January 8, 2010
This report has been prepared by Samsung Securities (Asia) Limited.
*Not licensed in Hong Kong nor carrying on any business in Hong Kong. ANALYST CERTIFICATION AND IMPORTANT DISCLOSURES BEGIN ON PAGE 29
Li & Fung (494 HK)
COMPANY INSIGHTS
Don’t fight The Matrix… own the Outsourcing Oracle
Bears attack Li & Fung due to lack of organic growth and aggressive
acquisitions. However, the company’s strategy has been successful in
delivering historical growth; our case study of Oracle (ORCL US, N/R) plus
analysis from McKinsey shows that the market rewards ―Active Acquirers‖
that take advantage of a downturn (while 60% of companies simply freeze).
Given the fragmented nature of the sourcing market, far from being
problematic, a policy of acquisitive growth strengthens Li & Fung’s formidable
Global Matrix, which represents a sustainable competitive advantage.
Moreover, we believe that the present macro recovery will surprise on the
upside led by inventory restocking and a shift to an inflationary cycle.
Importantly, the Li & Fung Matrix is demonstrating operational leverage for
the first time. Combined, these factors drive impressive earnings growth.
We think that a moderate re-rating to the historical average 25x PE is justified
by 32% 2009-11e EPS CAGR. Note - this CAGR is NOT inflated by calculating
it from the cyclical low (which would be 2008), and is above the 27% EPS
CAGR from 2005-07, which triggered a re-rating to over 35x PE. Given ROE
recovery and all time high EBIT margins plus positive newsflow from better
retail sales, a return to the average 25x PE may even be conservative.
Our 12-month target of HK$43.00 represents 31% upside. BUY Li & Fung.
SUMMARY FINANCIAL DATA 12-07 12-08 12-09E 12-10E 12-11E
Revenue (HK$m) 92,460 110,722 115,686 148,925 176,120
YoY growth 36.0% 19.8% 4.5% 28.7% 18.3%
EBIT (HK$m) 3,600 3,044 4,547 6,452 7,794
EBIT margin 3.9% 2.7% 3.9% 4.3% 4.4%
EPS (diluted, HK$) 0.88 0.69 1.06 1.54 1.86
YoY growth 32.9% -22.1% 54.0% 45.4% 20.7%
Net margin 3.3% 2.2% 3.4% 3.8% 3.9%
ROE 31.0% 18.1% 21.8% 28.4% 31.2%
PE 37.1x 47.7x 31.0x 21.3x 17.6x
Dividend yield 2.2% 1.7% 2.6% 3.8% 4.6%
Source: Company reports, Samsung Securities. Price based on close 6 January 2010 HK$32.80.
0
1,000
2,000
3,000
4,000
5,000
6,000
1999-2001 2002-2004 2005-2007 2008-2010E
Evolution of Li & Fung's 3-year plans
Net profit (HK$m)
Lead industrychange.Reinvent
distribution through value-chain logistics.
Create new culture.Regional stream
organization, operations
focus and IT invesment.
Net profit (HK$m)
New service agency model.
Unbundling distribution and the creation of
a "Menu of Services."
Create operating leverage.
Active acquisition strategy.
HK$43.00
Target price
Upside +31%
Current price HK$32.80
Matt Marsden
+852 3411 3710
Technical analysis contributed by:
Seung Min You and Sang Cheol Im
Samsung Securities Korea*
SAMSUNG vs THE STREET
Li & Fung Reloaded
Samsung target price vs Consensus +19%
Samsung 2010e EPS vs Consensus +15%
Street recommendation distribution 62% Buy
19% Hold
19% Sell
Our 2010e EPS numbers are 15% ahead of
consensus, driven by a combination of operating
leverage (Li & Fung is demonstrably increasing
EBIT margins for the first time), the impact of
2009 acquisitions, plus a macro recovery which
will surprise on the upside.
Three Oracles help us divine that this stock will
reward investors:
Our case study of Oracle (ORCL US, N/R)
and McKinsey’s work shows that the market
will reward companies that can successfully
grow via “Active Acquisition.”
The Oracle of Omaha. Warren Buffet, looks to
invest in companies with a sustainable
competitive advantage. Li & Fung’s sourcing
network has been strengthened by recent
acquisitions and qualifies as a “Deep moat.”
The Oracle from the Matrix movie trilogy
shows that countercyclical investment can
bring rewards. Our 12-month price target of
HK$43 is significantly ahead of consensus.
“What is the Matrix? Control”
Morpheus, The Matrix, 1999.
January 8, 2010
THE PITCH
Growth by acquisition is not a negative. Our case studies show that the market rewards reputable companies that are “Active acquirers.”
The acquisitions completed during the downturn will help Li & Fung outperform during recovery, and have strengthened the company’s core sustainable competitive advantage; Li & Fung’s Matrix of global sourcing capabilities.
For the first time, Li & Fung is achieving operational leverage through cost savings. As top line picks up, earnings will explode. We see 32% EPS CAGR 2009-11e, which easily justifies a return to the historical mean PER of 25x.
FUNDAMENTALS p3
The company’s core strength - its global matrix - has been enhanced by recent acquisitions. Li & Fung operates in a fragmented market; so far from being problematic, their policy of acquisitive growth is essential to success.
Macro recovery will surprise on the upside. We forecast 29% YoY revenue growth in 2010e helped by inventory restocking, a shift to inflation and 2009 acquisitions.
Top line recovery will combine with operational leverage, for the first time, resulting in earnings upside surprise. Our 2010e EPS is 15% above consensus.
VALUATION p17
A moderate re-rating to the historic average of 25x PE is supported by 32% EPS CAGR 2009-11e. Note - our EPS CAGR is NOT inflated by calculating it from the cyclical low (which would use 2008 as a base).
We note that our 2009-11e EPS CAGR is above the 27% EPS CAGR seen in 2005-07, which triggered a re-rating to over 35x PE.
ROEs are heading back to historic highs and EBIT margins are actually going to be higher. Plus newsflow will be positive. Far from being aggressive, a return to the historic average PE of 25x may even be conservative.
Using a 25x PE target applied to blended 2010 / 11e EPS gives us a January 2011 price objective of HK$43.00, representing 31% upside.
A DCF yields a fair value of HK$44.00, representing 34% upside.
TECHNICALS p20
A mild correction is in the offing over the next two quarters.
That said, with the medium-term support line remaining intact, a strong downward trend reversal is unlikely in the near term.
In the medium to long term, we find the stock attractive technically.
BEAR VIEWS & BLUE SKIES p22
A bear view PE based valuation yields a fair value of HK$19.00, representing 42% downside.
A blue sky PE based valuation yields a fair value of HK$54.00, representing 65% upside.
Li & Fung
RETURN FORECAST
<15% 15-30% >30%
Stars reflect absolute value of u/downside to target price
Fundamentals Li & Fung’s acquisition strategy is NOT a negative, and has helped build The Matrix of global sourcing capabilities which is a sustainable competitive advantage. Earnings should surprise on the upside as top line growth combines with operational leverage to deliver 32% EPS CAGR 2009-11e.
Valuation
Our base case PE valuation yields a January 2011 price objective of HK$43, which represents 31% upside.
Technicals
Mild correction near-term likely. We find the stock attractive long-term technically.
VALUATION
12-08A 12-09E 12-10E
PER (x) 47.7x 31.0x 21.3x
PBR (x) 8.6x 6.7x 6.0x
EV/EBITDA (x) 34.4x 23.5x 17.1x
Dividend Yield (%) 1.7% 2.6% 3.8%
ROE (%) 18.1% 21.8% 28.4%
SAMSUNG vs THE STREET
Samsung Street
Target price (HK$) 43.00 36.03
EPS 10E (HK$) 1.54 1.34
Buy/Hold/Sell Buy 10/3/3
AT A GLANCE
Li & Fung is the world’s leading sourcing agency.
Sector Sourcing
Market capitalization US$15.5bn
Shares outstanding (float) 3,776m/60.8%
52 week high-low HK$12.4 – 36.2
Bloomberg 494 HK
One year performance 1M 6M 12M
Li & Fung +0% +59% +136%
Hang Seng Index -1% +22% +43%
THREE NUMBERS THAT MATTER
Top line growth 2010e EPS CAGR 2009-11e ROE recovery 2010e
+29%
+32%
28% After -2% YoY top line decline in H1 2009 (the first
ever YoY decline in our memory) we think that a return to organic growth and acquisitions will boost top line, and forecast 29% growth this year.
After a 22% YoY decline in 2008, EPS growth is
returning. We forecast 32% CAGR 2009-11e.
Top line growth and operational leverage will lead
to a recovery in return metrics. We forecast ROE will improve from 18% in 2008 to 28% in 2010e.
January 8, 2010
Li & Fung
3
1. Business Fundamentals
Of Oracles and Acquisitions…
Three Oracles
Three Oracles help us divine that this stock will reward investors:
1) A case study of the software services giant Oracle (ORCL US, N/R), reveals that
the company’s active acquisition strategy has driven share price outperformance
since mid-2004. We explore McKinsey’s study of acquisition strategies, and
conclude that far from being a negative, the market should reward Li & Fung for
its ―Active Acquisition‖ policy.
2) The ―Oracle of Omaha‖, Warren Buffet, looks to invest in companies which have
dug deep economic moats. This serves to remind us of Li & Fung’s core strength of
its Global Sourcing Matrix, which has been strengthened further by recent
acquisitions. The Matrix acts as a sustainable competitive advantage, locking in
customers and suppliers.
3) The Oracle from The Matrix movies. This oracle has the power of foresight, but
she herself claims that she lacks the ability to see past her own choice, explaining
that no one, including herself, can see past a choice they do not understand. This
reminds us of how bears on Li & Fung don’t understand that inorganic growth can
be entirely a good thing.
We forecast an earnings explosion in 2010-11e driven by top line growth as the
macroeconomic recovery surprises on the upside, combined with acquisition gains and
(for the first time) operational leverage at Li & Fung. We forecast 32% EPS CAGR
2009-11e.
1) Oracle (ORCL US) "We'd be interested in buying almost anything"
Bears attack Li & Fung for the previous lack of organic growth (H1 09 revenues
declined by 2% YoY), and for the highly acquisitive nature of the company i.e. Li &
Fung has effectively been buying revenue, but has still not managed to generate top line
growth during the downturn.
However, McKinsey have found that, long-term, a company’s actual choice of markets
and M&As are four times more important than outperforming in its markets.
In The Granularity of Growth, McKinsey created a database of roughly 200 global
companies and decomposed the most important sources of growth; market
momentum, mergers, and share gains.
Then they identified segments that had experienced significant upturns or downturns
and looked at the strategies companies adopted during those periods. Finally,
McKinsey computed each company’s total returns to shareholders so as to compare
performance across growth strategies.
INDEX
1. Business fundamentals p3
2. Valuation p17
3. Technical analysis p20
4. Bear Views & Blue Skies p22
Fundamentals Li & Fung’s acquisition strategy is NOT a negative, and has helped build The Matrix of global sourcing capabilities which is a sustainable competitive advantage. Earnings should surprise on the upside as top line growth combines with operational leverage to deliver 32% EPS CAGR 2009-11e.
McKinsey have found that a company’s actual choice of markets and M&As are crucial.
January 8, 2010
Li & Fung
4
McKinsey found that of the potential strategic moves companies can take to grow in a
downturn—divest, acquire, invest to gain share—an effective acquisition strategy
(defined as growth through M&A at a rate higher than that of 75% of a company’s
peers) created significant value for shareholders. During an upturn, on the other hand,
divestments created slightly more value than acquisitions did.
Many companies simply freeze: 60% of companies in the database made no portfolio
moves at all in downturns (vs. 40% in upturns).
―The best growth companies take a different approach. They view a downturn as a
time to increase their leads and make acquisitions. They pounce on the opportunities
it creates with an alacrity that is the stuff of legends: think of GE’s speedy dispatch of
an army of deal makers to Asia after the financial markets took a downturn in 1998.
We’re not saying companies should go on a spending spree in a downturn and tighten
their belts in an upturn. Nor are we unaware that some companies simply aren’t in a
financial position to exploit the opportunities downturns present. But for large
numbers of healthy companies and their CEOs, we hope our research findings are a
useful counterweight to the natural tendency, which is likely to harm shareholders.
Simply put, countercyclical investment can separate the leaders from the also-rans.‖
Source: M&A strategies in a down market, McKinsey, August 2008.
In conclusion, while organic revenue growth through gaining market share is
important for companies, this alone seldom guarantees long-term growth. We believe
that Li & Fung’s is an Active Acquirer, and as such has taken advantage of the
downturn to add to its capabilities and competitive edge, increasing ―stickiness‖ to
clients. We think that the acquisition strategy will help to generate EPS CAGR of 32%
2009-11e, which will be reflected in the future stock price.
Oracle case study
The watershed event for Oracle this decade was in June 2003 when executives
launched an unwelcome bid to acquire archrival PeopleSoft. Oracle's hostile, litigious
takeover scheme, finally consummated some 18 months later in January 2005, marked
the opening salvo in Oracle's new acquisition and growth strategies, a path which it had
appeared unwilling to take on such a grand scale in the past.
"We'd be interested in buying almost anything," CEO Ellison proclaimed at an
analyst’s meeting in July 2003.
True to Ellison's word, by the close of 2009 Oracle had acquired 56 companies—30 of
which filled out Oracle's applications portfolio, and 26 of which spruced up its
technology lines of business.
―What about the results for Oracle's diverse groups of willing and not-so-willing
customers? Industry analysts interviewed for this article claim it's a mixed bag:
"Customers have benefited from increased number and range of solutions—from
continued investment, such as Apps Unlimited, and especially from the integration
work that Oracle has done," says Warren Wilson, research director at Ovum. "But
they're increasingly locked in to Oracle—with far fewer options and switching costs
[that] are high."
In a downturn, an effective acquisition strategy creates significant value for shareholders.
Li & Fung’s is an Active Acquirer, and has taken advantage of the downturn to add to its capabilities, increasing “stickiness” to clients.
January 8, 2010
Li & Fung
5
Three Oracles
Oracle’s CEO Larry Ellison ―Oracle of Omaha‖ Warren Buffet The Oracle from The Matrix
Sources SHCollective.com, Hackthematrix.org
Its most recent quarterly data reveals that during a global economic recession—with steep drops in software spending by its customers—the vendor was able to increase profitability and operating margins, year over year. And, in comparison to rival SAP, the returns from Oracle's acquired customer bases have been able to cushion deep dives in software revenues.
In a 2008 interview with The New York Times, Ellison said: "It's crazy to say you will
only grow through [in-house] innovation. It's bizarre that there's a stigma to buying
something rather than building it yourself."
Source: CIO.com, December 2009.
From FY00 to FY09, Oracle’s revenues grew from US$10bn to US$23bn. Moreover, the
stock price has significantly outperformed since the company adopted an active
acquisition strategy. From the beginning of 2003, Oracle shares have put on 112%, over
five times as much as the 22% gain in the S&P, and twice as much as the broad S&P I.T.
index’s gain of 59%.
Oracle’s stock price outperformance 2003-09
Source: Bloomberg
Li & Fung has also pursued an aggressive acquisition strategy, announcing 23
purchases from the beginning of 2006 (we expect more smaller ―roll up‖ acquisitions,
completed in H2 2009, to be reported at the 2009 results announcement in late March
2010).
5
10
15
20
25
30
Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10
Oracl stock price Rel to S&P 500 index Rel to S&P IT index
US$
We do not think that there should be a stigma to buying something rather than building it yourself.
Li & Fung has also pursued an aggressive acquisition strategy, announcing 23 purchases from the beginning of 2006.
Oracle’s stock price has significantly outperformed since the company adopted an active acquisition strategy.
