perpetual securities of US$500m. Management stressed the cross-selling opportunities across the three business segments: Trading, Logistics and Distribution. We maintain our view that there seems to be less growth opportunity for the traditional business and more opportunities in Distribution. Reiterate SELL on weak earnings visibility to a price target of HK$10.60, implying 19% downside.
Only two acquisitions announcedIt was slightly disappointing that Li & Fung only announced two acquisitions: US apparel-agent Foreign Resources Corporation and Hong Kong sweater manufacturer Brilliant Global. The company issued US$500m of perpetual securities two weeks ago, which were earmarked for business development and acquisitions. Management indicated that the company still has US$150-200m from the March placement. With a rich war chest, we expected more acquisitions.
Maintain 3-year core OP targetManagement reiterate the company’s 3-year core OP target of US$1.5bn. The business unit heads were confident about the potential cross-selling opportunities and highlighted that their business units remained on track. Top thirty sourcing customers are growing at double-digit while the Wal-Mart business is turning profitable. The company continues to build up LF Europe and LF Asia and wrap up the restructuring of LF USA.
No change in viewWe believe that Li & Fung is seeing less growth opportunity in its sourcing business given the company’s leading position and already strong relationships with large retailers. We like the long-term growth potential in Distribution and Asia, but this will take time. 2H and 2013 operating margin should improve as rising input costs and restructuring costs from LF USA roll off. We expect core OP of US$1.06bn in 2013, which is 29% below management’s target of US$1.5bn
Reiterate SELL to price target of HK$10.60Given the weak earnings visibility, we maintain our SELL rating on Li & Fung.Our price target of HK$10.60 is based on 15x 2013 earnings, implying 19% downside.
Prepared for: [email protected] Matthew Wong 11/15/12 02:38:27 PM HSBC - Hong Kong {IM}
Still clouded by uncertainty Li & Fung - SELL
15 November 2012 [email protected] 2
Still clouded by uncertaintyThe analyst day largely focused on cross-selling opportunities and the ramp-up of LF Europe and LF Asia. CEO Bruce Rockowitz stressed that the US is outperforming as Europe continues to struggle and Asia slows down. However, he believes that Europe may be hitting a bottom with the UK seeing some positive signs. He also expects gradual improvement in Asia.
Price declines, which negatively impact Trading in 2012, may flatten in 2013. Bruce expects solid growth in Trading and Logistics in 2013. The Wal-Mart/DSG business is turning profitable.
On Distribution, he expects margins to recover to 2010 levels at LF USA as input prices stabilize and restructuring costs come down. LF Europe would likely grow through acquisitions in 2013 as the European market should stay weak. He is confident that LF Asia would post solid growth in 2013.
Bruce mentioned that 2H would be better than 1H, but yoy growth may still be only moderate. We expect 2H core OP to grow by +7% to US$641m. The company is still very committed to its 3-year plan with core OP target of US$1.5bn. He acknowledged that the company may miss this target, but it should not be a very material miss given organic growth opportunities and the robust acquisition pipeline.
Figure 1
Financial forecast
US$m 2010 2011 1H2012 2H2012CL 2012CL 2013CLRevenue 15,912 20,030 9,128 12,497 21,624 24,350growth 0.0% 25.9% 3.7% 11.3% 8.0% 12.6%Total margin 2,238 3,074 1,322 1,715 3,037 3,418margin 14.1% 15.3% 14.5% 13.7% 14.0% 14.0%CORE Operating profit 725 882 221 641 862 1,059growth 41.8% 21.6% (21.6%) 6.9% (2.2%) 22.8%margin 4.6% 4.4% 2.4% 5.1% 4.0% 4.4%Net profit 548 681 312 517 829 776growth 27.0% 24.2% 32.6% 15.9% 21.7% (6.4%)margin 3.4% 3.4% 3.4% 4.1% 3.8% 3.2%Adjusted net profit 548 681 125 517 641 776growth 27.0% 24.2% (47.0%) 15.9% (5.9%) 21.0%margin 3.4% 3.4% 1.4% 4.1% 3.0% 3.2%
Source: CLSA Asia-Pacific Markets
We summarise the key points and our thoughts from each of the individual presentations by the business unit heads below.
