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Wednesday, 27 August 2014

Trade and tribulations

Shifting trade winds catch Li & Fung off-guard

Once upon a time, manufacturing was relatively simple: China produced and America bought. That’s changing, and supply chain companies like Hong Kong-listed Li & Fung are doing their best to adapt. A Jan. 11 profit warning that wiped the equivalent of $2.2 billion from the company’s valuation shows there’s plenty of room for error.

Li & Fung is a product of East-West trade. Over half its sourcing still takes place in China, and most of its turnover comes from the United States. But as China starts producing higher-value products - and consuming more - making money from trade requires lateral thinking. Clothes and shoes, the classic output of “Cheap China”, fell from 15 percent of exports this time a decade ago to half that in December.

The challenge for Li & Fung is that the pace of adjustment is uncertain. Exports from China to the United States contracted by 3 percent year-on-year in November, but expanded by 10 percent in December. Such volatility creates peril for those trying to plot a change of strategy, like Li & Fung chief Bruce Rockowitz. Central to Friday’s warning of a 40 percent fall in 2012 operating profit was the news that the company is taking a bath on designing and producing products for U.S. consumers.

Rockowitz is nonetheless on the right lines. Broadening into manufacturing, logistics and product design is wise – even if it leaves the company at risk of being squeezed between rising input costs and penny-pinching customers. So too is the decision to buy smaller sourcers and Asia-focused distributors in an attempt to make Li & Fung less cyclical. The company tends to structure deals so it gets some money back if they don’t perform. That’s shrewd, but makes it all too apparent when deals underwhelm.

While the strategy may be right, investors will still wonder how Rockowitz got his timing so wrong. The company will now be lucky to hit $1 billion of operating profit in 2013, never mind the $1.5 billion it set as a target just two years ago. With Li & Fung’s valuation easing to 19 times this year’s revised earnings figure, from 23 times at the beginning of 2013, investors are doing some sensible re-tooling of their own.

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Shares of Hong Kong-listed Li & Fung fell by as much as 16 percent after the Hong Kong based supply chain manager warned its operating profits would be lower by around 40 percent for 2012 than in the previous year.

The group said that the problem lay with its U.S. business, and announced a management change and restructuring, including a reduction in the number of brands distributed in the United States. It added that earnings for 2012 were unlikely to be higher than in 2011.

The company had announced on Aug. 9 that half-year core operating profit fell 22 percent year on year, on slower-than-expected turnaround of its U.S operations and weak demand in Europe. Analysts had previously predicted healthy top-line growth for the company.

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