Li & Fung's wake-up call: buy better, not bulk

HONG KONG, March 21 Wed Mar 20, 2013 4:59pm EDT

HONG KONG, March 21 (Reuters) - Quality, not quantity: that's the advice investors would like global supply chain manager Li & Fung Ltd to heed as it snaps up little-known brands to fuel growth in a business environment where more retailers source goods on their own.

Caught out by a decline in retail sales in the United States and Europe, which account for 80 percent of its revenues, Li & Fung switched its strategy over the past three years to become less of a middleman and more of a brand-management business.

But many of the brands it has acquired so far have underwhelmed investors. The company has already warned of a 40 percent slide in 2012 operating profits and shares have fallen nearly 24 percent so far this year.

"Since its acquisitions have so far failed to impress investors or create value for shareholders, it will help if the company slows its pace of M&A and looks to some good quality ones," said Steve Chow, the retail sector analyst at Hong Kong brokerage firm Sunwah Kingsway Research.

Li & Fung supplies some of the world's largest retailers including Kohl's Corp, Wal-Mart Stores Inc and Target Corp with goods from shoes to cosmetics.

Wal-Mart and Carter's Inc, however, are now sourcing more goods directly from manufacturers. In response, Li & Fung cut the number of brands it distributes in the United States.

The company is expected to outline its M&A strategy when it reports earnings on Thursday. In August, Li & Fung described its acquisition pipeline as strong and said it expected to strike more deals in 2013.

"If they focus on buying good brands at good valuations, it will be an interesting opportunity as Asia and emerging markets are really hungry for brands," said consumer analyst Nicholas Studholme-Wilson at Hong Kong brokerage Sun Hung Kai Financial.

Li & Fung was among the best annual performers on the Hong Kong Stock Exchange between 2007 and 2011. The stock has so far plunged 61 percent from an all-time high hit in 2011.

BUY BETTER; BUY SLOWER

Some analysts say a three-year target to grow operating profits to $1.5 billion by 2013 has pressured management to rush into deals. In January, Credit Suisse said it appeared that some companies Li & Fung had acquired in the past few years had failed to meet earnings targets.

Li & Fung signed four acquisitions for its trading network unit, which represents about 70 percent of the group's turnover, and six licensing deals in the first half of 2012, building on 19 acquisitions in 2011.

In January, it made its first major acquisition since raising $1 billion in equity and a perpetual bond last year, paying $190 million for Lornamead, which owns personal care brands such as Yardley cosmetics and hair products Finesse and Aqua Net.

"Management has got to integrate acquisitions better and it needs to get more synergy," said Studholme-Wilson. "The company needs managers who are still hungry to grow the business."

Li & Fung, whose clients also include J C Penney Co Inc , is expected to post a profit of $629 million for 2012, according to Thomson Reuters StarMine SmartEstimate.

Profit for the second half is estimated at $317 million.

In August, Li & Fung recorded a 32.5 percent increase in its January-June profit to $312 million.