Trading LF Sourcing by Marc Compagnonq China remains the biggest production country, but Li & Fung is seeing
production moving from southern China to eastern and western China.
q There is also a shift towards sourcing and production to low-cost countries, with Vietnam and Bangladesh as the major beneficiaries. Production volume is growing at +15% and +10% yoy in these countries, respectively.
q Prices have come down by 6-7% this year, negatively impacting Li &Fung’s sourcing business, which is on a commission-basis. The company expects price deflation to continue into 1H 2013 and levels off in 2H 2013.
US outperforming other markets
Expects LF USA margins to recover
Latest production trends
Price declines hurt sourcing business
Prepared for: [email protected] Matthew Wong 11/15/12 02:38:27 PM HSBC - Hong Kong {IM}
Still clouded by uncertainty Li & Fung - SELL
15 November 2012 [email protected] 3
q LF Sourcing sees single-digit growth in the US and the rest of the world while Europe fell by double-digit. However, the top thirty customers are growing at double-digit, thanks to market share gains and the customers’ strong industry position.
q Fashion accessories is the fastest-growing category for the Sourcing business at +28% yoy.
q New acquisition: Li & Fung announced that it has acquired US-based apparel agent Foreign Resources Corporation (FRC), with annual turnover in excess of US$100m. FRC specializes in outerwear. The deal should be closed by the end of this month.
DSG by Dow Famulakq Management stressed that its relationship with Wal-Mart is progressing as
expected. The business is turning profitable in 2012.
q Li & Fung is introducing new suppliers, which now account for 30% of Wal-Mart’s total supplier base.
q The company also helped to lower the leadtime for onboarding from 90 days in 2011 to 51% days in 2012.
LF Beauty by Dow Famulakq This business was set up in 2008. It still has plenty of room to grow
organically, including emerging markets, new product categories, and new retail channels.
q LF Beauty also looks to grow through acquisitions and management indicated a strong pipeline.
LF Fashion by Wai Ping Leungq LF Fashion has solid design capabilities with offices in Hong Kong, Istanbul,
London, Shanghai, India, etc. The business partners with external factories for production, and does not own any factories itself.
q 66% of LF Fashion’s business comes from Europe. The US accounts for 23% while China takes up 3%.
q New acquisition: Li & Fung has acquired Brilliant Global, a Hong Kong-based sweater manufacturer, with expected sales for 2012 at US$150m. Brilliant Global sells wholly to the US market, hence this will be complementary to LF Fashion’s strategy to grow its US business. Meanwhile, it can also leverage LF Fashion to tap into the Europe market. Management aims to double this business to US$300m by 2016.
LF Products by Henry Chanq LF Products focuses on furniture, home textiles and accessories, toys and
seasonal gifts.
q Henry mentioned that Wal-Mart and Target are both heavily promoting Kurio (an Android tablet for kids), which is set to be this year’s “hottest” Christmas gift.
q Latin America and Asia are the key focus markets for LF Products.
Key customers growing at double-digit
Wal-Mart business turning profitable
Strong design capabilities
Acquired Hong Kong-based sweater manufacturer
Acquired US-based apparel agent
Kurio is the “hottest” Christmas gift this year
Prepared for: [email protected] Matthew Wong 11/15/12 02:38:27 PM HSBC - Hong Kong {IM}
Still clouded by uncertainty Li & Fung - SELL
15 November 2012 [email protected] 4
CLSA view on Trading: The company announced two acquisitions, which was slightly disappointing given the recent issue of perpetual securities of US$500m. We believe that Li & Fung is seeing less growth opportunity in its sourcing business given the company’s leading position and already strong relationships with large retailers.
LF Logistics by Joseph Phiq The logistics division is separated into 1) in-country logistics and 2) supply
chain solutions.
q In-country logistics focuses on Asia. Organic growth and roll-up acquisitions should be key growth drivers. Supply chain solutions, however, targets a global footprint and aims to grow organically and through platform acquisitions.
CLSA view on Logistics: There should be plenty of room for logistics to grow by leveraging on Li & Fung’s existing base of customers. However, this will take time.
DistributionLF USA by Rick Darlingq Customer concentration is high in LF USA with the top ten customers
accounting for 65% of sales and the top thirty 85% of sales.
q Management discussed gross margin in details for LF USA. Cotton and raw material hikes impacted margins in 2011 while leather price increases hurt margins in 2012. The company sees input prices stabilizing. On the back of 25% visibility of 2013 orders, management expects gross margin of LF USA to recover to 2010 level.
q The company looks to achieve this through economies of scale, rationalization of supplier base, and some price increases.
q Restructuring costs should reach US$70m this year, which should lead to a US$60m reduction in operating costs. In 2013, we should see around US$30m of restructuring costs.