January 8, 2010
Li & Fung
6
Li & Fung’s acquisitions 2006-09
Announced
date
Consolidated
from
Acquired company Total acquisition price Deal multiple Business scope Reason for acquisition Financing
Upfront
amount
Performance
based
Oct-09 Nov-09 Wear Me Apparel US$102m US$300m in
2010-14
5.6x-22x 2008
PBT
US-based designer and seller of
young men's and children's apparel
Expand into new markets and
categories including those for
young men and juniors
Internal cash
Jun-09 Clearskies (Shubiz's
sourcing operation
in China)
N.A N.A N.A UK-based designer and supplier of
ladies' fashion footwear to UK
retailers
Grow Li & Fung's footwear
presence in Europe
N.A
Mar-09 Shubiz
Mar-09 JMI N.A N.A N.A Shanghai-based producer of high-
end gloves, outerwear and
accessories
Expand product offering for
existing customers
N.A
Feb-09 Mar-09 Liz Claiborne'
sourcing operation
US$83m None N.A US-based designer and retailer of
fashion brands, apparel, accessories
and fragrance products with FY07
sales of US$1.3bn
Enhance Li & Fung's sourcing
platform
Internal cash
Nov-08 Nov-08 Miles Fashion US$51m None 4.9x 2007 PBT German apparel wholesaler to
discounters and retail chains in
Europe
Accelerate the Europe onshore
business
Internal cash
Aug-08 Sep-08 Van Zeeland US$200m US$295m in
2009-11
5.3x-13x 2007
PBT
NYC based importer of mid-tier and
department store handbags
Strengthen the handbag business
in the US. Expand retail
distribution channels
Internal cash and
borrowings
Jul-08 Wilson & Wong
Trading
N.A N.A N.A HK based manufacturer focusing on
ladies fashion garments
Expands fashion customer base N.A
Jul-08 RT Sourcing N.A N.A N.A Sourcing company specializing in
primary packaging and components
for beauty brands
Strengthen health, beauty and
cosmetics business
N.A
Apr-08 Giant
Merchandising's
T-shirt licensed
business
N.A N.A N.A US licensee of brands Provide further category and
brand expansion in licensed
product business
N.A
Feb-08 Silvereed Group N.A N.A N.A HKbased manufacturer focusing on
ladies fashion garments
Expand fashion customer base N.A
Jan-08 Jan-08 Imagine (C.D.P
Asia)
HKD$33m None 2.7x 2007 PBT Asian based company designing and
developing point-of-sales displays for
retailers and manufacturers globally
Strengthen health, beauty and
cosmetics business
Internal cash
Sep-07 4Q 07 Liz Claiborne' four
brands (Emma
James, Intuitions,
JH collectibles,
Tapemeasure)
No initial cash
consideration
N.A N.A US based designer and retailer of
fashion brands of apparel,
accessories and fragrance products
Expand Li & Fung's proprietary
brand portfolio
N.A
Nov-07 Nov-07 American Marketing
Enterprises
US$128m None 8.6x 2006 PBT US based children's entertainment
character licensed company
Expand Li & Fung's leadership in
the children's sleepwear business
Internal cash
Dec-07 Alliance
Merchandising
US$13m None N.A One of the largest Indian buying
agency specializing in home
hardgoods
Strengthen geographical mix of
business
N.A
Aug-07 Sep-07 Regatta US$148 US$152m by
Apr 2012
5.3x-10.7x 2006
PBT
US apparel and brand management
company offering proprietary brands
and private label products
Enhance Li & Fung's designing
and marketing ability in
proprietary brands
Cash raised via
new share
issuance plus
internal reserves
Aug-07 Aug-07 Peter Black GBP48m None 5.2x FY07 PBT Supplier of footwear, accessories and
personal care merchandise to UK
and Continental European retailers
Develop Li & Fung's European
onshore business and support the
health, beauty and cosmetics
business
Internal cash
Jun-07 Jun-07 CGroup US$120m US$80m per
half year from
Mar 2008
10.3x-17.2x
2006 PBT
HK based health, beauty and
cosmetics supplier chain company
Leverage synergies with existing
customers
Cash raised via
new share
issuance plus
internal reserves
Feb-07 Mar-07 Tommy Hilfiger's
sourcing operation
US$248m None 8x FY06 PAT Tommy Hilfiger is a designer brand
with American lifestyle
Reinforce Li & Fung's designer
brand souring capabilities
Internal cash
Sep-06 Mar-07 KarstadtQuelle's
sourcing arm
EUR60m None 5.5x 2005 PBT Leader in the department store and
mail order business in Germany
Rebalance Li & Fung's
geographical mix and enhance
sourcing capabilities
Internal cash
January 8, 2010
Li & Fung
7
2006 2006 Homestead N.A N.A N.A US home textile company Enhance the home textiles
business
N.A
Jul-06 Sep-06 Rossetti Handbags
and Accessories
US$162m US$41m 5.7x 2005 PBT Designer and importer of handbags in
the US
Expand the handbag category Internal cash and
bank borrowings
May-06 May-06 Oxford womenswear
Group
US$37m None 3.7x FY05 OP Design-intensive producer of mid-
priced private label women's apparel
collections targeting US mass
merchants
Boost private label wholesale
business in the US
Internal cash and
bank borrowings
Source: Samsung Securities, Company reports
We see a direct comparison between the acquisition strategies of Oracle and Li & Fung:
Both companies make opportunistic acquisitions of larger companies, while also
employing a ―Roll up‖ acquisition strategy which selectively acquires smaller
companies to gain core competencies, gain access to a new geography or gain
entry or increased penetration into clients.
Oracle buys the intellectual property of others, while Li & Fung buys sourcing
capabilities. Oracle has gained market leverage by building a full technology stack
and a broad portfolio of applications to offer customers. In a similar fashion, Li &
Fung has become an ―Automatic go to‖ in the sourcing market because of its scale,
reach into 40 sourcing territories and extensive category sourcing capabilities.
Both companies have achieved customer ―stickiness.‖
Both companies use acquisitions to ensure continuous growth.
Both gain new talent from acquisitions. In fact, the majority of Li & Fung’s
directors have been bought into the company via acquisition.
However, a key difference in the situation between Oracle and Li & Fung, is that
Oracle’s aggressive buying strategy has nudged other enterprise vendors, including SAP
and IBM, to make purchases that they might not have otherwise made if Oracle wasn't
a deep-pocketed and ever-present threat to buy up every promising vendor in sight.
SAP and IBM have bought dozens of other companies over the last five years.
Li & Fung has much more limited competition in making acquisitions. This is simply
because no other player in the sourcing agency space has achieved anywhere near the
scale of Li & Fung (the nearest competitor, The Connor Group, commands around one
tenth of Li & Fung’s billings).
Li & Fung tends to employ a three-year earn-out policy when paying for acquisitions, in
order to retain management talent and maximize acquisition value / minimize risk.
Management guide that they can afford to be patient and wait for opportunities that
represent real value e.g. the acquisition of Wear Me Apparel announced in November
2009 for US$102m, was at just US$20m above the NAV value of the company and at
around 3.5x 2010e PE. Li & Fung was able to take advantage of a Private Equity owner
who needed to exit this company to make the purchase at such an attractive valuation.
Agent Smith: If you can't beat us...
Agent Smith Clone: ...join us!
Agent Thompson: You!
Agent Smith: Yes, me.
[turns Thompson into another Smith]
Agent Smith: Me... me... me...
Agent Smith Clone: Me too!
Source: The Matrix Revolutions, 2003.
Acquisitions have helped both companies achieve growth and customer “stickiness.”
A key difference in the situation between Oracle and Li & Fung, is that Li & Fung faces less competition when making acquisitions.
Li & Fung management can wait for opportunities that represent real value.
January 8, 2010
Li & Fung
8
War chest makes Li & Fung dangerous to short
After two rounds of fundraising, US$500m in new shares to Temasek in September
2008 (issued at no discount) and a placement of 120m shares at a 6% discount in May
2009 raising US$346m, Li & Fung guide that they are able to finance around
US$900m of acquisitions per annum from existing cash, credit lines and operational
cash flow.
It occurs to us that shorting Li & Fung stock can be a very dangerous game –
management have the capability to surprise the market by announcing a large
acquisition (or outsourcing deal) at any time.
2) The Oracle of Omaha
The ―Oracle of Omaha‖ Warren Buffet looks to invest in companies he describes as
having an ―Economic moat‖, which is the ability of the company to keep its competitors
at bay from hurting its profits – we think this is just a poetic way of saying ―Sustainable
competitive advantage‖.
The wider the moat, the longer the company can protect its profits. The deeper the
moat, the more profitable the company is.
In general, there are four ways for a company to build an economic moat:
1. Low costs or prices.
2. Locking in customers.
3. Locking out competitors.
4. Product differentiation and branding.
It’s worth reminding ourselves that Li & Fung’s acquisitions have helped to build a
moat that is both wide and deep:
Li & Fung has built a sourcing matrix with over 80 offices, sourcing from 40
countries. Li & Fung’s Matrix is illustrated on page 10.
The Matrix provides customers with prices that they could not source themselves,
hence locking them in.
Li & Fung seeks to become a partner to selected suppliers (Li & Fung has a
network of over 8,000 suppliers) providing trade finance, a steady flow of orders
from a large customer base and so is able to secure competitive prices – although
Li & Fung does not seek to represent more than 30% of any one suppliers output.
In terms of product differentiation, no competitor has Li & Fung’s scale, and Li &
Fung can provide a one-stop-shop service for design, material sourcing, product
testing, quality assurance, compliance checking of factories, logistics and help
clients navigate around quota systems and trade restrictions.
In terms of branding, our channel checks indicate that, because of scale, Li &
Fung has achieved an automatic ―Go to‖ status in the sourcing market. Moreover,
company management is adept at investor and public relations (perhaps too
polished sometimes), have a sound reputation and a good track record.
The example of the ―Cargo Pants‖ illustrated below, taken from the book Competing
in a flat world, Fung, Fung and Wind, 2008, nicely summarizes the capabilities of Li
& Fung’s network.
Shorting Li & Fung can be dangerous because of management’s capacity to announce deals.
Li & Fung’s sourcing Matrix provides a sustainable competitive advantage.
January 8, 2010
Li & Fung
9
Cargo pants: The power of network orchestration
Source: Competing in a flat world, Fung, Fung & Wind, 2008.
―A US retailer places an order with Li & Fung for 300,000 pairs of men’s twill cargo
shorts. Li & Fung owns no factories, no weaving machines, no dye, no cloth, no
zippers. It does not directly employ a single seamstress. Yet one month later, the order
is shipped. The buttons come from China; the zippers come from Japan; the yarn is
spun in Pakistan, and woven into fabric and dyed in China; and the garment is sewn
together in Bangladesh. Because the customer needs quick delivery, the order is
divided among three factories.
If the order had come in two weeks later, it would have resulted in a completely
different supply chain, using different partners drawn from a network of 8,300
suppliers around the globe. Like a message routed through Internet, the project
moves along the best specific path chosen from a broader network. The supply chain
is evoked by the order the customer. This is the power of network orchestration.‖
3) The Oracle from the Matrix
In the Matrix film trilogy, the Oracle is a mysterious but powerful figure, incongruously
depicted as a cheerful old lady who enjoys smoking cigarettes and baking cookies. She
possesses the power of foresight, which she uses to advise and guide the humans
attempting to fight the system. We liken this to the Li & Fung management team, with
the foresight to actively acquire companies during the downturn. We also liken this to
our own forecasts, which predict strong earnings growth at Li & Fung 2009-11e.
Later, she is revealed to be a sapient program that is integral to the very nature of the
Matrix itself. Whether her power of prediction is deterministic or not is a concept given
much treatment in all three films. She herself claims that she lacks the ability to see
past her own choice, explaining that no one, including herself, can see past a choice
they do not understand. This reminds us of how bears on Li & Fung don’t understand
that inorganic growth can be entirely a good thing.
Management had the foresight to actively acquire companies during the downturn.
January 8, 2010
Li & Fung
10
The Li & Fung Matrix
Source: Li & Fung
Dalian Beijing
Qingdao Nanjing Suzhou
Shanghai Hangzhou Ningbo
Hepu Longhua Shantou
Chengdu Guangzhou
Dongguan Shenzhen Liuyang
Zhanjiang Taipei Seoul
Tokyo Macau Hong Kong
Bremerhaven Bucharest
Dusseldorf Sofia Istanbul
Izmir Denizli Cairo
Huddersfield St Albans
London Amersfoort Paris
Vienna Turin Oporto
Madrid Barcelona Warsaw
Amman Sharjah
Faisalabad Karachi Lahore
Delhi
Mumbai Bangalore
Chennai Tripura
Colombo
Dhaka
Durban
Antananarivo Moka
Bangkok
Hanoi Phnom Penh Ho Chi Minh City
Makati Saipan Kuala Lumpur
Singapore Jakarta
San Francisco Boston
New York City
Gaffney Guadalajara Mexico City
Guatemala City Managua
San Pedro Sula
Santo Domingo
January 8, 2010
Li & Fung
11
Earnings explosion
A combination of factors will drive strong earnings growth at Li & Fung through 2009-
11e:
Inventory restocking at Li & Fung’s major customers, supported by a Western
consumer that simply refuses to lay down and die.
The evidence points to the end of the current deflationary cycle. We believe that
the macroeconomic environment is likely to provide a positive surprise to the
market. Our top line forecasts for Li & Fung are ahead of consensus by 9% in
2010e and 13% in 2011e, see page 14.
We estimate that acquisitions made through 2009 will add at least HK$817m to
2010e EBIT (13% of 2010e EBIT).
For the first time ever, Li & Fung is achieving operational leverage as part of the
current 2008-10 three-year plan, see page 16.
Soft base effect. H1 2009 revenues declined by 2% YoY. Li & Fung had to grapple
with deflation of 7%, plus bankruptcy of some key accounts. No accounts have
gone bankrupt since the results were released in August, and we think that
deflationary pressures are easing fast.
We forecast that Li & Fung will grow net profit by a CAGR of 32% 2009-2011e (NB we
do not inflate this figure by using the weak year of 2008 as a base).
Li & Fung’s revenue growth and net profit 2006-12E.
Source: Company reports, Samsung Securities
The stage is set for a better cyclical start for 2010
Apart from raising productivity and reducing costs, one of the other ways Li & Fung’s
customers have reacted to the downturn, is to reduce inventory levels.
Li & Fung tell us that most of their clients have reduced inventory substantially in 2009
in order to reduce risk. We understand that most businesses prefer to re-stock only
when there are sure signs of end-demand, even if this proves to be a more costly
approach to managing inventory.
0
1,000
2,000
3,000
4,000
5,000
6,000
7,000
8,000
9,000
0.0%
5.0%
10.0%
15.0%
20.0%
25.0%
30.0%
35.0%
40.0%
2006 2007 2008 2009E 2010E 2011E 2012E
Net profit (HK$m, RHS) Revenue YoY growth (LHS)
Macro environment is likely to provide a positive surprise to the market.
We forecast that Li & Fung will grow net profit by a CAGR of 32% 2009-2011e.
For the first time achieving operational leverage.
January 8, 2010
Li & Fung
12
China and HK monthly freight volume by air (YoY change)
Source: Bloomberg
We think that the Inventory to Sales ratio of US wholesalers has now fallen to levels
that suggest that a correction is imminent. Indeed, volumes of air freight are growing
rapidly, which suggests that the inventory restocking cycle has actually begun.
China exports and US wholesale inventory / sales ratio
Source: Bloomberg
Anecdotally, low inventory levels at some North American retailers may rapidly be
becoming a problem. The economist Louis Gave provides some amusing anecdotal
evidence from his Christmas holidays:
―Louis recently relayed his frustration from his holiday in Whistler, Canada:
He could not find a single shop stocking ski boots for his youngest son,
He had to visit three shops before finally finding gloves to the kids,
He had to see five shops before being able to find sleds for the kids,
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-30
-20
-10
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20
30
40
Jan-0
7
Mar-
07
May-
07
Jul-07
Sep-0
7
Nov-
07
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8
Mar-
08
May-
08
Jul-08
Sep-0
8
Nov-
08
Jan-0
9
Mar-
09
May-
09
Jul-09
Sep-0
9
Nov-
09
(%)
HK Freight Volume by Air (RHS) China Freight Volume by Air (LHS)
1.10
1.15
1.20
1.25
1.30
1.35
1.40 -30
-20
-10
0
10
20
30
40
50
60
70
93 95 97 99 01 03 05 07 09
(%)
China Exports (3mma, YoY%)
US Wholesale Inventory to Sales Ratio (3mma, RHS Inverted)
(x)
Inventory restocking is imminent.
January 8, 2010
Li & Fung
13
He was forced to do three shops before finding ski boots of his size (and no
freakish feet size either, just a normal size 10).
In fact, every shop told Louis the same story: "we under-ordered, because we feared
demand would be very weak..." Meanwhile, yesterday Whistler had its biggest-ever
day, with more than 20k people on the mountain! This might quickly get problematic.
After all, the Olympics are five weeks away, and it takes two to three months to get
stock in...The way we see it, the low inventory levels does not portend well for the
deflationists out there. Indeed, after a day of very frustrating shopping, Louis would
have gladly paid whatever the asking price was for his kid’s boots, sleds and gloves...
