Global Exporter Li & Fung's Shares Dive 16% on Profit Warning

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Shares of Li & Fung fell 16 percent to a three-month low after the global supply chain manager warned of a steep drop in core operating profit, taking investors by surprise and triggering concern over its ability to reach a three-year earnings target.

A global economic slowdown has weighed on consumer-related companies and Li & Fung, which sources and supplies goods from shoes to cosmetics to retailers such as Wal-Mart Stores and Target, has reported shrinking margins in recent years.

The Hong Kong-listed company warned on Friday of a 40 percent fall in full-year 2012 core operating profit, hit by restructuring costs and an additional provision tied to its U.S. business unit, LF USA, for which it appointed a new chief.

"It was a surprise to the market in terms of timing. It booked in all the provisions from its U.S. operation, but it makes sense to me in a way to book in all one-off losses (in 2012) to pave the way for a turnaround in 2013," said William Lo, an analyst at Ample Capital.

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"The U.S. market is picking up and the outlook for Li & Fung is not that bad," he said. "It may need to revise down its three-year target in the current operating environment, but any weakness in the stock price appears to be a buying opportunity."

The warning comes part way through Li&Fung's ambitious 3-year plan to grow core operating profit to $1.5 billion by 2013.

However, some investors have questioned whether its reliance on acquisitions to meet growth targets is working, and say its business model is at risk as companies look to save costs by cutting out the middleman and sourcing goods directly.

The latest profit warning means Li & Fung now expects core operating profit to fall to around $500 million in 2012, well short of its three-year target ending in 2013 target.

The downgrade also came just two months before the company is due to report its full-year results and two months after an analyst briefing, which would likely raise questions on management's "guidance credibility", Barclays analysts said in a note.

Shares Slide

Shares of Li & Fung, whose global distribution centers make it a useful barometer of consumer sentiment, fell as much as 16 percent to HK$11.64, the lowest since October, while the benchmark Hang Seng Index added 0.3 percent. It was the stock's biggest percentage loss since August last year.

The plunge came amid heavy volume -- more than six times the stock's 30-day average -- suggesting some large investors were rushing for the exit.

Nearly a third of Li & Fung shares that can be borrowed are out on loan, compared with an average of about 8.6 percent for Hang Seng index constituents, according to data from Markit Securities Finance, indicating some hedge funds are also anticipating a slump in the shares.

Analysts at Credit Suisse noted that as well as the weakness in the company's U.S. business, it appeared that some companies Li & Fung had acquired in the past few years had failed to meet earnings targets.

Li & Fung said on Friday it planned to further reduce brands for distribution in the United States, which analysts said pointed to the failure of some acquisitions.

"Over the past few years, L&F's consistent earnings disappointment and frequent fund raisings have proven our view that the company's acquisition strategy to grow earnings is unsustainable, given the slow organic growth and the grim growth prospects of the newly-acquired companies," UOB Kay Hian wrote in a research note.

With around 60 percent of Li & Fung's sales destined for U.S.-based retailers, sluggish growth in that market has been a big concern for investors as well as the company's role as a middleman.

"We are concerned about the sustainability of its role as the middleman. Its market share is shrinking as more retail groups and clients take up their own sourcing works," Hian added.

Li & Fung on Friday sought to reassure investors over its role as a supplier, telling analysts that large retailers opening their own sourcing offices would act as competitors rather than taking away all of that business.

The company, valued at nearly $15 billion, was founded early last century as a trader in porcelain, jade and silk. It offers one-stop supply chain management - from product design, raw material sourcing and manufacturing to shipping and wholesale.