(The following was released by the rating agency)
-- Li & Fung’s execution of its strategy in the distribution segment was materially weaker than we expected in 2012, suggesting its financial results for last year will be much lower than our base case.
-- Recovery prospects in 2013 are unclear for the sourcing, distribution, and logistics company, given the global economic uncertainty and recent major restructuring at Li & Fung’s distribution business in the U.S.
-- We are placing the ‘A-’ corporate credit rating on Li & Fung and the ratings on its notes on CreditWatch with negative implications.
-- We aim to resolve the CreditWatch within the next three months once audited results for 2012 are available and following our thorough evaluation of the company’s operational and financial prospects for 2013.
On Jan. 15, 2013, Standard & Poor’s Ratings Services placed the following ratings on CreditWatch with negative implications: the ‘A-’ long-term corporate credit rating and ‘cnAA-’ long-term Greater China regional scale rating on Li & Fung Ltd.; our ‘A-’ issue rating and ‘cnAA-’ Greater China regional scale rating on Li & Fung’s outstanding senior unsecured notes; and our ‘BBB’ issue rating and ‘cnA’ Greater China regional scale rating on the company’s U.S. dollar-denominated hybrid capital securities. Li & Fung is a sourcing, distribution, and logistics company, and is based in Hong Kong.
We placed the ratings on CreditWatch because Li & Fung’s recent profit warning suggests that its operating results for 2012 could be materially weaker than our base-case scenario, under which we revised the rating outlook on the company to negative from stable in November 2012.
We require a breakdown of the results by business segment, including margin trends, which have yet to be made available. In particular, we need greater visibility over the likely performance in 2013 of LF USA, its distribution business in the U.S. Li &Fung disclosed on Jan. 11, 2013, that it expects core operating profit for full-year 2012 to be about 40% lower than a year earlier, mainly because of ongoing restructuring costs and additional provisions associated with LF USA. The U.S. entity was the main contributor to the revenue and profit in the distribution segment in 2010-2011.
We’re highly uncertain whether the operations of LF USA can significantly improve in 2013. LF USA spent close to US$200 million on operational restructuring in 2012, and has had a new president since mid-December. We understand that the majority of the restructuring-related costs were written off against expenses in 2012, which dragged down the performance. We expect LF USA to generate a profit in 2013. Economic uncertainty in Europe and the U.S. remain a question mark over Li & Fung’s performance in the next 12 months.
The sourcing and logistics businesses are progressing smoothly, compared with the distribution segment. Nevertheless, Li & Fung’s overall core operating profit is likely to be a mere US$530 million for full-year 2012, calculated with the information from the profit alert. This figure compares with US$565 million from the sourcing segment alone in 2011 and is a huge shortfall from the company’s original target of US$1.5 billion in core operating profit for 2013. In our view, it will be extremely challenging for Li & Fung to meet that target this year.
Li & Fung has a strong global network and good record in the sourcing business. The company has a large scale and a cash-generative business model. However, in our opinion, Li & Fung’s “intermediate” financial risk profile is deteriorating, and its growth strategy is aggressive and has been weakly executed under the company’s current three-year plan. Li & Fung’s exposure to the U.S. and European consumer markets are additional challenges. Nevertheless, we view the company’s business risk profile as “strong.”
CreditWatch We aim to resolve the CreditWatch over the next three months, after reviewing the audited 2012 financial accounts and making a thorough analysis of the company’s recovery prospects for 2013.
The company has breached our rating downgrade triggers for the first two years of its current three-year plan. We originally expected the company to noticeably improve its financial strength in 2013, which would keep it in line with the current rating. We will lower the rating by one notch within three months if we no longer believe Li & Fung is likely to improve its ratio of net debt to EBITDA of 2.2x in 2013.
Related Criteria And Research
-- Methodology: Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012
-- Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011
-- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008
Li & Fung Ltd.
Corporate Credit Rating A-/Watch Neg/-- A-/Negative/--
Greater China Regional Scale cnAA-/Watch Neg/-- cnAA-/--/--
Senior Unsecured cnAA-/Watch Neg cnAA-
Senior Unsecured A-/Watch Neg A-
Subordinated cnA/Watch Neg cnA
Subordinated BBB/Watch Neg BBB