This all comes back to a theme that we have tried to highlight in our research: the risk
is not that the US recovery will be anemic, the risk is that is it will be anything but
anemic. After all, a stronger-than-expected rebound could trigger a scramble by
policy makers to get out from behind the curve and a scramble to restock goods on the
shelves, putting pressure on prices.... As such, the recent rally in the US$ makes sense,
as does the weakness of government bonds.‖
Source: Ticking the boxes, GaveKal, 29 December 2009.
Our strategist, Alfred Chin, believes that a lower CPI base and pressure from rising
food prices will likely lead to inflationary expectations in the equity market generally.
Consumer price index YoY %
Source: Bloomberg
Li & Fung guide that they think that the current deflationary cycle will shift to inflation
from mid-2010. This will relieve ASP pressure across the board and help Li & Fung’s
cost plus sourcing agency model.
So far, the official data is showing minimal restocking at company levels, but it seems
that the U.S. consumer simply refuses to lay down and die.
Indeed, SpendingPulse, a unit of MasterCard Advisers, has reported that US Christmas
holiday sales rose 3.6% YoY, or 1% taking in to account the extra day between
Thanksgiving and Christmas in 2009 (SpendingPulse relies on data from the
MasterCard payments network and estimates for use of cash and other payment forms.
It excludes automobile and gasoline sales).
This does not appear to just be low-end discount spending: Apple reported strong holiday sales too (pushing shares to a new record high), highlighting decent discretionary consumer demand.
-4
-2
0
2
4
6
8
10
05 06 07 08 09
(%)
US Eurozone CHINA
Inflationary expectations return.
U.S. Christmas holiday sales rose 3.6% YoY.
January 8, 2010
Li & Fung
14
Our forecasts vs market consensus
FY ending 31 Dec 2009E 2010E 2011E
Revenue (HK$m)
Consensus 115,431 136,103 156,047
Highest 133,646 154,325 182,546
Lowest 109,615 119,116 139,124
Samsung 115,686 148,925 176,120
Difference 0% 9% 13%
EBIT (HK$m)
Consensus 4,299 5,832 7,000
Highest 4,819 7,189 8,161
Lowest 3,121 4,502 5,181
Samsung 4,547 6,452 7,794
Difference 6% 11% 11%
Net profits (HK$m)
Consensus 3,669 5,017 6,007
Highest 4,275 6,254 7,341
Lowest 3,012 3,920 4,603
Samsung 3,882 5,645 6,814
Difference 6% 13% 13%
Diluted EPS (HK$)
Consensus 0.99 1.34 1.59
Highest 1.15 1.66 1.94
Lowest 0.81 1.04 1.23
Samsung 1.06 1.54 1.86
Difference 7% 15% 17%
DPS (HK$)
Consensus 0.80 1.07 1.27
Highest 0.94 1.33 1.56
Lowest 0.57 0.85 0.80
Samsung 0.85 1.24 1.49
Difference 7% 16% 18%
Source: Bloomberg consensus, Samsung Securities
On 24 December the company’s own guidance turned upbeat. During an interview with
Bloomberg, Bruce Rockowitz, Li & Fung’s President, stated:
The cycle is at the bottom and ―Things are incrementally coming up.‖
Western consumers are no longer concerned about what they only really need and
the price. ―It’s now changing to what people want.‖
The luxury sector, which died in the depths of the downturn, is recovering.
Mr. Rockowitz was feeling ―Much more happy, much more bullish by far….than a
year ago.‖
We forecast YoY top line growth of 29% in 2010e (helped by acquisitions made in
2009) and 18% in 2011e.
Li & Fung’s guidance has become more upbeat.
January 8, 2010
Li & Fung
15
Self flagellation of achieving operating leverage
―How do organizations plan in a way that allows for renewal but also creates enough
stability so entrepreneurial units know where they stand? How do companies in a flat
world balance the need to motivate their divisions to move towards a common goal
with the freedom to allow them to respond to changes in their immediate business
environments?
The solution for L&F has been to develop a planning process that creates stretch goals
that are renewed every three years. In this rapidly changing world, five-year plans
are too long and one-year budgets are too short to build anything meaningful (like
client relationships). Three years seems to be just the right duration.‖
From Competing in a Flat World, Fung, Fung and Wind, January 2008.
L&F’s management publicly announce three-year plans. These are not public guidance
but ―Stretch Goals.‖ While the company does not always hit the self imposed targets
(e.g. Li & Fung missed the 2002-2004 plan due to SARs and the general economic
slowdown), we are impressed with the challenge and management focus that the plans
generate.
Group Managing Director William Fung has referred to the ―Self flagellation of meeting
the three-year plans‖.
Li & Fung: Evolution of the 3-year plan
Source: Competing in a flat world, Samsung Securities
For the current 2008-10 plan, the company has the following goals:
To grow group revenues from US$12bn in 2007, to US$20bn in 2010. We forecast
that Li & Fung can generate US$19.2bn top line by 2010e, 4% short of its goal.
Of revenues, US$3bn is to come from the U.S. Onshore business and US$1bn is to
come from the European Onshore business. We forecast that the company can hit
its target to generate US$4bn revenues from the Onshore businesses.
To achieve a 2x goal, i.e. to grow core operating profit at twice the rate of revenues
to reach US$1bn by 2010 i.e. to create operating leverage. We forecast that core
operating profit will reach US$833m by 2010e, i.e. 17% short of management’s
goal.
0
1,000
2,000
3,000
4,000
5,000
6,000
1999-2001 2002-2004 2005-2007 2008-2010ENet profit (HK$m)
Lead industrychange.Reinvent
distribution through value-chain logistics.
Create new culture.Regional stream
organization, operations
focus and IT invesment.
Net profit (HK$m)
New service agency model.
Unbundling distribution and the creation of
a "Menu of Services."
Create operating leverage.
Active acquisition strategy.
Li & Fung’s current 3-year plan aims to create operating leverage.
January 8, 2010
Li & Fung
16
The big surprise at H1 2009 results was the cost savings achieved. Li & Fung reported a
6% YoY drop in total operating expenses. The company guide that operating expenses
can drop by 10% YoY i.e. 2008 operating expenses of HK$8.9bn can decrease to
HK$8.1bn in 2009e. Moreover, more cost cutting can be achieved in 2010e.
A look through our historical accounts indicates that Li & Fung have never achieved
economies of scale, despite an incredible 22% top line CAGR 1992 – 2007. In our
opinion, a focus on expense control and operating leverage marks a milestone in the
maturity of Li & Fung, and a strong new earnings driver going forward.
Samsung forecasts vs Li & Fung’s 2008-10 plan
(in US$m) Samsung Li & Fung’s 2010 plan Difference
Total revenue 19,216 20,000 -3.9%
Sourcing 14,818 16,000 -7.4%
US onshore 3,392 3,000 13.1%
European onshore 1,006 1,000 0.6%
Core operating profit 833 1,000 -16.7%
Source: Company reports, Samsung Securities
The operational leverage that we are currently seeing at Li & Fung positions the
business very nicely for any rebound in top line. This is exactly what we anticipate for
2010e.
We forecast that EBIT margin will recover from 2.7% in 2008 to a normalized 3.9% in
2009e, but then reach a new high of 4.3% in 2010e.
Li & Fung EBIT and EBIT growth 2006-14E
Source: Company reports, Samsung Securities
The Architect: What you did was dangerous.
The Oracle: Change always is, but it’s worth it.
Source: The Matrix Revolutions, 2003.
-20%
-10%
0%
10%
20%
30%
40%
50%
60%
0
2,000
4,000
6,000
8,000
10,000
12,000
14,000
2006 2007 2008 2009E 2010E 2011E 2012E 2013E 2014E
EBIT (HK$m, LHS) EBIT YoY growth (RHS)
The operational leverage that we are currently seeing, positions the business very nicely for any rebound in top line.
January 8, 2010
Li & Fung
17
2. Valuation
Increasing return metrics lead us to Zion
At some point, Li & Fung’s growth rate will inevitably slow. But across 2010-11e, we
think that earnings will be propelled by a combination of improvement in the
macroeconomic environment, the impact of acquisitions and operational leverage.
Operational leverage should enhance return metrics. For 2008-11e, we forecast
expansion in ROE from 18% to 31%, ROA from 7% to 12% and ROIC from 15% to 32%.
Li & Fung’s return metrics 2006-12E
Source: Samsung Securities, Company reports
Examining the PE band for the stock from 2003 to date, we find that Li & Fung has
traded within a volatile one-year forward PE range of between 12x and 55x. The
average one-year forward PE has been 25x.
We choose to use this period, as pre 2003 the stock’s valuation was affected by the Dot
Com Bubble, trading over 50x PE during some periods, because of Li & Fung’s On-Line
Studio Direct internet business venture (now discontinued).
0.0%
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30.0%
35.0%
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2006 2007 2008 2009E 2010E 2011E 2012E
ROE ROA ROIC
INDEX
1. Business fundamentals p3
2. Valuation p17
3. Technical analysis p20
4. Bear Views & Blue Skies p22
Valuation
Our base case PE valuation yields a January 2011 price objective of HK$43, which represents 31% upside.
At some point, Li & Fung’s growth rate will inevitably slow…
Increasing return metrics should support valuation multiples.
...but that point is not yet here. Operational leverage will help bottom line growth and increase returns.
January 8, 2010
Li & Fung
18
Li & Fung: One-year forward PE bands
Source: Company reports, Samsung Securities, Bloomberg
The stock price hit an all time high of HK$39.25 in November 2007. The stock
experienced multiple expansion from mid-2004 through 2007. We note that EPS
CAGR 2005-07, when the stock price really took off, was 27% (EPS CAGR 2004-07 was
20%).
We forecast 2009-11e underlying EPS CAGR of 32% (NB we are not inflating our EPS
CAGR number by using the low base year of 2008).
We are therefore comfortable using the historical 2003 -09 average of 25x as our one-
year forward PE multiple target.
In fact, we think that with recovering ROE, EBIT margins heading for an all time high,
positive newsflow from better retail sales plus fast EPS growth, targeting 25x PE may
even be conservative.
In January 2011 we believe that the market will partly be pricing the stock from
anticipated 2011 earnings. Thus, we blend our 2010e and 2011e EPS to arrive at
HK$1.70 and multiply this figure by 25x to yield a PE multiple based priced target of
HK$43, rounding to the nearest Hong Kong dollar.
Our price objective represents 31% upside. We initiate coverage of Li & Fung with a
three-star BUY rating.
DCF valuation for reference
We provide a DCF valuation for reference.
We use a WACC of 9.5% and a long-term growth rate of 3.0%.
We explicitly forecast out for 10 years. We think that our assumptions are reasonable.
Our FCF CAGR 2010-19e is 15%, this compares with historical FCF CAGR of 28% over
2001-09e.
Our DCF fair value emerges at HK$44 per share, rounding to the nearest Hong Kong
dollar, implying 34% upside.
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Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11
HK$ 25x
20x
30x
15x
We are comfortable targeting the historical average PER of 25x.
Our price objective represents 31% upside.
EPS CAGR 2005-07, when the stock price really took off, was 26%.
We forecast 2009-11e underlying EPS CAGR of 32%.
We are not inflating our EPS CAGR by using a low base.
For reference, a DCF valuation emerges at HK$44 per share.
January 8, 2010
Li & Fung
19
Li & Fung: DCF valuation
Current price (HK$, 6 Jan 2010) 32.8
Weighted average number of shares - basic 3,651
Mkt cap (HK$m) 119,752
Net debt (2009E) 1,416
EV (HK$m) 121,168
% Equity 99%
% Debt 1%
Risk free rate 4.0%
Equity risk premium 6.0%
Beta 0.93
Cost of equity 9.6%
Cost of debt 3.0%
Tax rate 12.0%
WACC 9.5%
Explicit forecast (HK$m) 2009E 2010E 2011E 2012E 2013E 2014E 2015E 2016E 2017E 2018E 2019E
NOPLAT 4,161 5,871 7,015 8,210 9,311 11,011 12,421 13,722 15,041 16,309 17,569
Depreciation and amortization 613 629 660 700 747 805 869 936 1,005 1,073 1,139
Change in working capital -156 -1,109 -1,005 -943 -1,101 -1,276 -1,151 -1,156 -1,579 -1,133 -1,123
CapEx -521 -655 -757 -854 -931 -1,046 -1,138 -1,223 -1,300 -1,365 -1,421
Free Cash Flow 4,096 4,736 5,912 7,113 8,027 9,494 11,001 12,279 13,167 14,885 16,164
PV of FCF
4,325 4,931 5,418 5,584 6,031 6,382 6,506 6,371 6,577 6,523
Sum of PV of explicit forecast 58,648
Terminal growth assumption 3.0%
WACC 9.5%
FCF at 2020E (HK$m) 16,649
Terminal value of FCF at 2019 (HK$m) 256,176
PV of terminal forecast 103,381
LT Growth Rate
Enterprise Value (HK$m) 162,029
2.0% 2.5% 3.0% 3.5% 4.0%
Net debt ((HK$m, 2009E) 1,416
WA
CC
8.5% 43.7 46.2 49.1 52.7 57.0
Intrinsic Market value (HK$m) 160,613
9.0% 41.7 43.8 46.3 49.3 52.8
Value per share (HK$) 44.0
9.5% 40.0 41.8 44.0 46.5 49.5
Current price (HK$, 6 Jan 2010) 32.8
10.0% 38.5 40.1 42.0 44.1 46.6
Upside potential 34%
10.5% 37.1 38.6 40.2 42.1 44.3
Source: Samsung Securities estimates.
January 8, 2010
Li & Fung
20
3. Technical Analysis
Welcome to the machine Agent Smith: Never send a human to do a machine’s work.
Source: The Matrix, 1999.
Undergoing a technical correction
The stock has been stuck in a narrow range since October 2009 on investor caution as
the stock approaches its historic high (hit in November 2007).
We do not find any evidence to suggest that the recent correction has eroded the stock’s
medium-term uptrend. However, we believe the technical correction will continue for
another one to two quarters for the following reasons:
1) Our trend-following trading model based on the fraction MACD showed a selling
signal at end-2009, indicating a slowdown in upside momentum.
2) Relative strength vs the Hang Seng Index will likely turn down, facing resistance
at the March 2009 high.
In the medium to long term, we find the stock attractive technically, as it has remained
in an uptrend within a gradual, but stable band since 2000 and the RS vs HSI has
sustained an uptrend over the same period.
Li & Fung (494.HK) weekly log, 40-week EMA, fraction MACD, RS
Identifying market trend: When 40-week EMA turn positive and Fraction MACD is above 1, we indicate that the market is in bullish trend. Trading signal: Long signal (L) is indicated when the stock surpasses the weekly high, which formed when the fraction MACD breaches its signal line upward. Conversely, short signal (S) appears when the stock surpasses the weekly low, which formed when the fraction MACD breaches its signal line downward. Source: Bloomberg, Samsung Securities
2005 A M J J A S O N D 2006 A M J J A S O N D 2007 A M J J A S O N D 2008 M A M J J A S O N D 2009 M A M J J A S O N D 2010 A M J J A
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frac MACD(10,20)
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Analysts SeungMin You [email protected] (822) 2020-7024
SangCheol Im [email protected] (822) 2020-7779
INDEX
1. Business fundamentals p3
2. Valuation p17
3. Technical analysis p20
4. Bear Views & Blue Skies p22
Technical
A mild correction is in the offing over the next
two quarters. That said, with the medium-term
support line remaining intact, a strong
downward trend reversal is unlikely in the
near term. In the medium to long term, we
find the stock attractive technically.
In the medium to long term, we find the stock attractive.
We believe the current technical correction will continue for another one to two quarters.
January 8, 2010
Li & Fung
21
Li & Fung (494.HK) monthly log, RS
Source: Bloomberg, Samsung Securities
Our SSC model-based significant peaks have declined from HK$36.2 to HK$34.6 since
Oct 2009, while the MACD has rapidly fallen into negative territory. That said, with the
medium-term support line remaining intact, a downward trend reversal is unlikely in
the near term.
Our first and second support lines lie at HK$30 and HK$25, respectively, the latter
carrying more importance technically, based on resistance lines formed between
Apr~Jul 2009 and our SSC model-based meaningful troughs. Share-price declines
year-t0-date have been mild despite the rapid decline in the MACD, thanks to bargain
hunting demand, which has been equally as strong as selling pressure. All in all, a mild
rather than deep correction is in the offing.
