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Bob Ferrari, Founder and Executive Editor
Li & Fung, the global apparel services and logistics provider, and a supplier to major retailers such as Wal-Mart and Target late last week suffered a plunge in its stock price because it warned of a missed profit target. This Hong Kong based global supplier, and one of Asia’s most admired companies, had prided itself on its strategic three-year planning process. Last Friday it issued a public warning indicating that operating profit in 2012 would be 40 percent lower than in 2011 because of restructuring charges related to its U.S. business. That announcement followed previous earnings misses.
Supply Chain Matters featured two previous commentaries related to this supplier. Like others, we originally admired the company’s performance in the industry. But, in August of 2012, our commentary, What’s Up with Li &Fung?, noted the occurrence of a 22 percent drop in profits and a string of analyst downgrades after questions were raised about Li & Fung’s growth strategy. The company’s growth by acquisition strategy was pegged on a consistent growth in share price to fund such acquisitions. Reports at the time indicated that operating earnings had been offset by accounting changes related to previous acquisitions not meeting designated performance targets. We questioned whether the strategy of growth by acquisition vs. growth in additional services was in conflict.
In late September, we noted financial media reports indicating that Wal-Mart had cancelled its international stores supply contract with Li & Fung. Wal-Mart terminated its option to acquire Li & Fung’s Direct Sourcing Group in 2016 opting to its own direct apparel sourcing for international stores. At the time, Li & Fung officials clarified that the supplier would continue to supply products for certain categories for Wal-Mart’s domestic business units.
According to a recently published report in the Financial Times, the latest restructuring involves reducing the products sold related to a 2010 U.S. joint venture to license sports and entertainment branded apparel. Friday’s profit warning precipitated a 15 percent drop in Li & Fung’s stock price, and invoked comments from stock analysts questioning management guidance creditability, while reducing expectations for 2012-2013 performance. Analysts also expect more bad news, because of this creditability gap. According to a report in The Wall Street Journal, these analysts further signaled that problems might run deeper than one division and last longer than a year.
The FT article specifically concludes:
“The market is proving a much sterner audience for Li & Fung. Not only are its ambitious targets in its three year plan being questioned, but also its strength as an efficient acquirer of smaller companies.”
There is speculation from FT that the company may have better luck in 2013 by passing on inflationary direct labor increases occurring in China to its existing customers. Whether these customers are willing to adsorb such increases in certainly up for speculation.
Needless to state, if a supplier affixes its business planning on rolling three year growth targets, it had better have the consistency and operating performance to sustain investor creditability to its growth targets. With the global apparel industry continuing to struggle with higher direct labor costs and needs for increased worker and factory safety, the need for operational consistency and creditability will become even more challenging.
The Wall Street Journal and other business media are reporting that Wal-Mart will adopt a “zero tolerance policy” for suppliers who subcontract Wal-Mart orders to outside factories without that retailer’s knowledge. This new policy change, which is being communicated to suppliers in a 10 page letter, is expected to take effect on March 1.
The new policy supersedes the previous “three strikes” approach, which allowed Wal-Mart suppliers the time to address sub-contract sourcing issues discovered, and comes in the wake of the tragic fire within a sub-contracting clothing factory located in Bangladesh, which was working on Wal-Mart branded apparel. Wal-Mart further indicates that it will require suppliers to pass preapproval audits before suppliers are allowed to do business with the retailer, and specifically that all factories located in Bangladesh must undergo additional safety standard checks in electrical and building safety.
Suppliers have been invited to Wal-Mart Bentonville corporate headquarters on Thursday for a briefing on required safety changes. The retailer further indicates that in order to alleviate any future confusion, it will publish on its web site the names of any suppliers that are not authorized to do business with Wal-Mart suppliers.
Global based labor rights activists are reported to be negatively reacting this latest announcement because it does not specifically address financial incentives to suppliers to institute required wage and safety standards at sub-contracted factories. Wal-Mart on the other hand, indicates that it will investigate the creation of a fund or revolving line of credit those supplier factories can tap to make improvements.
From our viewpoint, Wal-Mart is once again leveraging its massive purchasing power and tendencies to “mandate” supplier requirements. A more two-way dialogue with the retailer’s primary and secondary suppliers, certain labor rights groups and other industry action groups would provide a more constructive set of actions that could address the broader industry problem of financial resources to institute labor and safety standards among primary and secondary suppliers. We trust that the upcoming briefings regarding the new policy would allow for more two-way interaction that would address the broader problems identified by industry participants.