Li & Fung. Still clouded by uncertainty

Transcription

1 Li & Fung HK$ SELL Aaron Fischer, CFA aaron.fischer@clsa.com (852) Mariana Kou, CFA (852) November 2012 Hong Kong Consumer Reuters Bloomberg 0494.HK 494 HK Priced on 14 November 2012 HK 21, M hi/lo HK$20.15/ M price target HK$10.60 ±% potential -19% Shares in issue 8,356.6m Free float (est.) 67.5% Market cap US$14,084m 3M average daily volume HK$352.4m (US$45.5m) Foreign s'holding 12.3% Major shareholders Victor and William Fung 29.9% Stock performance (%) 1M 3M 12M Absolute (15.7) Relative 7.8 (1.3) (23.3) Abs (US$) (15.4) Nov 10 May 11 Nov 11 May 12 Li & Fung (LHS) Source: Bloomberg (H K$ ) (% ) Rel to HS I (RHS) Still clouded by uncertainty Li & 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 announced It 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$500m of perpetual securities two weeks ago, which were earmarked for business development and acquisitions. Management indicated that the company still has US$ m from the March placement. With a rich war chest, we expected more acquisitions. Maintain 3-year core OP target Management 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 view 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. 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$10.60 Given the weak earnings visibility, we maintain our SELL rating on Li & Fung. Our price target of HK$10.60 is based on 15x 2013 earnings, implying 19% downside. Financials Year to 31 December 10A 11A 12CL 13CL 14CL Revenue (US$m) 15,912 20,030 21,624 24,350 26,824 Rev forecast change (%) Net profit (US$m) NP forecast change (%) EPS (US ) CL/consensus (21) (EPS%) EPS growth (% YoY) (6.4) 25.1 PE (x) Dividend yield (%) ROE (%) Net debt/equity (%) Company update Find CLSA research on Bloomberg, Thomson Reuters, CapIQ and themarkets.com - and profit from our evalu@tor proprietary database at clsa.com

2 US outperforming other markets Still clouded by uncertainty The analyst day largely focused on cross-selling opportunities and the rampup 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 Bruce expects solid growth in Trading and Logistics in The Wal- Mart/DSG business is turning profitable. Expects LF USA margins to recover 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 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 H2012 2H2012CL 2012CL 2013CL Revenue 15,912 20,030 9,128 12,497 21,624 24,350 growth 0.0% 25.9% 3.7% 11.3% 8.0% 12.6% Total margin 2,238 3,074 1,322 1,715 3,037 3,418 margin 14.1% 15.3% 14.5% 13.7% 14.0% 14.0% CORE Operating profit ,059 growth 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 growth 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 growth 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% We summarise the key points and our thoughts from each of the individual presentations by the business unit heads below. Latest production trends Trading LF Sourcing by Marc Compagnon q 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. Price declines hurt sourcing business 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 November 2012 aaron.fischer@clsa.com 2

3 Key customers growing at double-digit Acquired US-based apparel agent 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. Wal-Mart business turning profitable DSG by Dow Famulak q Management stressed that its relationship with Wal-Mart is progressing as expected. The business is turning profitable in 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 LF Beauty by Dow Famulak q This business was set up in 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. Strong design capabilities LF Fashion by Wai Ping Leung q 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%. Acquired Hong Kongbased sweater manufacturer q New acquisition: Li & Fung has acquired Brilliant Global, a Hong Kongbased 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 LF Products by Henry Chan q LF Products focuses on furniture, home textiles and accessories, toys and seasonal gifts. Kurio is the hottest Christmas gift this year 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. 15 November 2012 aaron.fischer@clsa.com 3

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. Cross-selling potential should be tremendous for Logistics LF Logistics by Joseph Phi q 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. Distribution LF USA by Rick Darling q Customer concentration is high in LF USA with the top ten customers accounting for 65% of sales and the top thirty 85% of sales. Management expects LF USA margins to recover to 2010 level 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 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 1H H H H H November 2012 aaron.fischer@clsa.com 4