Li & Fung (494.HK) daily log, MACD, Stochastics, RS
Note: The Samsung stochastics cycle (SSC) model is used to determine short-to-medium-term trend reversals, and set meaningful resistance (or support) targets using stochastics (slow 10, 5). Meaningful resistance occurs at the Share’s intraday peak during a period when the stochastics oscillator turns downward at the 70% level and falls to 30%. In contrast, meaningful support occurs at the Share’s intraday trough during a period when stochastics turn upward at 30% and rise to the 70% threshold. Breakthroughs at such targets (30% and 70%) are thought to mark trend reversals
Source: Bloomberg, Samsung Securities
December 2009 February March April May June July August September October November December 2010 February
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60
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0.800.850.900.951.001.051.101.151.201.251.301.351.401.45
RS to HSI (RHS)
Stochastics Slow (10,5,1)
15
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35
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MACD (12,26 RHS)
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14.90
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20.95
17.44
24.70
19.20
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25.95
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1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012
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All in all, a mild rather than deep correction is in the offing.
A downward trend reversal is unlikely in the near term.
January 8, 2010
Li & Fung
22
4. Bear Views & Blue Skies
The red pill, or the blue pill?
Markets are all about balance of probability. We provide strong opinions but do not
ignore the possibility that events will go against us. We therefore try to quantify the
risks if we are wrong. Given two stocks with an identical percentage upside to Target, it
is critical to know that one has, for example 5% downside and the other 25%. We
believe that this is how many investors think, and we attempt to reflect this in our
research.
Addressing the bear arguments
There are several reasonable bearish arguments on Li & Fung that we will address here:
1. The company’s organic growth is deeply negative in 2009. Without acquisitions,
Li & Fung would not be growing at all – this is not a sustainable business model.
We argue that history shows that the market still rewards inorganic growth. We
believe that Li & Fung’s acquisition strategy has helped to build the company’s
sourcing matrix capabilities, enhancing its sustainable competitive advantage,
and creating a new earnings stream in the U.S. Onshore business. We also think
that Li & Fung will be able to return to organic growth from 2010e, benefiting
from a better than expected macroeconomic recovery. Moreover, there are many
opportunities for Li & Fung e.g. develop its inter-Asia sourcing business to cater
to rising Asian consumer spending, spurring a new leg of growth in the mid-term.
2. The company’s strategy of buying growth must eventually lead to declining
ROIC. Li & Fung is demonstrating that it can achieve (for the first time) operating
leverage. This will result in improving return metrics. We anticipate that ROIC
will improve from 15% to 32% 2008-11e.
3. Li & Fung can only buy poor businesses at low multiples. Acquisitions or
acquired outsourcing procurement contracts are of underperforming brands.
Good businesses simply won’t sell out to Li & Fung. The example of Wear Me
Apparel, acquired for just 3.5x 2010e PE shows that Li & Fung is, in fact, well
positioned to opportunistically buy decent businesses at good valuations. This is
because acquisition targets realize that they can benefit from plugging in to the
sourcing matrix, and Li & Fung does not have to enter a bidding war for
acquisitions – there are no competitors with anywhere near the same scale.
4. The stock trades at consensus 24x 2010e PER. Surely, this must be too expensive
for a company that has to buy all of its growth and is dangerously exposed to
weak retail sales in The U.S. and Europe? We think that the macro will surprise
on the upside - the company is nicely positioned for recovery. The stock’s
historical PER from 2003 has been 25x. We forecast 32% EPS CAGR 2009-11e,
superior to the 27% EPS CAGR produced 2005-07, when the stock re-rated to
over 35x PER. Our PER target of 25x is conservative considering fast EPS growth,
recovering ROE, and EBIT margins going to new all time highs.
INDEX
1. Business fundamentals p3
2. Valuation p17
3. Technical analysis p20
4. Bear Views & Blue Skies p22
Bear Views & Blue Skies Our bear views valuation gives 42% downside, while our blue skies valuation gives 65% upside.
We address the bear arguments on Li & Fung.
Li & Fung may develop its inter-Asia sourcing business to cater to rising Asian consumer spending, spurring a new leg of growth in the mid-term.
Li & Fung does not have to enter a bidding war for acquisitions.
Our PER target of 25x is conservative considering fast EPS growth, recovering ROE, and EBIT margins going to new all time highs.
January 8, 2010
Li & Fung
23
5. Li & Fung is becoming a large company and is threatened by On-line
competition e.g. Ali-Baba. At some point, the growth rate must slow, which
should be followed a PE multiple de-rating. This argument must eventually be
true, but we think that Li & Fung is far from reaching maturity yet (forecasting
32% EPS CAGR 2009-11e). Li & Fung’s clients mostly source in size, so a face-to-
face business relationship, rather than sourcing via On-line methods, is necessary.
We note that Li & Fung discontinued its Studio Direct On-line business unit six
years ago.
6. The company refuses to give any financial disclosure on how previous
acquisitions are fairing. This is more than disappointing, and must mean that
not all acquisitions have been successful. We completely agree with this point. We
urge management to increase financial disclosure on previous acquisitions, so
that the market can be reassured that the acquisition strategy is working overall.
Bear view valuation gives 42% downside
Our bear view quantifies the risks we see for Li & Fung by factoring in a worst case
scenario into the valuation. In our bear view scenario we take the following
assumptions:
Sales stagnate. We factor in flat sales in 2009e, 2010e and 2011e. Despite the clear
signs of economic stabilization and inventory restocking, plus acquisitions, we
assume flat revenues from 2008e.
Despite the positive trend we see at present, in our bear view we that margins stay
flat from 2009e. We assume 2010e and 2011e net margin of 3.4%.
Valuation multiples for the stock decline. We use 18x blended 2010/11e for our
bear view PE target multiple.
We arrive at a blended 2010/11e EPS of HK$1.03, which is 40% below our base case
forecast of HK$1.70.
Using a PE multiple target of 18x, and rounding to the nearest Hong Kong dollar, we
arrive at bear view valuation of HK$19 per share. This implies 42% downside from the
stock’s current price.
Blue sky valuation gives 65 % upside
In our blue sky scenario, we keep our 2010e forecasts unchanged, but become more
optimistic on our 2011e assumptions:
We increase our 2011e YoY top line growth rate from +18% to +25%, resulting in
2011e group revenues of HK$186,156m. This could happen if the group continues
to actively acquire.
Net margins increase from 3.8% in 2010e to 4.1% in 2011e (up from our current
2011e base case assumption of 3.9%) due to further operating leverage gains.
This results in 2011e EPS of HK$2.08.
Valuation multiples for the stock become excited. We use 30x blended 2010/11e
for our blue skies PE target multiple.
We arrive at a blended 2010/11e EPS of HK$1.81, which is 6% above our base case
forecast of HK$1.70.
Using a PE multiple target of 30x, and rounding to the nearest Hong Kong dollar, we
arrive at blue skies valuation of HK$54 per share. This implies 65% upside to the
stock’s current price.
Our bear view quantifies the risks we see for Li & Fung by factoring in a worst case scenario…
..which emerges at HK$19 per share, implying 42% downside to the current share price.
Our blue sky valuation implies 65% upside to the current share price.
In our blue sky scenario, we become more optimistic for our 2011e assumptions.
For large clients, a face-to-face relationship, rather than sourcing on-line, is necessary.
We urge management to increase financial disclosure on previous acquisitions.
January 8, 2010
Li & Fung
24
Li & Fung ratios 2004-13E
FY ending 31 Dec 2004 2005 2006 2007 2008 2009E 2010E 2011E 2012E 2013E
YoY growth
Total revenue 10.6% 17.9% 22.3% 36.0% 19.8% 4.5% 28.7% 18.3% 15.5% 11.6%
Gross profit 14.4% 31.0% 29.6% 33.2% 18.8% 6.4% 29.9% 19.4% 16.6% 12.6%
Core operating profit 17.9% 19.6% 26.0% 35.9% -3.2% 47.4% 41.9% 20.8% 18.4% 14.7%
Total operating profit (EBIT) 18.6% 21.1% 28.0% 49.2% -15.4% 49.4% 41.9% 20.8% 18.4% 14.7%
Net profit 19.4% 20.1% 23.0% 39.0% -20.9% 60.3% 45.4% 20.7% 18.0% 14.1%
Margins
GP margin 9.2% 10.2% 10.8% 10.6% 10.7% 10.7% 10.8% 10.9% 11.0% 11.1%
Core OP margin 3.3% 3.3% 3.4% 3.4% 2.8% 3.9% 4.3% 4.4% 4.5% 4.7%
OP margin 3.3% 3.4% 3.5% 3.9% 2.7% 3.9% 4.3% 4.4% 4.5% 4.7%
Net margin 3.2% 3.2% 3.2% 3.3% 2.2% 3.4% 3.8% 3.9% 4.0% 4.0%
Returns
ROE 31.7% 38.7% 26.6% 31.0% 18.1% 21.8% 28.4% 31.2% 33.3% 34.5%
ROA 13.2% 11.7% 10.0% 9.6% 6.5% 9.0% 11.3% 12.2% 13.0% 13.6%
ROIC 48.8% 30.6% 26.5% 22.7% 15.4% 21.5% 28.6% 32.4% 36.1% 38.7%
Working capital
Inventory days 4 5 8 9 9 9 9 9 9 10
AR days 36 51 50 54 49 50 50 50 50 50
AP days 39 44 45 50 47 49 49 49 49 49
Gearing
Current ratio 2.7x 2.2x 2.3x 1.5x 1.3x 1.5x 1.8x 2.2x 2.5x 2.8x
Debt/equity 16.0% 54.3% 45.8% 61.2% 48.2% 35.8% 32.0% 29.1% 26.4% 23.9%
Net cash/equity 33.9% -27.3% -4.8% -46.3% -31.2% -8.0% -2.6% 1.4% 6.1% 9.9%
Valuation
PE 64.4x 59.4x 49.3x 37.1x 47.7x 31.0x 21.3x 17.6x 14.9x 13.1x
PB 20.3x 22.8x 13.0x 11.4x 8.6x 6.7x 6.0x 5.5x 5.0x 4.5x
EV/EBITDA 71.2x 59.6x 46.1x 31.4x 34.4x 23.5x 17.1x 14.3x 12.2x 10.7x
Dividend yield 2.0% 1.5% 1.7% 2.2% 1.7% 2.6% 3.8% 4.6% 5.4% 6.1%
Source: Samsung Securities, Company reports
January 8, 2010
Li & Fung
25
Li & Fung income statement 2004-13E
FY ending 31 Dec, HK$m 2004 2005 2006 2007 2008 2009E 2010E 2011E 2012E 2013E
Total revenue 47,171 55,617 68,010 92,460 110,722 115,686 148,925 176,120 203,408 226,969
Cost of sales -42,848 -49,956 -60,675 -82,692 -99,119 -103,343 -132,886 -156,976 -181,095 -201,845
Gross profit 4,323 5,661 7,335 9,768 11,603 12,343 16,039 19,144 22,313 25,125
Other income 223 264 312 518 421 463 596 704 814 908
Total core operating expenses -2,990 -4,065 -5,303 -7,099 -8,940 -8,259 -10,182 -12,054 -13,902 -15,452
Core operating profit 1,556 1,861 2,344 3,187 3,084 4,547 6,452 7,794 9,225 10,581
Gain on disposal of assets 0 28 69 457 0 0 0 0 0 0
Other non-core operating expenses 0 -4 0 -43 -40 0 0 0 0 0
Total operating profit (EBIT) 1,556 1,885 2,412 3,600 3,044 4,547 6,452 7,794 9,225 10,581
Depreciation and amortization -145 -147 -217 -263 -482 -613 -629 -660 -700 -747
EBITDA 1,701 2,032 2,629 3,863 3,527 5,160 7,081 8,454 9,924 11,328
Interest income 43 70 98 208 113 106 159 185 216 252
Interest expenses -11 -21 -148 -500 -480 -416 -414 -414 -414 -414
Share of profits of associates 36 9 11 5 6 6 6 6 6 6
PBT 1,623 1,942 2,373 3,314 2,683 4,243 6,204 7,571 9,033 10,426
Taxation -133 -151 -172 -253 -259 -361 -558 -757 -994 -1,251
PAT 1,490 1,791 2,202 3,061 2,424 3,882 5,645 6,814 8,040 9,175
Minority interests 1 0 0 -1 -2 0 0 0 0 0
Net profit 1,491 1,790 2,202 3,060 2,422 3,882 5,645 6,814 8,040 9,175
Weighted average number of shares - diluted 2,928 3,243 3,312 3,464 3,520 3,664 3,664 3,664 3,664 3,664
Diluted EPS (HK$) 0.51 0.55 0.66 0.88 0.69 1.06 1.54 1.86 2.19 2.50
YoY growth
Total revenue 10.6% 17.9% 22.3% 36.0% 19.8% 4.5% 28.7% 18.3% 15.5% 11.6%
Gross profit 14.4% 31.0% 29.6% 33.2% 18.8% 6.4% 29.9% 19.4% 16.6% 12.6%
Core operating profit 17.9% 19.6% 26.0% 35.9% -3.2% 47.4% 41.9% 20.8% 18.4% 14.7%
Total operating profit (EBIT) 18.6% 21.1% 28.0% 49.2% -15.4% 49.4% 41.9% 20.8% 18.4% 14.7%
Net profit 19.4% 20.1% 23.0% 39.0% -20.9% 60.3% 45.4% 20.7% 18.0% 14.1%
Margins
GP margin 9.2% 10.2% 10.8% 10.6% 10.7% 10.7% 10.8% 10.9% 11.0% 11.1%
Core OP margin 3.3% 3.3% 3.4% 3.4% 2.8% 3.9% 4.3% 4.4% 4.5% 4.7%
OP margin 3.3% 3.4% 3.5% 3.9% 2.7% 3.9% 4.3% 4.4% 4.5% 4.7%
Net margin 3.2% 3.2% 3.2% 3.3% 2.2% 3.4% 3.8% 3.9% 4.0% 4.0%
Source: Samsung Securities, Company reports
January 8, 2010
Li & Fung
26
Li & Fung balance sheet 2004-13E
FY ending 31 Dec, HK$m 2004 2005 2006 2007 2008 2009E 2010E 2011E 2012E 2013E
Cash and bank balance 2,350 1,248 3,394 1,472 2,275 4,950 5,842 6,675 7,839 8,993
Inventories 458 628 1,331 2,060 2,329 2,492 3,204 3,871 4,465 5,253
Trade & bills receivables 4,642 7,739 9,231 13,716 14,715 15,847 20,401 24,126 27,864 31,092
Prepayments, deposits and other receivables 767 885 1,316 1,747 2,028 2,155 2,774 3,281 3,790 4,228
Due from related companies 29 25 62 72 84 84 84 84 84 84
Derivative financial instruments 0 4 0 0 35 35 35 35 35 35
Current assets 8,247 10,528 15,335 19,067 21,466 25,563 32,340 38,071 44,076 49,686
PPE 715 948 1,114 1,130 1,283 2,749 2,859 3,038 3,269 3,528
Intangible assets 1,304 2,809 4,713 11,375 14,602 14,531 14,465 14,402 14,343 14,286
Prepaid premium for land leases 765 766 681 3 3 2 2 2 2 2
Investment in associated companies 56 7 14 15 24 24 24 24 24 24
Available for sale financial assets 0 92 82 85 20 20 20 20 20 20
Deferred tax assets 73 118 106 116 111 111 111 111 111 111
Investment securities 110 0 0 0 0 0 0 0 0 0
Non-current assets 3,024 4,740 6,710 12,723 16,043 17,437 17,481 17,597 17,770 17,971
Total assets 11,270 15,268 22,045 31,789 37,509 43,000 49,821 55,668 61,846 67,657
Trade and bills payables 4,625 6,059 7,544 11,231 12,667 13,873 17,840 21,074 24,311 27,097
Accrual charges and sundry payables 741 1,006 1,316 2,395 2,772 2,831 3,641 4,301 4,961 5,530
Current portion of LT liabilities 41 0 0 0 0 0 0 0 0 0
Short term bank loans 203 0 2,777 442 278 200 200 200 200 200
Bank overdraft 0 204 92 205 93 93 93 93 93 93
Bank advances for discounted bills 0 1,554 123 328 313 313 313 313 313 313
Taxation payable 291 391 321 466 466 466 466 466 466 466
Others 125 648 765 1,279 1,259 1,259 1,259 1,259 1,259 1,259
Total current liabilities 6,026 9,862 12,937 16,346 17,848 19,036 23,811 27,705 31,604 34,958
Long term liabilities 509 753 797 5,064 5,760 5,760 5,760 5,760 5,760 5,760
Balance of purchase consideration payable 0 0 0 464 383 300 250 200 200 200
Pension obligations 18 20 25 30 24 24 24 24 24 24
Deferred taxation 7 8 18 21 112 112 112 112 112 112
Non-current liabilities 535 781 841 5,579 6,279 6,196 6,146 6,096 6,096 6,096
Share capital 73 73 85 86 91 91 91 91 91 91
Reserves 3,064 3,540 6,883 8,082 12,122 15,580 16,709 18,072 19,680 21,515
Proposed dividend 1,605 1,043 1,331 1,727 1,199 2,127 3,093 3,734 4,405 5,027
Minority interest -32 -32 -32 -31 -30 -30 -30 -30 -30 -30
Total shareholders' equity 4,709 4,625 8,267 9,864 13,382 17,769 19,864 21,867 24,147 26,603
Total liabilities and shareholder's equity 11,270 15,268 22,045 31,789 37,509 43,000 49,821 55,668 61,846 67,657
Source: Samsung Securities, Company reports
January 8, 2010
Li & Fung
27
Li & Fung cashflow 2004-13E
FY ending 31 Dec, HK$m 2004 2005 2006 2007 2008 2009E 2010E 2011E 2012E 2013E
EBIT 1,556 1,885 2,412 3,600 3,044 4,547 6,452 7,794 9,225 10,581
Depreciation and amortization 145 147 217 263 482 613 629 660 700 747
Gain / Loss on disposals 2 -25 -62 -426 -2 0 0 0 0 0
Others 41 47 58 112 86 0 0 0 0 0
Operating profit before changes in working capital 1,744 2,054 2,625 3,549 3,610 5,160 7,081 8,454 9,924 11,328
Change in working capital -524 174 -1,930 664 214 -156 -1,109 -1,005 -943 -1,101
Cash generated from operating activities 1,221 2,228 695 4,213 3,825 5,004 5,972 7,449 8,982 10,227
HK profits tax paid -80 -60 -149 -122 -165 -361 -558 -757 -994 -1,251
Overseas tax paid -26 -54 -73 -71 -82 0 0 0 0 0
Net cash inflow / (outflow) from operating activities 1,115 2,114 473 4,020 3,578 4,643 5,414 6,692 7,988 8,976
Purchase of PPE -206 -369 -302 -320 -494 -521 -655 -757 -854 -931
Acquisitions -67 -708 -1,264 -4,565 -2,457 -1,468 0 0 0 0
Settlement of consideration payable for acquisitions -146 -133 -685 -814 -919 -83 -50 -50 0 0
Disposals 6 9 22 491 73 0 0 0 0 0
Interest Income 43 70 98 208 113 106 159 185 216 252
Others -31 51 117 -36 -27 -12 -12 -12 -12 -12
Net cash inflow / (outflow) from operating activities -401 -1,079 -2,014 -5,035 -3,711 -1,978 -558 -634 -650 -690
Net proceeds from new shares 122 175 2,886 275 4,072 2,682 0 0 0 0
New bank loans 0 0 0 0 0 0 0 0 0 0
Repayment of bank loans 0 -44 2,594 -2,737 71 -78 0 0 0 0
Issue of long-term notes 0 0 0 3,862 0 0 0 0 0 0
Interest paid -11 -14 -148 -431 -400 -416 -414 -414 -414 -414
Dividends paid -1,078 -2,034 -1,564 -2,051 -2,560 -2,178 -3,550 -4,811 -5,760 -6,718
Others -6 -191 0 0 0 0 0 0 0 0
Net cash inflow / (outflow) from investing activities -973 -2,108 3,768 -1,081 1,183 10 -3,964 -5,225 -6,174 -7,132
Net increase / (decrease) in cash and cash equivalents -259 -1,074 2,228 -2,097 1,050 2,675 892 833 1,164 1,155
Foreign exchange difference 15 -29 31 61 -135 0 0 0 0 0
Cash and cash equivalents (year beginning) 2,391 2,147 1,044 3,302 1,267 2,182 4,857 5,748 6,581 7,745
Cash and cash equivalents (year-end) 2,147 1,044 3,302 1,267 2,182 4,857 5,748 6,581 7,745 8,900
Source: Samsung Securities, Company reports
January 8, 2010
Li & Fung
28
Appendix: Our favorite lines from The Matrix
Morpheus: This is your last chance. After this, there is no turning back. You take the blue pill - the story ends, you wake up
in your bed and believe whatever you want to believe. You take the red pill - you stay in Wonderland and I show you how
deep the rabbit-hole goes.
