ANALYSIS: Li & Fung on target for record revenues
Last week, Hong Kong-based Li & Fung announced a 22% jump in 2006 sales to HK$68bn (US$8.7bn). The world's biggest textile sourcing group is now poised to punch well above its target $10bn revenues this year, helped by its recent acquisition of Tommy Hilfiger's sourcing operations. Dominique Patton reports.
Li & Fung's ambitious three-year acquisition plan, launched after it bought Hong Kong rival Colby in 2000, has already seen it take on the purchasing unit of German retailer KarstadQuelle for a hefty US$1bn, on top of some smaller deals earlier last year such as Rosetti handbags in the US.
But analysts at Merrill Lynch say the Hilfiger deal, which "wasn't in the pipeline," will now tip the group's turnover well over target to $11.8bn in 2007.
Li & Fung launched its acquisition strategy at the right time. With consolidation in the retail sector seeing more companies change hands, and private equity move in, the Hong Kong group has had plenty of opportunities to pitch for new business.
New owners, without historical ties to previous trading agreements, often examine their new business and identify ways to build greater efficiency.
"Often these companies just say, 'take these operations off our hands'," says Denise Chai, analyst at Merrill Lynch, noting that the Hilfiger deal in February came less than a year after the group was bought by private equity firm Apax Partners for US$1.6bn.
KarstadtQuelle also needed to free up some cash by selling off a non-core item, she says. "It was a suffering company, needing a turnaround. This is very typical of how Li & Fung gets new customers."
Rapid expansion of the group, which is now seven times the size of nearest competitor William E Connor, is being generated organically too.
Private label, the Hong Kong firm's 'bread and butter,' is on a strong upwards trend. Department store penetration averages 18% and is rising further on the back of a number of new brand launches in the US such as Martha Stewart at Federated, American Living by Ralph Lauren at JC Penney, and Very Vera by Vera Wang at Kohl's, according to Merrill Lynch.
Strong demand from US customers - 71% per cent of the group's business - helped Li & Fung post a 22% growth in sales for 2006 (KarstadtQuelle did not have time to contribute much to this growth), with president Bruce Rockowitz citing demand for more value-added services along the supply chain, "particularly in design and product development services as well as our increasing involvement in replenishment orders" as a driver of this growth.
The group has 100 people working in design and is well-positioned to benefit from the trend for faster fashion and shorter lead times, says Alan Lui, an analyst at KGI Securities, given the scale of its sourcing operations.
One of the Forbes' Asia Fabulous 50 companies, Li & Fung has a "quite unique model," adds Lui. It does not own its own factories or even logistics operations, significantly reducing risk and overheads. And its scale means it can buy goods for less than individual retailers and its units can share costs.
But the additional scale and reach added through last year's major deals will also make it easier for Li & Fung to attract further business, say analysts. The group has recently taken on South Africa's largest retailer Edcon and Australia's biggest department store Myer as its customers.
Diversified sourcing operations
The recent acquisitions have also further diversified the group's sourcing operations, with KarstadtQuelle giving the group further access to production facilities in Eastern Europe and Italy.
Li & Fung has anyway been moving to become less dependent on China which has seen double-digit increases in labour costs and is set to see more currency revaluation. Li & Fung's purchasing in India, Bangladesh, Sri Lanka and Pakistan has been increasing by more than 40% a year. It is also the biggest exporter of apparel from Vietnam.
Sourcing from China has dropped from 100% about 10 years ago to around 40%, according to the firm that now has offices in more than 40 countries.
Moreover it says it can buffer further risks in China - such as the currency revaluation - by moving away from the established regions into the country's western provinces which are less developed.
In any case, KGI's Lui says that China will keep higher value fashion production for some time yet, losing only low value-added products to other destinations. In addition, the inflation driven by rising wages and raw material pressures does in fact benefit the middle man by helping to pad out revenue growth, says Merrill Lynch.
Complex trading environment
Despite concerns about the impact of quotas, Li & Fung is also managing to successfully leverage the increasingly complex trading environment to its advantage.
"There are so many bilateral agreements in place now and companies need to know how quickly specific quotas are running out and how much capacity is left. This isn't the business of a US or European retailer," explains Chai.
The only thing that appears to threaten Li & Fung's growth is its ambition. Internal restructuring to accommodate the recent acquisitions may disrupt the business, says Chai, who had to revise earnings downwards for the year based on heavier restructuring than expected.
But the trend toward mergers and acquisitions and private equity buyouts of retailers in the US and Europe will ultimately result in new customers for Li & Fung.
"Net profit came in about 5% light. However we think the big picture has not changed and the company's decision to invest in a stronger platform to take advantage of the global trend toward outsourcing is an unequivocal long-term positive," says Chai.
An interactive databank with intelligence on the major apparel sourcing countries
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