Figure 2
LF USA gross margin
Source: Company
36.2
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1H 2010 2H 2010 2010 1H 2011 2H 2011 2011 1H 2012
(%)
Cross-selling potential should be tremendous for
Logistics
Management expects LF USA margins to recover to
2010 level
Prepared for: [email protected] Matthew Wong 11/15/12 02:38:27 PM HSBC - Hong Kong {IM}
Still clouded by uncertainty Li & Fung - SELL
15 November 2012 [email protected] 5
LF Europe by Dow Famulakq Management highlighted a strong acquisition pipeline for LF Europe in
early 2013.
q The business is still young and growing rapidly. Russia is one of the high growth markets in the region, with a retail market growing at double-digit.
q Given the macro environment in Europe, Li & Fung also stressed that the company is cautiously managing credit risk in this area. The top 12 customers of LF Europe, which accounts for around 70% of business, are factored with recourse. Around 22-23% of the business is covered by credit insurance, and the rest is smaller customers, with limited risk exposure.
LF Asia Food, Health, Beauty & Cosmetics by Gerald Raymondq This business has tremendous cross-selling opportunities with LF Beauty.
q The company is looking to expand footprint in the next 12-18 months. It currently covers Hong Kong, Thailand and has China, Taiwan, Singapore, Malaysia and the Philippines scheduled to be launched in 2013.
q LF Asia FHBC grew at +32% Cagr in 2010-12, which partially due to a low base. Contribution margin grew by +12% in 2011 and +42% in 2012 and management expects a +30% contribution growth in 2013.
LF Fashion & Home by Jason Rabinq LF Fashion & Home was only launched in 2011. It is now focusing on
international brands, which should benefit as Asian consumers shift away from local brands.
q Points-of-sale expansion will drive growth of this business. a new showroom is scheduled to open in Shanghai in 2013 to support the business’ growth in the mainland.
CLSA view on Distribution: We see strong long-term potential in the Distribution business. This shift should be positive as Distribution business carries wider-margins. However, we believe it takes time to build up the onshore platform. Also, the shift towards Distribution leads to a declining ROE.
Managing credit risk in Europe
Cross-selling with LF Beauty
Opening showroom in Shanghai
Prepared for: [email protected] Matthew Wong 11/15/12 02:38:27 PM HSBC - Hong Kong {IM}
Still clouded by uncertainty Li & Fung - SELL
15 November 2012 [email protected] 6
Summary financialsYear to 31 December 2010A 2011A 2012CL 2013CL 2014CLSummary P&L forecast (US$m)Revenue 15,912 20,030 21,624 24,350 26,824Op Ebitda 838 1,106 1,204 1,223 1,487Op Ebit 679 880 984 971 1,205Interest income 14 19 13 13 13Interest expense (98) (129) (83) (104) (125)Other items 2 1 1 1 2Profit before tax 596 772 915 881 1,094Taxation (48) (91) (86) (105) (123)Minorities/Pref divs 0 - - - -Net profit 548 681 829 776 971
Summary cashflow forecast (US$m)Operating profit 679 880 984 971 1,205Operating adjustments - - - - -Depreciation/amortisation 159 226 220 252 282Working capital changes (97) (76) (387) (933) (538)Net interest/taxes/other 4 (106) (86) (105) (123)Net operating cashflow 745 924 731 185 826Capital expenditure (78) (113) (119) (125) (131)Free cashflow 667 811 612 60 695Acq/inv/disposals (456) (688) (585) (832) (367)Int, invt & associate div (189) (169) 13 13 13Net investing cashflow (723) (971) (691) (944) (485)Increase in loans (13) 25 0 0 0Dividends (426) (468) (527) (557) (665)Net equity raised/other 847 (54) 487 1,316 324Net financing cashflow 408 (497) (40) 759 (341)Incr/(decr) in net cash 430 (544) 0 0 0Exch rate movements 0 2 0 0 0Opening cash 539 969 426 426 426Closing cash 969 426 426 426 426