Morpheus: The pill you took is part of a trace program. It's designed to disrupt your input/output carrier signal so we can
pinpoint your location.
Neo: What does that mean?
Cypher: It means buckle your seatbelt, Dorothy, 'cause Kansas is going bye-bye.
Oracle: I'd ask you to sit down, but, you're not going to anyway. And don't worry about the vase.
Neo: What vase?
[Neo turns to look for a vase, and as he does, he knocks over a vase of flowers, which shatters on the floor]
Oracle: That vase.
Neo: I'm sorry...
Oracle: I said don't worry about it. I'll get one of my kids to fix it.
Neo: How did you know?
Oracle: Ohh, what's really going to bake your noodle later on is, would you still have broken it if I hadn't said anything?
Neo: I know kung fu.
Morpheus: [eyeing him, hand on chin] Show me.
Morpheus: How did I beat you?
Neo: You... you're too fast.
Morpheus: Do you believe that my being stronger or faster has anything to do with my muscles in this place? Do you think
that's air you're breathing now?
Agent Smith: Tell me, Mr. Anderson, what good is a phone call when you are unable to speak?
Neo: What are you trying to tell me? That I can dodge bullets?
Morpheus: No, Neo. I'm trying to tell you that when you're ready, you won't have to.
Neo: Okey dokey.. free my mind. Right, no problem, free my mind, free my mind, no problem, right...
Oracle: You're cuter than I thought. I can see why she likes you.
Neo: Who?
Oracle: Not too bright, though.
Agent Smith: Do you hear that, Mr. Anderson? That is the sound of inevitability.
Cypher: I know what you're thinking, 'cause right now I'm thinking the same thing. Actually, I've been thinking it ever since
I got here: Why oh why didn't I take the BLUE pill?
Tank: So what do you need? Besides a miracle.
Neo: Guns. Lots of guns.
Trinity: Neo... nobody has ever done this before.
Neo: That's why it's going to work.
Source: neoandtrinity.net
January 8, 2010
Li & Fung
29
Disclosures & Disclaimers
For reports to be distributed to US:
Securities research is prepared, issued and exclusively distributed by Samsung Securities (Asia) Limited in Hong Kong, an organization licensed with the Securities and Futures Commission of Hong Kong. This research may be distributed in the United States only to major institutional investors as defined under applicable US regulations and may not be circulated to any other person otherwise. All transactions by US investors involving securities discussed in this report must be effected through Samsung Securities (America) Inc., a broker-dealer registered with the US Securities & Exchange Commission and a member of the Financial Industry Regulatory Authority, and not through a non-U.S. affiliate. The analysts listed [on the front of this report] are employees of Samsung Securities (Asia) Limited, or a non-U.S. affiliate thereof, and are not registered/qualified as research analysts under applicable U.S. rules and regulations and may not be subject to U.S. restrictions on communications with covered companies, public appearances, and trading
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This report is for private circulation only, not for sale, and is issued and distributed only to persons who are regarded as professional investors as defined under the Financial Investment Services and Capital Markets Act of Korea. For reports to be distributed to Singapore:
This report is provided pursuant to the financial advisory licensing exemption under Regulation 27(1)(e) of the
Financial Advisers Regulation of Singapore and accordingly may only be provided to persons in Singapore who are institutional investors as defined in Section 4A of the Securities and Futures Act, Chapter 289 of Singapore. This report is intended only for the person to whom Samsung has provided this report and such person may not send, forward or transmit in any way this report or any copy of this report to any other person." Analyst Certification
The views expressed in this research report accurately reflect the personal views of the analyst(s) about the subject securities or issuers and no part of the compensation of the analyst(s) was, is, or will be directly or indirectly related to the inclusion of specific recommendations or views in this research. The analyst principally responsible for the preparation of this research receives compensation based on the overall revenues, including investment banking
revenues of Samsung Securities (Asia) Limited and its related entities and has taken reasonable care to achieve and maintain independence and objectivity in making any recommendations. General Additional information is available upon request. Information has been obtained from sources believed to be reliable but Samsung do not warrant its completeness or accuracy except with respect to any disclosures relative to [Name of Issuer] and/or its affiliates and the analyst’s involvement with the issuer that is the subject of the research. The pricing is as of the close of market for the securities discussed, unless otherwise stated. Opinions and estimates constitute our judgment as of the date of this material and are subject to change without notice. Past performance is not indicative of future results. This material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The opinions and recommendations herein do not take into account individual client circumstances, objectives, or needs and are not intended as recommendations of particular securities, financial instruments or strategies to particular clients. The recipient of this report must make its own independent decisions regarding any securities or financial instruments mentioned herein. Periodic updates may be provided on companies/industries based on company specific developments or announcements, market conditions or any other publicly available information. Clients should contact analysts and execute transactions through a Samsung subsidiary or affiliate in their home jurisdiction unless governing law permits otherwise. Copyright 2009 Samsung Securities (Asia) Limited. All rights reserved. This report or any portion hereof may not be
reprinted, sold or redistributed without the written consent of Samsung Securities (Asia) Limited.
January 29, 2010
This report has been prepared by Samsung Securities (Asia) Limited. ANALYST CERTIFICATION AND IMPORTANT DISCLOSURES BEGIN ON PAGE 8
Li & Fung (494 HK)
The Ultimate Outsourcer WHAT’S THE STORY?
Event: Li & Fung announced a major new deal to act as a direct sourcing agent for Wal-Mart, to add at least US$2bn per annum to top line from mid-2010.
Impact: This deal proves that the company’s sourcing network provides a sustainable competitive advantage. Li & Fung becomes the ultimate outsourcer.
Action: The impact on market consensus EPS estimates will be limited to around +1% to +5% in 2010-11e. However, we expect valuation multiple expansion to 25x PER on better long-term growth prospects. BUY Li & Fung.
THE QUICK VIEW
After market close yesterday, Li & Fung announced that they have entered into a series
of agreements to supply clothes and other consumer goods to Wal-Mart. This was
followed by an international conference call.
Main points:
Management guide that the deal should initially generate an additional annual
US$2bn of sales (conservatively) from July 2010e. Wal-Mart isn’t obligated to any
sourcing volume under the agreement or exclusivity to Li & Fung i.e. Wal-Mart
may still source any goods from other suppliers (Li & Fung began supplying Wal-
Mart in 2003) but the deal is expected to become a major growth driver for Li &
Fung for the next two three-year plans, through 2016.
We estimate that Wal-Mart, the world’s largest retailer, will become Li & Fung’s
biggest client by 2012e, overtaking Kohl’s by sourcing US$2.5bn worth of goods.
The long-term potential of this deal is clearly significant. We estimate that Wal-
Mart will add US$5bn to top line, with an EBIT margin of 1.5%, by 2017e.
Li & Fung will create a buying agency within its network called WSG (Wal-Mart
Sourcing Group) to handle the business, which will be based in Hong Kong and
“over time, will employ hundreds” of employees, Li & Fung President Bruce
Rockowitz said. The company is transferring top management talent to run the
new unit, which will be co-located with Li & Fung’s existing business. WSG will
not compete with Wal-Mart’s direct sourcing arm.
Wal-Mart will have a call option to acquire WSG after January 1, 2016. No details
are available on the option price, but William Fung guided that the option
represented a “Fair deal for both parties.” He added that this mechanism actually
gave Li & Fung a higher degree of security than usual, as most clients could just
leave at any time, if they became unhappy, without paying any penalty.
The deal means that Li & Fung stands a very good chance of hitting its three-year
plan revenue target of US$20bn by the end of 2010. We increase our 2010e top
line estimate from US$19.2bn to US$20.2bn.
The margins for WSG will be “in line with those of a very high volume business,”
Rockowitz said. During the conference call, management guided that typical net
margins for a very high volume client are between 1% and 4%.
We increase our EPS estimates by 1% in 2010e, 2% in 2011e and 3% in 2012e.
A replay of the call is available for 14 days on:
International dialing: +852 2112 1555
Passcode: 218552#
Matt Marsden [email protected] +852 3411 3710
Company Update
SAMSUNG vs THE STREET
Don’t fight The Matrix
Samsung target price vs Consensus +14%
Samsung 2010e EPS vs Consensus +14%
Street recommendation distribution 67% Buy
17% Hold
17% Sell
Our 2010e EPS numbers are 14% ahead of
consensus, driven by a combination of:
Operating leverage (Li & Fung is demonstrably
increasing EBIT margins for the first time).
The impact of 2009 acquisitions.
The impact of the new Wal-Mart deal.
Plus a macro recovery which will surprise on
the upside.
AT A GLANCE
HK$43.00
Target price
Up/downside +33%
Current price HK$32.30
Sector Sourcing
Market capitalization US$15,743m
Shares outstanding (float) 3,777m (61%)
52 week high-low HK$36.20 – 14.22
Bloomberg 494 HK
One year performance 1M 6M 12M
Li & Fung +1% +35% +102%
Hang Seng Index -5% -1% 55%
January 29, 2010
Company Update – Li & Fung
2
Don’t fight The Matrix
Li & Fung’s policy of acquisitive growth has created a global
sourcing matrix, which represents a sustainable competitive
advantage. The latest deal with Wal-Mart proves that Li &
Fung’s scale - the ability to source from over 15,000 suppliers
in more than 40 territories - makes it an “Automatic go to” for
retailers looking to improve their supply chain.
We see 2009-11e EPS CAGR of 34% driven by:
The macro recovery will surprise on the upside led by
inventory restocking and a shift to an inflationary cycle.
Importantly, Li & Fung is demonstrating operational
leverage for the first time. We note that H1 2009 net
income for Li & Fung in rose 13% YoY to HK$1.4bn
(US$180m) on sales which were down 2% YoY to
HK$46.3bn (US$6bn) due to cost savings. Management
guide that margins will continue to improve in 2010e
driven by continuing repositioning of staff and general
cost efficiencies.
Gains from recent acquisitions and the Wal-Mart deal.
Please see our report Don’t fight The Matrix…Own the
Outsourcing Oracle, published January 8, 2010, for our
full thesis.
Samsung forecasts: Old vs new 20010-12E
FY ending 31 Dec, HK$m New Old Change
2010E
Total turnover 156,675 148,925 5%
EBIT 6,530 6,452 1%
Diluted EPS (HK$) 1.56 1.54 1%
2011E
Total turnover 191,620 176,120 9%
EBIT 7,980 7,794 2%
Diluted EPS (HK$) 1.90 1.86 2%
2012E
Total turnover 222,783 203,408 10%
EBIT 9,515 9,225 3%
Diluted EPS (HK$) 2.26 2.19 3%
Source: Samsung Securities
Base case valuation gives 33% upside
We think that a moderate re-rating to the historical average
25x PE is justified by 34% 2009-11e EPS CAGR. Note - this
CAGR is NOT inflated by calculating it from the cyclical low
(which would be 2008), and is above the 27% EPS CAGR from
2005-07, which triggered a re-rating to over 30x PE.
Given ROE recovery and all time high EBIT margins plus
positive newsflow from better retail sales, a return to the
average PE could even be conservative.
In January 2011 we believe that the market will partly be
pricing the stock from anticipated 2011 earnings. Thus, we
blend our 2010e and 2011e EPS to arrive at HK$1.73 and
multiply this figure by 25x to yield a PE multiple based priced
target of HK$43, rounding to the nearest Hong Kong dollar
No change to our target price).
Our 12-month price objective represents 33% upside. We
reiterate our three-star BUY rating on Li & Fung.
Li & Fung: 1-year forward PE band chart
Source: Bloomberg, Samsung Securities
Bear views and blue skies
Markets are all about balance of probability. We provide
strong opinions but do not ignore the possibility that events
will go against us. We therefore try to quantify the risks if we
are wrong. Given two stocks with an identical percentage
upside to Target, it is critical to know that one has, for
example 5% downside and the other 25%. This is how many
investors think, and we attempt to reflect this in our research.
Bear view valuation gives 41% downside
Our bear view quantifies the risks we see for Li & Fung by
factoring in a worst case scenario into the valuation. In our
bear view scenario we take the following assumptions:
Sales stagnate. We factor in flat sales in 2009e, 2010e
and 2011e. Despite the clear signs of economic
stabilization and inventory restocking, plus acquisitions
and the Wal-Mart deal, we assume flat revenues from
2008e.