5 LF Europe by Dow Famulak q Management highlighted a strong acquisition pipeline for LF Europe in early 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. Managing credit risk in Europe 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. Cross-selling with LF Beauty LF Asia Food, Health, Beauty & Cosmetics by Gerald Raymond q This business has tremendous cross-selling opportunities with LF Beauty. q The company is looking to expand footprint in the next months. It currently covers Hong Kong, Thailand and has China, Taiwan, Singapore, Malaysia and the Philippines scheduled to be launched in q LF Asia FHBC grew at +32% Cagr in , 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 LF Fashion & Home by Jason Rabin q LF Fashion & Home was only launched in It is now focusing on international brands, which should benefit as Asian consumers shift away from local brands. Opening showroom in Shanghai 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. 15 November 2012 aaron.fischer@clsa.com 5

6 Summary financials Year to 31 December 2010A 2011A 2012CL 2013CL 2014CL Summary P&L forecast (US$m) Revenue 15,912 20,030 21,624 24,350 26,824 Op Ebitda 838 1,106 1,204 1,223 1,487 Op Ebit ,205 Interest income Interest expense (98) (129) (83) (104) (125) Other items Profit before tax ,094 Taxation (48) (91) (86) (105) (123) Minorities/Pref divs Net profit Summary cashflow forecast (US$m) Operating profit ,205 Operating adjustments Depreciation/amortisation Working capital changes (97) (76) (387) (933) (538) Net interest/taxes/other 4 (106) (86) (105) (123) Net operating cashflow Capital expenditure (78) (113) (119) (125) (131) Free cashflow Acq/inv/disposals (456) (688) (585) (832) (367) Int, invt & associate div (189) (169) Net investing cashflow (723) (971) (691) (944) (485) Increase in loans (13) Dividends (426) (468) (527) (557) (665) Net equity raised/other 847 (54) 487 1, Net financing cashflow 408 (497) (40) 759 (341) Incr/(decr) in net cash 430 (544) Exch rate movements Opening cash Closing cash Summary balance sheet forecast (US$m) Cash & equivalents Debtors 2,451 2,476 3,464 4,201 4,755 Inventories 769 1, Other current assets Fixed assets Intangible assets 4,882 6,526 7,017 7,731 7,995 Other term assets Total assets 9,494 10,920 11,892 13,483 14,400 Short-term debt Creditors 3,097 3,409 2,740 3,041 3,350 Other current liabs Long-term debt/cbs 2,472 3,251 2,823 3,827 4,194 Provisions/other LT liabs Minorities/other equity 6 5 (4) (4) (4) Shareholder funds 3,626 3,934 6,049 6,324 6,553 Total liabs & equity 9,494 10,920 11,892 13,483 14,400 Ratio analysis Revenue growth (% YoY) Ebitda growth (% YoY) Ebitda margin (%) Net profit margin (%) Dividend payout (%) Effective tax rate (%) Ebitda/net int exp (x) Net debt/equity (%) ROE (%) ROIC (%) EVA /IC (%) November 2012 aaron.fischer@clsa.com 6

7 Companies mentioned Li & Fung (494 - HK$ SELL) Recommendation history of Li & Fung Ltd 494 HK Stock price (HK$) Aaron Fischer, CFA Other analysts No coverage BUY U-PF O-PF SELL 15 Jan 10 May 10 Sep 10 Jan 11 May 11 Sep 11 Jan 12 May 12 Sep 12 Date Rec Target Date Rec Target 24 September 2012 SELL May 2011 O-PF August 2012 SELL March 2011 U-PF June 2012 O-PF March 2011 O-PF March 2012 U-PF January 2011 O-PF January 2012 U-PF August 2010 O-PF October 2011 O-PF June 2010 O-PF September 2011 O-PF March 2010 O-PF August 2011 BUY March 2010 BUY 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 CLSA Asia-Pacific Markets ( CLSA ). Note: In the interests of timeliness, this document has not been edited. The analyst/s who compiled this publication/communication hereby state/s and confirm/s that the contents hereof truly reflect his/her/their views and opinions on the subject matter and that the analyst/s has/have not been placed under any undue influence, intervention or pressure by any person/s in compiling such publication/ communication. 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 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 webadmin@clsa.com or (852) If you require disclosure information on previous dates, please contact compliance_hk@clsa.com 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 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) /04/ November 2012 aaron.fischer@clsa.com 7