Summary balance sheet forecast (US$m)Cash & equivalents 969 426 426 426 426Debtors 2,451 2,476 3,464 4,201 4,755Inventories 769 1,036 566 637 702Other current assets 0 14 4 4 4Fixed assets 309 325 394 463 498Intangible assets 4,882 6,526 7,017 7,731 7,995Other term assets 20 24 14 14 14Total assets 9,494 10,920 11,892 13,483 14,400Short-term debt 161 152 152 152 152Creditors 3,097 3,409 2,740 3,041 3,350Other current liabs 94 103 113 125 137Long-term debt/CBs 2,472 3,251 2,823 3,827 4,194Provisions/other LT liabs 38 66 17 17 17Minorities/other equity 6 5 (4) (4) (4)Shareholder funds 3,626 3,934 6,049 6,324 6,553Total liabs & equity 9,494 10,920 11,892 13,483 14,400
Ratio analysisRevenue growth (% YoY) 18.8 25.9 8.0 12.6 10.2Ebitda growth (% YoY) 47.9 32.0 8.8 1.6 21.6Ebitda margin (%) 5.3 5.5 5.6 5.0 5.5Net profit margin (%) 3.4 3.4 3.8 3.2 3.6Dividend payout (%) 80.4 81.0 62.4 81.9 74.4Effective tax rate (%) 8.0 11.7 9.4 11.9 11.2Ebitda/net int exp (x) 9.9 10.1 17.2 13.4 13.3Net debt/equity (%) 45.8 75.6 42.2 56.2 59.9ROE (%) 18.6 18.0 16.6 12.6 15.1ROIC (%) 16.1 12.8 11.5 9.3 10.5EVA®/IC (%) 8.9 5.6 4.3 2.1 3.3Source: CLSA Asia-Pacific Markets
Prepared for: [email protected] Matthew Wong 11/15/12 02:38:27 PM HSBC - Hong Kong {IM}
Still clouded by uncertainty Li & Fung - SELL
15 November 2012 [email protected] 7
Companies mentionedLi & Fung (494 - HK$13.06 - SELL)
Recommendation history of Li & Fung Ltd 494 HK
Date Rec Target Date Rec Target24 September 2012 SELL 10.60 30 May 2011 O-PF 20.0010 August 2012 SELL 14.40 24 March 2011 U-PF 20.0011 June 2012 O-PF 16.10 21 March 2011 O-PF 23.0023 March 2012 U-PF 18.50 25 January 2011 O-PF 26.0006 January 2012 U-PF 16.30 13 August 2010 O-PF 22.5007 October 2011 O-PF 16.30 28 June 2010 O-PF 20.0002 September 2011 O-PF 17.40 25 March 2010 O-PF 22.5012 August 2011 BUY 18.00 05 March 2010 BUY 23.75Source: CLSA Asia-Pacific Markets
Key to CLSA investment rankings: BUY: Total return expected to exceed market return AND provide 20% or greater absolute return; O-PF: Total return expected to be greater than market return but less than 20% absolute return; U-PF: Total return expected to be less than market return but expected to provide a positive absolute return; SELL: Total return expected to be less than market return AND to provide a negative absolute return. For relative performance, we benchmark the 12-month total return (including dividends) for the stock against the 12-month forecast return (including dividends) for the local market where the stock is traded.
©2012 CLSA Asia-Pacific Markets (“CLSA”). Note: In the interests of timeliness, this document has not been edited.
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The CLSA Group, CLSA's analysts and/or their associates do and from time to time seek to establish business or financial relationships with companies covered in their research reports. As a result, investors should be aware that CLSA and/or such individuals may have one or more conflicts of interests that could affect the objectivity of this report. Regulations or market practice of some jurisdictions/markets prescribe certain disclosures to be made for certain actual, potential or perceived conflicts of interests relating to research report and such details are available at www.clsa.com/member/research_disclosures/. Disclosures therein include the position of the CLSA Group only and do not reflect those of Credit Agricole Corporate & Investment Bank and/or its affiliates. If investors have any difficulty accessing this website, please contact [email protected] or (852) 2600 8111. If you require disclosure information on previous dates, please contact [email protected]
IMPORTANT: The content of this report is subject to and should be read in conjunction with the disclaimer and CLSA's Legal and Regulatory Notices as set out at www.clsa.com/disclaimer.html, a hard copy of which may be obtained on request from CLSA Publications or CLSA Compliance Group, 18/F, One Pacific Place, 88 Queensway, Hong Kong, telephone (852) 2600 8888. 27/04/2012
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Aaron Fischer, CFAOther analystsNo coverage
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Prepared for: [email protected] Matthew Wong 11/15/12 02:38:27 PM HSBC - Hong Kong {IM}