Despite the positive trend we see at present, in our bear
view we that margins stay flat from 2009e. We assume
2010e and 2011e net margin of 3.4%.
Valuation multiples for the stock decline. We use 18x
blended 2010/11e for our bear view PE target multiple.
We arrive at a blended 2010/11e EPS of HK$1.03, which is
41% below our base case forecast of HK$1.73.
Using a PE multiple target of 18x, and rounding to the nearest
Hong Kong dollar, we arrive at bear view valuation of HK$19
per share. This implies 41% downside from the stock’s current
price.
0
5
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30
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p-0
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b-0
5
Ju
l-0
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Dec-0
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y-0
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Oct-
06
Ma
r-0
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Au
g-0
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Ja
n-0
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30x
HK$ 25x
20x
15x
January 29, 2010
Company Update – Li & Fung
3
Blue sky valuation gives 73 % upside
In our blue sky scenario, we keep our 2010e forecasts
unchanged, but become more optimistic on our 2011e
assumptions:
We increase our 2011e YoY top line growth rate from
+22% to +25%, resulting in 2011e group revenues of
HK$195,844m. This could happen if the group continues
to actively acquire or the Wal-Mart business does better
than estimated.
Net margins increase from 3.8% in 2010e to 4.1% in
2011e (up from our current 2011e base case assumption
of 3.9%) due to further operating leverage gains.
This results in 2011e EPS of HK$2.19.
Valuation multiples for the stock become excited. We
use 30x blended 2010/11e for our blue skies PE target
multiple.
We arrive at a blended 2010/11e EPS of HK$1.88, which is 9%
above our base case forecast of HK$1.73.
Using a PE multiple target of 30x, and rounding to the nearest
Hong Kong dollar, we arrive at blue skies valuation of HK$56
per share. This implies 73% upside to the stock’s current
price.
Self flagellation of the three-year plan
“How do organizations plan in a way that allows for
renewal but also creates enough stability so entrepreneurial
units know where they stand? How do companies in a flat
world balance the need to motivate their divisions to move
towards a common goal with the freedom to allow them to
respond to changes in their immediate business
environments?
The solution for L&F has been to develop a planning process
that creates stretch goals that are renewed every three years.
In this rapidly changing world, five-year plans are too long
and one-year budgets are too short to build anything
meaningful (like client relationships). Three years seems to
be just the right duration.”
From Competing in a Flat World, Fung, Fung and Wind,
January 2008.
L&F’s management publicly announce three-year plans. These
are not public guidance but “Stretch Goals.” While the
company does not always hit the self imposed targets (e.g. Li
& Fung missed the 2002-2004 plan due to SARs and the
general economic slowdown), we are impressed with the
challenge and management focus that the plans generate.
Group Managing Director William Fung has referred to the
“Self flagellation of meeting the three-year plans”.
For the current 2008-10 plan, the company has the following
goals:
To grow group revenues from US$12bn in 2007, to
US$20bn in 2010. We forecast that Li & Fung can reach
this goal, generating US$20.2bn top line by 2010e.
US$4bn of revenues to come from the Onshore
businesses. We forecast that this target will be hit.
To achieve a 2x goal. To grow core operating profit at
twice the rate of revenues to reach US$1bn by 2010 i.e.
to create operating leverage. We forecast that core
operating profit will reach US$843m by 2010e, 16%
short of management’s goal.
Li & Fung: Evolution of the 3-year plan
Source: Competing in a flat world, Samsung Securities
0
1,000
2,000
3,000
4,000
5,000
6,000
1999-2001 2002-2004 2005-2007 2008-2010E
Lead industry
change.Reinvent distribution through value-chain
logistics.
Create new
culture.Regional stream
organization,
operations focus and IT invesment.
Net profit
forecast (HK$m)
New service
agency model. Unbundling
distribution and the
creation of a "Menu of Services."
Create operating
leverage.Active acquisition
strategy.
January 29, 2010
Company Update – Li & Fung
4
Li & Fung Ratios 2004-13E
(FY ending 31 Dec) 2004 2005 2006 2007 2008 2009E 2010E 2011E 2012E 2013E
YoY growth
Total revenue 10.6% 17.9% 22.3% 36.0% 19.8% 4.5% 35.4% 22.3% 16.3% 12.3%
Gross profit 14.4% 31.0% 29.6% 33.2% 18.8% 6.4% 36.7% 23.4% 17.3% 13.3%
Core operating profit 17.9% 19.6% 26.0% 35.9% -3.2% 47.4% 43.6% 22.2% 19.2% 14.9%
Total operating profit (EBIT) 18.6% 21.1% 28.0% 49.2% -15.4% 49.4% 43.6% 22.2% 19.2% 14.9%
Net profit 19.4% 20.1% 23.0% 39.0% -20.9% 60.3% 47.2% 22.1% 18.9% 14.3%
Margins
GP margin 9.2% 10.2% 10.8% 10.6% 10.7% 10.7% 10.8% 10.9% 11.0% 11.1%
Core OP margin 3.3% 3.3% 3.4% 3.4% 2.8% 3.9% 4.2% 4.2% 4.3% 4.4%
OP margin 3.3% 3.4% 3.5% 3.9% 2.7% 3.9% 4.2% 4.2% 4.3% 4.4%
Net margin 3.2% 3.2% 3.2% 3.3% 2.2% 3.4% 3.6% 3.6% 3.7% 3.8%
Returns
ROE 31.7% 38.7% 26.6% 31.0% 18.1% 21.8% 28.7% 31.7% 34.0% 35.2%
ROA 13.2% 11.7% 10.0% 9.6% 6.5% 9.0% 11.2% 12.0% 12.8% 13.3%
ROIC 48.8% 30.6% 26.5% 22.7% 15.4% 21.5% 28.6% 32.3% 36.0% 38.4%
Working capital
Inventory days 4 5 8 9 9 9 9 9 9 10
AR days 36 51 50 54 49 50 50 50 50 50
AP days 39 44 45 50 47 49 49 49 49 49
Gearing
Current ratio 2.7x 2.2x 2.3x 1.5x 1.3x 1.5x 1.9x 2.3x 2.6x 2.9x
Debt/equity 16.0% 54.3% 45.8% 61.2% 48.2% 35.8% 32.0% 28.9% 26.1% 23.6%
Net cash/equity 33.9% -27.3% -4.8% -46.3% -31.2% -8.0% -3.8% -0.7% 3.8% 7.2%
Valuation
PE 63.4x 58.5x 48.6x 36.6x 46.9x 30.5x 20.7x 17.0x 14.3x 12.5x
PB 20.0x 22.5x 12.8x 11.2x 8.4x 6.6x 5.9x 5.4x 4.8x 4.4x
EV/EBITDA 70.2x 58.7x 45.4x 30.9x 33.8x 23.1x 16.7x 13.8x 11.7x 10.2x
Dividend yield 2.1% 1.5% 1.7% 2.2% 1.8% 2.6% 3.9% 4.7% 5.6% 6.4%
Source: Company data, Samsung Securities, all multiples based on the close price of HK$32.3 on 28 Jan 2010
January 29, 2010
Company Update – Li & Fung
5
Li & Fung Income statement 2004-13E
(FY ending 31 Dec, HK$m) 2004 2005 2006 2007 2008 2009E 2010E 2011E 2012E 2013E
Total revenue 47,171 55,617 68,010 92,460 110,722 115,686 156,675 191,620 222,783 250,219
Cost of sales -42,848 -49,956 -60,675 -82,692 -99,119 -103,343 -139,802 -170,791 -198,344 -222,521
Gross profit 4,323 5,661 7,335 9,768 11,603 12,343 16,873 20,828 24,439 27,698
Other income 223 264 312 518 421 463 627 766 891 1,001
Total core operating expenses -2,990 -4,065 -5,303 -7,099 -8,940 -8,259 -10,970 -13,615 -15,814 -17,770
Core operating profit 1,556 1,861 2,344 3,187 3,084 4,547 6,530 7,980 9,515 10,930
Gain on disposal of assets 0 28 69 457 0 0 0 0 0 0
Other non-core operating expenses 0 -4 0 -43 -40 0 0 0 0 0
Total operating profit (EBIT) 1,556 1,885 2,412 3,600 3,044 4,547 6,530 7,980 9,515 10,930
Depreciation and amortization -145 -147 -217 -263 -482 -613 -635 -675 -725 -784
EBITDA 1,701 2,032 2,629 3,863 3,527 5,160 7,164 8,655 10,241 11,714
Interest income 43 70 98 208 113 106 156 174 199 231
Interest expenses -11 -21 -148 -500 -480 -416 -414 -414 -414 -414
Share of profits of associates 36 9 11 5 6 6 6 6 6 6
PBT 1,623 1,942 2,373 3,314 2,683 4,243 6,278 7,747 9,307 10,753
Taxation -133 -151 -172 -253 -259 -361 -565 -775 -1,024 -1,290
PAT 1,490 1,791 2,202 3,061 2,424 3,882 5,713 6,972 8,284 9,463
Minority interests 1 0 0 -1 -2 0 0 0 0 0
Net profit 1,491 1,790 2,202 3,060 2,422 3,882 5,713 6,972 8,284 9,463
Weighted average number of shares - diluted 2,928 3,243 3,312 3,464 3,520 3,664 3,664 3,664 3,664 3,664
Diluted EPS (HK$) 0.51 0.55 0.66 0.88 0.69 1.06 1.56 1.90 2.26 2.58
YoY growth
Total revenue 10.6% 17.9% 22.3% 36.0% 19.8% 4.5% 35.4% 22.3% 16.3% 12.3%
Gross profit 14.4% 31.0% 29.6% 33.2% 18.8% 6.4% 36.7% 23.4% 17.3% 13.3%
Core operating profit 17.9% 19.6% 26.0% 35.9% -3.2% 47.4% 43.6% 22.2% 19.2% 14.9%
Total operating profit (EBIT) 18.6% 21.1% 28.0% 49.2% -15.4% 49.4% 43.6% 22.2% 19.2% 14.9%
Net profit 19.4% 20.1% 23.0% 39.0% -20.9% 60.3% 47.2% 22.0% 18.8% 14.2%
Margins
GP margin 9.2% 10.2% 10.8% 10.6% 10.7% 10.7% 10.8% 10.9% 11.0% 11.1%
Core OP margin 3.3% 3.3% 3.4% 3.4% 2.8% 3.9% 4.2% 4.2% 4.3% 4.4%
OP margin 3.3% 3.4% 3.5% 3.9% 2.7% 3.9% 4.2% 4.2% 4.3% 4.4%
Net margin 3.2% 3.2% 3.2% 3.3% 2.2% 3.4% 3.6% 3.6% 3.7% 3.8%
Source: Company data, Samsung Securities
January 29, 2010
Company Update – Li & Fung
6
Li & Fung Balance sheet 2004-13E
(FY ending 31 Dec, HK$m) 2004 2005 2006 2007 2008 2009E 2010E 2011E 2012E 2013E
Cash and bank balance 2,350 1,248 3,394 1,472 2,275 4,950 5,608 6,207 7,278 8,295
Inventories 458 628 1,331 2,060 2,329 2,492 3,371 4,211 4,891 5,792
Trade & bills receivables 4,642 7,739 9,231 13,716 14,715 15,847 21,462 26,249 30,518 34,277
Prepayments, deposits and other receivables 767 885 1,316 1,747 2,028 2,155 2,919 3,570 4,150 4,662
Due from related companies 29 25 62 72 84 84 84 84 84 84
Derivative financial instruments 0 4 0 0 35 35 35 35 35 35
Current assets 8,247 10,528 15,335 19,067 21,466 25,563 33,479 40,356 46,957 53,143
PPE 715 948 1,114 1,130 1,283 2,749 2,888 3,118 3,405 3,722
Intangible assets 1,304 2,809 4,713 11,375 14,602 14,531 14,465 14,402 14,343 14,286
Prepaid premium for land leases 765 766 681 3 3 2 2 2 2 2
Investment in associated companies 56 7 14 15 24 24 24 24 24 24
Available for sale financial assets 0 92 82 85 20 20 20 20 20 20
Deferred tax assets 73 118 106 116 111 111 111 111 111 111
Investment securities 110 0 0 0 0 0 0 0 0 0
Non-current assets 3,024 4,740 6,710 12,723 16,043 17,437 17,510 17,677 17,905 18,165
Total assets 11,270 15,268 22,045 31,789 37,509 43,000 50,989 58,033 64,862 71,309
Trade and bills payables 4,625 6,059 7,544 11,231 12,667 13,873 18,768 22,928 26,627 29,873
Accrual charges and sundry payables 741 1,006 1,316 2,395 2,772 2,831 3,830 4,679 5,434 6,096
Current portion of LT liabilities 41 0 0 0 0 0 0 0 0 0
Short term bank loans 203 0 2,777 442 278 200 200 200 200 200
Bank overdraft 0 204 92 205 93 93 93 93 93 93
Bank advances for discounted bills 0 1,554 123 328 313 313 313 313 313 313
Taxation payable 291 391 321 466 466 466 466 466 466 466
Others 125 648 765 1,279 1,259 1,259 1,259 1,259 1,259 1,259
Total current liabilities 6,026 9,862 12,937 16,346 17,848 19,036 24,929 29,939 34,392 38,300
Long term liabilities 509 753 797 5,064 5,760 5,760 5,760 5,760 5,760 5,760
Balance of purchase consideration payable 0 0 0 464 383 300 250 200 200 200
Pension obligations 18 20 25 30 24 24 24 24 24 24
Deferred taxation 7 8 18 21 112 112 112 112 112 112
Non-current liabilities 535 781 841 5,579 6,279 6,196 6,146 6,096 6,096 6,096
Share capital 73 73 85 86 91 91 91 91 91 91
Reserves 3,064 3,540 6,883 8,082 12,122 15,580 16,723 18,117 19,774 21,666
Proposed dividend 1,605 1,043 1,331 1,727 1,199 2,127 3,130 3,820 4,539 5,185
Minority interest -32 -32 -32 -31 -30 -30 -30 -30 -30 -30
Total shareholders' equity 4,709 4,625 8,267 9,864 13,382 17,769 19,914 21,999 24,374 26,913
Total liabilities and shareholder's equity 11,270 15,268 22,045 31,789 37,509 43,000 50,989 58,033 64,862 71,309
Source: Company data, Samsung Securities
January 29, 2010
Company Update – Li & Fung
7
Li & Fung Cashflow 2004-13E
(FY ending 31 Dec, HK$m) 2004 2005 2006 2007 2008 2009E 2010E 2011E 2012E 2013E
EBIT 1,556 1,885 2,412 3,600 3,044 4,547 6,530 7,980 9,515 10,930
Depreciation and amortization 145 147 217 263 482 613 635 675 725 784
Gain / Loss on disposals 2 -25 -62 -426 -2 0 0 0 0 0
Others 41 47 58 112 86 0 0 0 0 0
Operating profit before changes in working capital 1,744 2,054 2,625 3,549 3,610 5,160 7,164 8,655 10,241 11,714
Change in working capital -524 174 -1,930 664 214 -156 -1,364 -1,269 -1,075 -1,263
Cash generated from operating activities 1,221 2,228 695 4,213 3,825 5,004 5,800 7,386 9,166 10,451
HK profits tax paid -80 -60 -149 -122 -165 -361 -565 -775 -1,024 -1,290
Overseas tax paid -26 -54 -73 -71 -82 0 0 0 0 0
Net cash inflow / (outflow) from operating activities 1,115 2,114 473 4,020 3,578 4,643 5,235 6,611 8,142 9,161
Purchase of PPE -206 -369 -302 -320 -494 -521 -689 -824 -936 -1,026
Acquisitions -67 -708 -1,264 -4,565 -2,457 -1,468 0 0 0 0
Settlement of consideration payable for acquisitions -146 -133 -685 -814 -919 -83 -50 -50 0 0
Disposals 6 9 22 491 73 0 0 0 0 0
Interest Income 43 70 98 208 113 106 156 174 199 231
Others -31 51 117 -36 -27 -12 -12 -12 -12 -12
Net cash inflow / (outflow) from operating activities -401 -1,079 -2,014 -5,035 -3,711 -1,978 -596 -711 -748 -807
Net proceeds from new shares 122 175 2,886 275 4,072 2,682 0 0 0 0
New bank loans 0 0 0 0 0 0 0 0 0 0
Repayment of bank loans 0 -44 2,594 -2,737 71 -78 0 0 0 0
Issue of long-term notes 0 0 0 3,862 0 0 0 0 0 0
Interest paid -11 -14 -148 -431 -400 -416 -414 -414 -414 -414
Dividends paid -1,078 -2,034 -1,564 -2,051 -2,560 -2,178 -3,567 -4,888 -5,908 -6,924
Others -6 -191 0 0 0 0 0 0 0 0
Net cash inflow / (outflow) from investing activities -973 -2,108 3,768 -1,081 1,183 10 -3,981 -5,301 -6,322 -7,338
Net increase / (decrease) in cash and cash equivalents -259 -1,074 2,228 -2,097 1,050 2,675 659 598 1,072 1,016
Foreign exchange difference 15 -29 31 61 -135 0 0 0 0 0
Cash and cash equivalents (year beginning) 2,391 2,147 1,044 3,302 1,267 2,182 4,856 5,515 6,113 7,185
Cash and cash equivalents (year-end) 2,147 1,044 3,302 1,267 2,182 4,856 5,515 6,113 7,185 8,201
Source: Company data, Samsung Securities
January 29, 2010
Company Update – Li & Fung
8
Disclosures & Disclaimers
For reports to be distributed to US:
Securities research is prepared, issued and exclusively distributed by Samsung Securities (Asia) Limited in Hong Kong, an organization licensed with the Securities and Futures Commission of Hong Kong. This research may be distributed in the United States only to major institutional investors as defined under applicable US regulations and may not be circulated to any other person otherwise. All transactions by US investors involving securities discussed in this report must be effected through Samsung Securities (America) Inc., a broker-dealer registered with the US Securities & Exchange Commission and a member of the Financial Industry Regulatory Authority, and not through a non-U.S. affiliate. The analysts listed [on the front of this report] are employees of Samsung Securities (Asia) Limited, or a non-U.S. affiliate thereof, and are not registered/qualified as research analysts under applicable U.S. rules and regulations and may not be subject to U.S. restrictions on communications with covered companies, public appearances, and trading securities held by a research analyst account.
