11 Jan 2013

Li & Fung warns on operating profits
Financial Times

Li & Fung, the Hong Kong clothes seller and retail sourcing group, has handed its investors a weekend dilemma by warning that full-year operating profits would come in 40 per cent below expectations.
The company, which has interests in brands such as Gieves & Hawkes and Cerruti through a sister company and supplies goods to Walmart and Target, made its announcement after the market had closed on Friday, leaving investors unable to trade on the news until Monday morning.*
Restructuring costs and provisions at Li & Fung’s US business were blamed for the expected shortfall, which the company said would mean that full-year profits attributable to shareholders were unlikely to beat those of 2011.
The group had told investors in August that profits attributable to shareholders for the first half were 33 per cent ahead of those in the first half of 2011. However, its shares lost a fifth of their value after the results because of a drop in operating profits at its distribution business, which was hit by the higher leather costs in footwear and handbags and also by restructuring costs.
Analysts said they had expected a fall in operating profits but were surprised by the extent.
'My sense is that cost blowouts are not the whole story,' said Peter Kennan, managing partner of Black Crane Capital, which has a short position in the company. 'Li & Fung’s gross margins and market share are under pressure.'
The group’s shares have risen almost 22 per cent since mid-November, but declined more than 5.5 per cent over this week ahead of the profit warning and finished on Friday at HK$13.88.
Li & Fung said its preliminary review of 2012 management accounts had revealed that its 'efforts to improve the second-half results will not achieve an improvement in core operating profit, and core operating profit is expected to be lower by approximately 40 per cent compared to the corresponding period in 2011'.
Li & Fung is restructuring the US business and cutting the number of brands it distributes as its struggles to boost profitability. Late last month it sidelined the head of the US business, Richard Nixon Darling, putting him into what it called a 'non-operating role' and promoting Dow Peter Famulak to the post.
The group said that the rest of its businesses were performing as expected, although it added that profits would be supported by accounting gains from the writing back of 'several contingent considerations'. These are deferred agreements, or 'earnouts', where part of payment for a deal is contingent on its future performance.
Such writebacks are signs that Li & Fung’s acquisitions have not been performing as well as it had initially expected. Most of its deals are paid for in about one-third cash, and two-thirds delayed earnouts.
*This story has been updated since original publication to correct the fact that Li & Fung does not own Aquascutum and to clarify the fact that Gieves & Hawkes is owned by a sister company