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Li & Fung Challenged with Creditability Crisis

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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.

Bob Ferrari

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