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Any investment or investment activity to which this report relates is available only to relevant persons and will be engaged in only with relevant persons. Persons who are not relevant persons should not rely on this report." For reports to be distributed to Korea: This report is for private circulation only, not for sale, and is issued and distributed only to persons who are regarded as professional investors as defined under the Financial Investment Services and Capital Markets Act of Korea. For reports to be distributed to Singapore: This report is provided pursuant to the financial advisory licensing exemption under Regulation 27(1)(e) of the Financial Advisers Regulation of Singapore and accordingly may only be provided to persons in Singapore who are institutional investors as defined in Section 4A of the Securities and Futures Act, Chapter 289 of Singapore. This report is intended only for the person to whom Samsung has provided this report and such person may not send, forward or transmit in any way this report or any copy of this report to any other person." Analyst Certification
The views expressed in this research report accurately reflect the personal views of the analyst(s) about the subject securities or issuers and no part of the compensation of the analyst(s) was, is, or will be directly or indirectly related to the inclusion of specific recommendations or views in this research. The analyst principally responsible for the preparation of this research receives compensation based on the overall revenues, including investment banking revenues of Samsung Securities (Asia) Limited and its related entities and has taken reasonable care to achieve and
maintain independence and objectivity in making any recommendations. General Additional information is available upon request. Information has been obtained from sources believed to be reliable but Samsung do not warrant its completeness or accuracy except with respect to any disclosures relative to [Name of Issuer] and/or its affiliates and the analyst’s involvement with the issuer that is the subject of the research. The pricing is as of the close of market for the securities discussed, unless otherwise stated. Opinions and estimates constitute our judgment as of the date of this material and are subject to change without notice. Past performance is not indicative of future results. This material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The opinions and recommendations herein do not take into account individual client circumstances, objectives, or needs and are not intended as recommendations of particular securities, financial instruments or strategies to particular clients. The recipient of this report must make its own independent decisions regarding any securities or financial instruments mentioned herein. Periodic updates may be provided on companies/industries based on company specific developments or announcements, market conditions or any other publicly available information. Clients should contact analysts and execute transactions through a Samsung subsidiary or affiliate in their home jurisdiction unless governing law permits otherwise. Copyright 2010 Samsung Securities (Asia) Limited. All rights reserved. This report or any portion hereof may not be reprinted, sold or redistributed without the written consent of Samsung Securities (Asia) Limited.
March 25, 2010
This report has been prepared by Samsung Securities (Asia) Limited. ANALYST CERTIFICATION AND IMPORTANT DISCLOSURES BEGIN ON PAGE 9
Li & Fung Ltd (494 HK)
The Matrix unplugged…
WHAT’S THE STORY?
Event: Li & Fung reported record earnings in 2009, with 39% YoY net profit
growth in the toughest ever trading environment. Management gave upbeat
guidance for 2010 and long-term growth prospects look rosy.
Unfortunately, the market’s expectations have become unplugged from reality.
The 2009 results actually missed consensus net profit estimates by 10%, and for
the first time ever YoY revenues fell, by 6%. All gains were from cost cutting,
acquisitions and new outsourcing deals.
Impact: Li & Fung has been the best performer in the HSI so far this year,
gaining 29% YTD. The stock will surely correct downwards after missing the
market’s estimates by such a wide margin.
The stock was within a whisker of reaching our old target price of HK$43.00,
reaching an all time high of HK$42.45 yesterday.
We now downgrade our EPS by 12% in 2010e, and 4% in 2011e, and reduce our
12-month target by 7% to HK$40.00.
Even though the long-term prospects still look good, market estimates have
become over-optimistic. We expect a rash of consensus EPS downgrades.
We downgrade the stock to a SELL. Our new target is 4% below the current
share price.
Action: At 30.5x 2010e PE, the stock price has run ahead of itself. We
recommend that investors take profits.
We think that the stock price is likely to overshoot on the downside. Traders
should look to profit from shorting this stock in the near-term.
We suggest a short Li & Fung / long Esprit pair trade.
We suggest that longer-term investors look to re-enter the stock at around
HK$35.00 (-17% from the current level).
Welcome back to reality
Li & Fung has gained 27% since we initiated coverage on January 8 2010, and has
been the best performer in the HSI, outperforming the index by 33% YTD. The
stock came within a whisker of hitting our old target price of HK$43.00 when it
made a new all time high of HK$42.45 yesterday.
Unfortunately, market consensus estimates have become unplugged from reality.
The 2009 results released after market close yesterday revealed a net profit
number of HK$3,369m, which was 14% below our forecast, and 10% below
Bloomberg market consensus.
After such a stellar performance, we don’t believe that the stock will be able to
withstand such a significant earnings miss unscathed.
In the Q&A session at the analysts meeting in Hong Kong yesterday, William
Fung, who is preparing for his third marathon in London on 25 April, apologized
to the analysts present. Dr. Fung said that the company probably should have
given updated guidance, when they realized that revenues were going to be down
YoY in late 2009 – previously Li & Fung’s guidance was for flat 2009 revenues.
Given the better than expected operational leverage achieved in 2009, if revenues
were flat then market consensus expectations would not have been disappointed.
Company Update
SAMSUNG vs THE STREET
Early seller catches the worm
Target price vs Consensus -5%
2011e EPS vs Consensus +0%
Recommendation distribution 68% Buy
16% Hold
16% Sell
The market has become over-bullish on this
stock with a 68% BUY rating distribution.
This is the first SELL published since mid
December 2009 (when the stock was at HK$31),
according to Bloomberg.
We believe that this report will be amongst the
first of a series of downgrades as the market
adjusts EPS figures back to reality.
Matthew Marsden
Analyst
+852 3411 3710
Summer Wang
Research Associate
+852 3411 3723
AT A GLANCE
HK$40.00 Target price
Up/downside -4%
Current price HK$41.75
Market capitalization HK$158.0bn
Shares outstanding (float) 3.78bn (70%)
52 week high-low HK$42.05-18.00
Bloomberg 494 HK
One year performance 1M 6M 12M
Li & Fung Ltd +17% +38% +117%
Hang Seng Index +3% 0% +51%
March 25, 2010
Company Update – Li & Fung Ltd
2
The sound of inevitability…
Ironically, the 2009 results show areas of strength:
The company delivered strong operating leverage
during the year due to effective cost control measures.
Indeed, Li & Fung delivered record net profit in 2009.
Margins improved from 2008 due to strong relative
performance from the onshore businesses and
increasing contribution from higher margin value-
added services. Overall core operating margin
expanded from 2.8% in 2008 to 3.8% in 2009.
Turnover was affected by exceptionally weak
consumer sentiment combined with inventory
destocking and customer insolvencies, which could be
considered one-off events.
The business was also affected by record 9% deflation
in 2009. Li & Fung guide that they expect overall
inflation to be flat in 2010.
Moreover, management guidance for 2010 and beyond is
upbeat:
Top line growth for 2010 YTD is “north of 20%.”
The company is very well positioned to continue to
take market share and benefit from the long slow
recovery and ongoing inventory restocking cycle.
“The mother of all outsourcing deals” with Wal-Mart
should contribute to earnings from 2011e. Due to start
up costs, we forecast no contribution to the bottom
line from the Wal-Mart deal in 2010. We forecast that
Wal-Mart will add HK$186m to group EBIT in 2011e
(2% of total group EBIT) growing to HK$775m in 2013
(6% of total EBIT).
Li & Fung will continue to benefit from operational
leverage in 2010, as cost cuts made in Q4 2009 filter
through to operational expenses. For the existing
business, excluding recent acquisitions and
outsourcing deals, operating costs should be able to
drop again on an absolute basis in 2011e.
We forecast an underlying net profit CAGR of 31% 2010-
12e. But, we believe that, trading at a 2010e PE multiple of
30.5x, all of the good news is priced in.
We note that Li & Fung is trading at the top of its PE band
range – see the chart on page 3. Moreover, our 2010e PE
estimate of 30.5x factors in 52% YoY net income growth
this year.
For now, we believe that the stock price will inevitably
underperform for a period as the market adjusts its
forecasts downwards.
We recommend longer-term investors to look to re-enter
the stock at around HK$35.00 (-17% from the stock’s
current level).
Li & Fung: Wal-Mart deal contribution to group revenue
Source: Samsung Securities forecasts
Disciplined valuation call; Short 494 / Long 330
We must stress that we don’t see Li & Fung as a long-term
structural short; this is a disciplined valuation call.
However, we do see a pair trade opportunity; Short Li &
Fung / Long Esprit (330 HK, BUY rating, Target Price
HK$79.00).
We have the most bullish view on the street on Esprit. We
think the company's fortunes will turn around as we go
through CY10, driven by:
Solid progress in the Retail Division, the positive sales
momentum seen in Q2 FY10 (October – December
2009) of +18.5% YoY should continue, driven by new
store openings and a return to gentle same-store-sales
growth. We think that this will combine with margin
expansion to deliver FY10e Retail Division EBIT YoY
growth of over 20%.
An ending of the deterioration in the Wholesale
Division. We think that the weak franchise partners
are being shaken out. Management guide that
wholesale orders will be encouraged by the new
designs and positive Retail Division same-store-sales
growth. We anticipate that the Wholesale Division
will return to gentle growth in H1 FY11e.
Moreover, Esprit will gain 100% control of their China
business, which will add around 4% to EPS and
become a long-term earnings driver.
We see a return to EPS growth by 34% YoY in FY11e,
and a re-rating to the average PE multiple of 16x
(Esprit is currently trading on a FY11e PE of 12.0x).
0
100,000
200,000
300,000
400,000
500,000
600,000
700,000
2010E 2011E 2012E 2013E 2014E 2015E 2016E
Total revenue (HK$m) Wal-mart Sourcing Group (HK$m)
March 25, 2010
Company Update – Li & Fung Ltd
3
Our 12-month target price for Esprit is HK$79.00,
representing 33% upside, and is the highest in the market.
Moreover, we notice that the PE valuation premium
commanded by Li & Fung vs Esprit has never been higher.
We think that the market will now correct this anomaly.
Esprit vs Li & Fung: One year forward rolling PE bands
Source: Datastream
The currency issue
One word of caution; It is widely known that Esprit’s
earnings are highly correlated to EUR / HK$ movement as
85% of sales are in Europe and all profits are reported in
HK$. There is a clear currency translation effect - a 1%
increase in the EUR vs HK$ translates into around a 1%
EPS increase, and vice-versa.
We understand that some investors may be nervous about
market speculation of a sharp reversal in the dollar’s
fortunes in 2010 hurting Esprit’s earnings.
In H2 FY09 (January – June) average EUR / HK$ was
10.35. Today EUR / HK$ is back at 10.35. If the Euro
weakens by more than 4% on average over the next three
months, Esprit would experience negative currency effects
in H2 FY10e results.
Li & Fung: Samsung forecasts old vs new 2010-12E
HK$m, FY ending 31 Dec New Old Change
2010E
Total turnover 142,728 156,675 -9%
EBIT 5,828 6,530 -11%
Diluted EPS (HK$) 1.38 1.56 -12%
2011E
Total turnover 182,925 191,620 -5%
EBIT 7,746 7,980 -3%
Diluted EPS (HK$) 1.83 1.90 -4%
2012E
Total turnover 234,255 222,783 5%
EBIT 9,883 9,515 4%
Diluted EPS (HK$) 2.34 2.26 4%
Source: Samsung Securities
Please see our reports on Li & Fung Don’t fight The
Matrix…Own the Outsourcing Oracle, published January
8, 2010, and our latest report on Esprit The last piece of
bad news. BUY!, published on February 4 2010 for our full
thesis on these stocks.
Valuation: Base case gives 4% downside
We think that a moderate de-rating to the historical
average 25x PE is justified by the earnings miss, which will
cause a flurry of consensus EPS downgrades on the stock.
In March 2011 we believe that the market will partly be
pricing the stock from anticipated 2011 earnings. Thus, we
blend our 2010e and 2011e EPS to arrive at HK$1.59 and
multiply this figure by 25x to yield a PE multiple based
priced target of HK$40.00, rounding to the nearest Hong
Kong dollar.
Our 12-month price objective represents 4% downside.
That leads us to downgrade our rating to SELL.
Li & Fung: 1-year forward PE band chart
Source: Bloomberg, Samsung Securities
Bear views and blue skies
Markets are all about balance of probability. We provide
strong opinions but do not ignore the possibility that
events will go against us. We therefore try to quantify the
risks if we are wrong. Given two stocks with an identical
percentage upside to Target, it is critical to know that one
has, for example 5% downside and the other 25%. This is
how many investors think, and we attempt to reflect this in
our research.
Bear view valuation gives 52% downside
Our bear view quantifies the risks we see for Li & Fung by
factoring a worst case scenario into the valuation. In our
bear view scenario we take the following assumptions:
We factor in 10% YoY sales growth in 2010e. This is below
management guidance for revenue growth “north of 20%”
so far in 2010, and ignores the clear signs of economic
0x
5x
10x
15x
20x
25x
30x
35x
40x
Mar-
04
Jul-04
Nov-0
4
Mar-
05
Jul-05
Nov-0
5
Mar-
06
Jul-06
Nov-0
6
Mar-
07
Jul-07
Nov-0
7
Mar-
08
Jul-08
Nov-0
8
Mar-
09
Jul-09
Nov-0
9
Mar-
10
ESPRIT HOLDINGS LI & FUNG
0.0
5.0
10.0
15.0
20.0
25.0
30.0
35.0
40.0
45.0
50.0 30x
HK$ 25x
20x
15x
March 25, 2010
Company Update – Li & Fung Ltd
4
stabilization and inventory restocking, plus acquisitions
and the Wal-Mart deal, which should boost revenue
growth further.
Despite the positive trend we see at present, in our bear
view we that margins stay flat from 2009. We assume
2010e net margin of 3.2%.
Valuation multiples for the stock decline to 20x PE, and we
use 2010e EPS.
We arrive at a 2010e EPS of HK$0.99, which is 38% below
our base case forecast of HK$1.38.
Using a PE multiple target of 20x, and rounding to the
nearest Hong Kong dollar, we arrive at bear view valuation
of HK$20 per share. This implies 52% downside from the
stock’s current price.
Blue sky valuation gives 27 % upside
In our blue sky scenario, we use a DCF model to capture
the long-term value of Li & Fung.
We provide a three-stage DCF valuation, using a WACC of
10.5%.
We explicitly forecast out for ten years to the end of 2019e.
We then assume a 3.0% terminal FCF growth rate into
perpetuity.
Our DCF fair value emerges at HK$53.00 per share,
rounding to the nearest Hong Kong dollar, implying 27%
upside.
