Shifting trade winds catch Li & Fung off-guard

January 14, 2013

By John Foley

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

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

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

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

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

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

 

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