Li & Fung - 1H09: cost cutting spurred profit, too much growth is priced in

1H09 results came in better than our estimates due to cost saving, but worse than market expectation as a result of drop in turnover, with net profit up 13% yoy to HK$1.4b. Valuation is too expensive. Maintain SELL with fair price of HK$18.8 based on 18x 2010F PE.
1H09 results came in better than our estimates due to cost saving, but worse than market expectation as a result of drop in turnover, with net profit up 13% yoy to HK$1.4b. The earnings growth was solely attributable to cost cutting. Due to dilution from the two share placements in Sep 08 and May 09 respectively, EPS only grew 6% yoy.

Despite its numerous M&As and outsourcing deals, turnover unexpectedly dipped 2% yoy to HK$46.3b in 1H09, mainly due to insolvency of its customers, order cuts and price deflation. Ytd, 10 customers of L&F have already filed for bankruptcy, compared to six for 2008. Besides, existing customers cut their orders for destocking purpose, as most of them saw a double-digit sales decline.

SG&A as a percentage of turnover dropped to 8% in 1H09 from 8.3% a year ago, due to the Group’s cost cutting measures. As such, EBIT margin rose 32bp yoy to 3.6% in 1H09. For 2009, the Group targets to reduce its operating expenses by US$100m or 10% of the 2008 cost base (excluding acquisitions).

Effective tax rate fell to 5.9% in 1H09 from 8.6% a year ago, due to tax management. Combined with an improvement in EBIT margin, it boosted net margin by 40bp yoy to 3.0% during the period.

Based on the larger than expected cost savings and lower effective tax rate, we raise our EPS forecasts for 2009, 2010 and 2011 to HK$0.88, HK$1.04 and HK$1.23 respectively. Our expected 27% EPS growth in 2009 is solely based on acquisitions (or outsourcing deals), operating cost savings, as well as tax expenses. The benefit will fade from 2010 onwards. We anticipate an 18% EPS growth for 2010-11 to factor in the new outsourcing deals, like Talbots.

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