Agent Smith: Do you hear that Mr. Anderson? That
is the sound of inevitability.
Source: The Matrix, 1999.
Li & Fung: DCF valuation
Source: Samsung Securities
Risk free rate 4.0% Equity risk premium 7.0% Beta 0.93 Cost of equity 10.5% Cost of debt 3.0% Tax rate 10.0% WACC 10.5%
Explicit forecast (HK$m) 2009 2010E 2011E 2012E 2013E 2014E 2015E 2016E 2017E 2018E 2019E
NOPAT 3,621 5,408 7,126 9,043 11,437 14,248 17,075 19,487 21,717 23,815 25,897
Depreciation and amortization 540 462 544 652 752 823 910 997 1,083 1,168 1,252
Change in working capital 1,483 -1,783 -1,222 -1,479 -2,173 -2,265 -2,332 -1,101 -1,843 -1,192 -1,282
Capex -470 -628 -787 -984 -1,217 -1,479 -1,730 -1,808 -1,892 -1,959 -2,027
Free Cash Flow 5,174 3,459 5,662 7,232 8,799 11,327 13,924 17,575 19,065 21,833 23,840
PV of FCF
3,209 4,754 5,494 6,049 7,046 7,838 8,952 8,788 9,106 8,998
Sum of PV of explicit forecast 70,234
Terminal growth assumption 3.0% WACC 10.5% FCF at 2020E 24,555
Terminal value of FCF at 2019a 326,961
PV of terminal forecast 123,404
LT Growth Rate
Enterprise Value 193,638
HK$ 2.0% 2.5% 3.0% 3.5% 4.0%
Net debt (2009E) 2,572
WA
CC
9.5% 52.7 55.2 58.1 61.5 65.6
Intrinsic Market value 196,210
10.0% 50.6 52.8 55.4 58.3 61.7
Value per share (HK$) 53.0
10.5% 48.8 50.8 53.0 55.6 58.5
Current price (HK$, 24 March 2010) 41.8
11.0% 47.2 49.0 50.9 53.2 55.7
Upside potential 27%
11.5% 45.7 47.3 49.1 51.1 53.3
March 25, 2010
Company Update – Li & Fung Ltd
5
Li & Fung: Financial ratios
FY ending 31 Dec 2004 2005 2006 2007 2008 2009 2010E 2011E 2012E 2013E
YoY growth
Total revenue 10.6% 17.9% 22.3% 36.0% 19.8% -5.6% 36.6% 28.2% 28.1% 26.7%
Gross profit 14.4% 31.0% 29.6% 33.2% 18.8% 4.0% 28.6% 29.3% 29.2% 27.8%
Core operating profit 17.9% 19.6% 26.0% 35.9% -3.2% 29.4% 46.1% 32.9% 27.6% 27.2%
Total operating profit (EBIT) 18.6% 21.1% 28.0% 49.2% -15.4% 27.4% 50.2% 32.9% 27.6% 27.2%
Net profit 19.4% 20.1% 23.0% 39.0% -20.9% 39.1% 51.9% 32.8% 28.2% 27.5%
Margins
Gross margin 9.2% 10.2% 10.8% 10.6% 10.7% 10.8% 10.9% 11.0% 11.1% 11.2%
Core operating margin 3.3% 3.3% 3.4% 3.4% 2.8% 3.8% 4.1% 4.2% 4.2% 4.2%
EBIT margin 3.3% 3.4% 3.5% 3.9% 2.7% 3.7% 4.1% 4.2% 4.2% 4.2%
Net margin 3.2% 3.2% 3.2% 3.3% 2.2% 3.2% 3.6% 3.7% 3.7% 3.7%
Returns
ROE 31.7% 38.7% 26.6% 31.0% 18.1% 19.0% 26.1% 31.2% 35.5% 39.6%
ROA 13.2% 11.7% 10.0% 9.6% 6.5% 8.1% 10.7% 12.2% 13.2% 14.2%
ROIC 48.8% 30.6% 26.5% 22.7% 15.4% 18.4% 22.3% 26.6% 30.6% 34.9%
Working capital
Inventory days 4 5 8 9 9 9 9 9 9 10
AR days 36 51 50 54 49 44 48 48 48 48
AP days 39 44 45 50 47 47 49 49 49 49
Gearing
Current ratio 2.7x 2.2x 2.3x 1.5x 1.3x 1.1x 1.2x 1.4x 1.7x 2.1x
Debt/equity 16.0% 54.3% 45.8% 61.2% 48.2% 38.2% 34.6% 31.1% 27.6% 24.2%
Net cash/equity 33.9% -27.3% -4.8% -46.3% -31.2% -14.5% -26.8% -25.4% -22.9% -18.9%
Valuation
PE 82.0x 75.6x 62.8x 47.3x 60.7x 46.1x 30.4x 22.9x 17.8x 14.0x
PB 25.8x 29.1x 16.6x 14.5x 10.9x 8.7x 7.9x 7.1x 6.3x 5.5x
EV/EBITDA 92.3x 77.3x 59.8x 40.7x 44.5x 35.5x 25.0x 18.9x 14.9x 11.8x
Dividend yield 1.6% 1.2% 1.3% 1.7% 1.4% 1.8% 2.6% 3.5% 4.5% 5.8%
Source: Company data, Samsung Securities, Valuation based on HK$41.75 as at market close 24 March 2010
March 25, 2010
Company Update – Li & Fung Ltd
6
Li & Fung: Income statement
HK$m, FY ending 31 Dec 2004 2005 2006 2007 2008 2009 2010E 2011E 2012E 2013E
Total revenue 47,171 55,617 68,010 92,460 110,722 104,479 142,728 182,925 234,255 296,805
Cost of sales -42,848 -49,956 -60,675 -82,692 -99,119 -92,406 -127,205 -162,847 -208,308 -263,633
Gross profit 4,323 5,661 7,335 9,768 11,603 12,073 15,524 20,079 25,947 33,172
Other income 223 264 312 518 421 645 571 732 937 1,187
Total core operating expenses -2,990 -4,065 -5,303 -7,099 -8,940 -8,727 -10,266 -13,064 -17,001 -21,792
Core operating profit 1,556 1,861 2,344 3,187 3,084 3,990 5,828 7,746 9,883 12,568
Gain on disposal of assets 0 28 69 457 0 0 0 0 0 0
Other non-core operating expenses 0 -4 0 -43 -40 -111 0 0 0 0
Total operating profit (EBIT) 1,556 1,885 2,412 3,600 3,044 3,880 5,828 7,746 9,883 12,568
Depreciation and amortization -145 -147 -217 -263 -482 -540 -462 -544 -652 -752
EBITDA 1,701 2,032 2,629 3,863 3,527 4,420 6,290 8,291 10,535 13,320
Interest income 43 70 98 208 113 91 85 40 34 38
Interest expenses -11 -21 -148 -500 -480 -372 -406 -406 -406 -406
Share of profits of associates 36 9 11 5 6 8 8 8 8 8
PBT 1,623 1,942 2,373 3,314 2,683 3,606 5,514 7,388 9,519 12,207
Taxation -133 -151 -172 -253 -259 -240 -397 -591 -809 -1,099
PAT 1,490 1,791 2,202 3,061 2,424 3,366 5,117 6,797 8,710 11,108
Minority interests 1 0 0 -1 -2 3 0 0 0 0
Net profit 1,491 1,790 2,202 3,060 2,422 3,369 5,117 6,797 8,710 11,108
Weighted average number of shares - diluted 2,928 3,243 3,312 3,464 3,520 3,720 3,720 3,720 3,720 3,720
Diluted EPS (HK$) 0.51 0.55 0.66 0.88 0.69 0.91 1.38 1.83 2.34 2.99
DPS (HK$) 0.67 0.49 0.56 0.72 0.57 0.77 1.11 1.47 1.88 2.40
YoY growth
Total revenue 10.6% 17.9% 22.3% 36.0% 19.8% -5.6% 36.6% 28.2% 28.1% 26.7%
Gross profit 14.4% 31.0% 29.6% 33.2% 18.8% 4.0% 28.6% 29.3% 29.2% 27.8%
Core operating profit 17.9% 19.6% 26.0% 35.9% -3.2% 29.4% 46.1% 32.9% 27.6% 27.2%
Total operating profit (EBIT) 18.6% 21.1% 28.0% 49.2% -15.4% 27.4% 50.2% 32.9% 27.6% 27.2%
Net profit 19.4% 20.1% 23.0% 39.0% -20.9% 39.1% 51.9% 32.8% 28.2% 27.5%
Margins
Gross margin 9.2% 10.2% 10.8% 10.6% 10.7% 10.8% 10.9% 11.0% 11.1% 11.2%
Core operating margin 3.3% 3.3% 3.4% 3.4% 2.8% 3.8% 4.1% 4.2% 4.2% 4.2%
EBIT margin 3.3% 3.4% 3.5% 3.9% 2.7% 3.7% 4.1% 4.2% 4.2% 4.2%
Net margin 3.2% 3.2% 3.2% 3.3% 2.2% 3.2% 3.6% 3.7% 3.7% 3.7%
Source: Company data, Samsung Securities
March 25, 2010
Company Update – Li & Fung Ltd
7
Li &Fung: Balance sheet
HK$m, FY ending 31 Dec 2004 2005 2006 2007 2008 2009 2010E 2011E 2012E 2013E
Cash and bank balance 2,350 1,248 3,394 1,472 2,275 4,202 1,530 1,236 1,150 1,471
Inventories 458 628 1,331 2,060 2,329 2,383 3,067 4,015 5,136 6,862
Trade & bills receivables 4,642 7,739 9,231 13,716 14,715 12,561 18,770 24,056 30,806 39,032
Prepayments, deposits and other receivables 767 885 1,316 1,747 2,028 2,332 2,659 3,408 4,364 5,530
Due from related companies 29 25 62 72 84 99 99 99 99 99
Derivative financial instruments 0 4 0 0 35 3 3 3 3 3
Current assets 8,247 10,528 15,335 19,067 21,466 21,579 26,127 32,817 41,558 52,996
PPE 715 948 1,114 1,130 1,283 1,256 2,745 4,101 5,537 6,601
Intangible assets 1,304 2,809 4,713 11,375 14,602 18,203 18,098 18,002 17,916 17,835
Prepaid premium for land leases 765 766 681 3 3 2 2 2 2 2
Investment in associated companies 56 7 14 15 24 28 28 28 28 28
Available for sale financial assets 0 92 82 85 20 720 720 720 720 720
Deferred tax assets 73 118 106 116 111 58 58 58 58 58
Investment securities 110 0 0 0 0 0 0 0 0 0
Non-current assets 3,024 4,740 6,710 12,723 16,043 20,267 21,651 22,911 24,262 25,244
Total assets 11,270 15,268 22,045 31,789 37,509 41,847 47,778 55,728 65,820 78,240
Trade and bills payables 4,625 6,059 7,544 11,231 12,667 12,005 17,077 21,862 27,965 35,392
Accrual charges and sundry payables 741 1,006 1,316 2,395 2,772 3,120 3,485 4,462 5,707 7,223
Current portion of LT liabilities 41 0 0 0 0 0 0 0 0 0
Short term bank loans 203 0 2,777 442 278 0 0 0 0 0
Bank overdraft 0 204 92 205 93 47 47 47 47 47
Bank advances for discounted bills 0 1,554 123 328 313 302 302 302 302 302
Taxation payable 291 391 321 466 466 521 521 521 521 521
Others 125 648 765 1,279 1,259 1,462 0 0 0 0
Total current liabilities 6,026 9,862 12,937 16,346 17,848 17,458 21,432 27,194 34,542 43,485
Long term liabilities 509 753 797 5,064 5,760 6,425 6,425 6,425 6,425 6,425
Balance of purchase consideration payable 0 0 0 464 383 140 250 200 200 200
Pension obligations 18 20 25 30 24 26 26 26 26 26
Deferred taxation 7 8 18 21 112 71 71 71 71 71
Non-current liabilities 535 781 841 5,579 6,279 6,662 6,772 6,722 6,722 6,722
Share capital 73 73 85 86 91 94 94 94 94 94
Reserves 3,064 3,540 6,883 8,082 12,122 15,811 16,834 18,194 19,936 22,157
Proposed dividend 1,605 1,043 1,331 1,727 1,199 1,854 2,679 3,558 4,560 5,815
Minority interest -32 -32 -32 -31 -30 -33 -33 -33 -33 -33
Total shareholders' equity 4,709 4,625 8,267 9,864 13,382 17,726 19,574 21,813 24,556 28,033
Total liabilities and shareholder's equity 11,270 15,268 22,045 31,789 37,509 41,847 47,778 55,728 65,820 78,240
Source: Company data, Samsung Securities
March 25, 2010
Company Update – Li & Fung Ltd
8
Li & Fung: Cash flow
HK$m, FY ending 31 Dec 2004 2005 2006 2007 2008 2009 2010E 2011E 2012E 2013E
EBIT 1,556 1,885 2,412 3,600 3,044 3,880 5,828 7,746 9,883 12,568
Depreciation and amortization 145 147 217 263 482 540 462 544 652 752
Others 43 22 -4 -314 84 0 0 0 0 0
Operating profit before changes in working capital 1,744 2,054 2,625 3,549 3,610 4,420 6,290 8,291 10,535 13,320
Change in working capital -524 174 -1,930 664 214 1,483 -1,783 -1,222 -1,479 -2,173
Tax paid -106 -115 -222 -193 -247 -240 -397 -591 -809 -1,099
Net cash inflow / (outflow) from operating activities 1,115 2,114 473 4,020 3,578 5,662 4,110 6,477 8,247 10,048
Capex -419 -1,209 -2,252 -5,699 -3,870 -1,978 -3,181 -1,837 -1,984 -1,717
Disposals 6 9 22 491 73 0 0 0 0 0
Interest Income 43 70 98 208 113 91 85 40 34 38
Others -31 51 117 -36 -27 -3,828 -10 -10 -10 -10
Net cash inflow / (outflow) from operating activities -401 -1,079 -2,014 -5,035 -3,711 -5,715 -3,106 -1,807 -1,960 -1,689
Net proceeds from new shares 122 175 2,886 275 4,072 2,682 0 0 0 0
Change in bank loans 0 -44 2,594 -2,737 71 -335 0 0 0 0
Issue of long-term notes 0 0 0 3,862 0 0 0 0 0 0
Interest paid -11 -14 -148 -431 -400 -372 -406 -406 -406 -406
Dividends paid -1,078 -2,034 -1,564 -2,051 -2,560 -2,179 -3,269 -4,558 -5,966 -7,631
Others -6 -146 -2,594 2,737 -71 0 0 0 0 0
Net cash inflow / (outflow) from investing activities -973 -2,108 3,768 -1,081 1,183 -538 -3,676 -4,964 -6,373 -8,038
Net increase / (decrease) in cash and cash equivalents -259 -1,074 2,228 -2,097 1,050 1,973 -2,672 -294 -86 321
Foreign exchange difference 15 -29 31 61 -135 0 0 0 0 0
Cash and cash equivalents (year beginning) 2,391 2,147 1,044 3,302 1,267 2,182 4,155 1,483 1,189 1,103
Cash and cash equivalents (year end) 2,147 1,044 3,302 1,267 2,182 4,155 1,483 1,189 1,103 1,424
Source: Company data, Samsung Securities
March 25, 2010
Company Update – Li & Fung Ltd
9
Disclosures & Disclaimers
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Additional information is available upon request. Information has been obtained from sources believed to be reliable but Samsung do not warrant its completeness or accuracy except with respect to any disclosures relative to [Name of Issuer] and/or its affiliates and the analyst’s involvement with the issuer that is the subject of the research. The pricing is as of the close of market for the securities discussed, unless otherwise stated. Opinions and estimates constitute our judgment as of the date of this material and are subject to change without notice. Past performance is not indicative of future results. This material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The opinions and recommendations herein do not take into account individual client circumstances, objectives, or needs and are not intended as recommendations of particular securities, financial instruments or strategies to particular clients. The recipient of this report must make its own independent decisions regarding any securities or financial instruments mentioned herein. Periodic updates may be provided on companies/industries based on company specific developments or announcements, market conditions or any other publicly available information. Clients should contact analysts and execute transactions through a Samsung subsidiary or affiliate in their home jurisdiction unless governing law permits otherwise. Copyright 2010 Samsung Securities (Asia) Limited. All rights reserved. This report or any portion hereof may not be reprinted, sold or redistributed without the written consent of Samsung Securities (Asia) Limited.
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