Li Fung Ltd. #BBB+# Rating Affirmed On Stronger Profitability And Prudent Leverage Outlook Negative

Stocks and Financial Services Press Releases Friday May 18, 2018 14:51
HONG KONG--18 May--S&P Global Ratings

HONG KONG (S&P Global Ratings) May 18, 2018--S&P Global Ratings today said it has affirmed its 'BBB+' long-term issuer credit rating on Li & Fung Ltd., a Hong Kong-based trading and logistics company. The outlook on the company remains negative. At the same time, we affirmed our 'BBB+' long-term issue rating on Li & Fung's outstanding senior unsecured notes and 'BBB-' long-term issue rating on the company's subordinated debt.

We affirmed the rating because we expect Li & Fung will maintain its credit metrics over the next 12-24 months due to improving profitability and prudent capital structure management. The company's 2017 operating results have seen some signs of stabilization due to the implementation of its strategic initiatives to improve efficiency.

We expect Li & Fung's EBITDA margins will improve over the next 12-24 months as the company continues to digitalize its supply chain and improve operating efficiency, which should support its operating cash flow generation. Excluding the impact of the divestment of its product verticals, the company reported an improvement in core operating profit of 13% year on year in 2017, despite a decline in revenue growth of 4.6%. While we expect the company will continue to implement its strategic initiatives, margins may slip if U.S. retail conditions become more challenging than we expect due to weaker consumer sentiment or more intense competition.

Nevertheless, we expect Li & Fung's debt-to-EBITDA ratio to stay at 2.4x-2.7x over the next 12-24 months, from about 2.7x in 2017 on a pro forma basis if including the net proceeds from the divestment of its product verticals businesses. We expect the company will prudently manage its balance sheet and not undertake material debt-funded expansion or aggressive dividend payments. The company received net proceeds of US$580 million as part of the divestment completed in April 2018, which was then used to call and redeem its outstanding US$500 million perpetual securities in May 2018.

However, Li & Fung's scale has significantly reduced over the last few years due to ongoing structural challenges in the retail sector and divestments of its noncore businesses. In addition, we consider the recovery in U.S. consumer sentiment to be fragile and that the risks of ongoing destocking and promotional activity by retailers, as well as intense competition from new retail formats, could persist and contribute to a lower topline. In addition, we believe Li & Fung's revenue will be very sensitive to trading-policy changes and geopolitical uncertainties, given its large exposure to the U.S. and European retail markets.

Nevertheless, we believe Li & Fung's ability to offer high value-added supply chain services and the company's diversified network of global factories and retail customers will continue to underpin its competitiveness in the global sourcing and logistics industry. We also consider the company may be able to temper the potential impact of U.S. tariffs by redirecting part of its sourcing to other regions outside China. As of end-2017, the company had a global network of more than 15,000 vendors and over 8,000 customers.

Despite the slowdown in operating cash flow generation over the last few years, we consider Li & Fung has remained disciplined in managing its leverage and capital structure, which we believe increases its financial buffers and flexibility to absorb business volatility. In addition to using proceeds to repay its debt, the company also repaid US$500 million of senior notes in 2017, mainly funded through the issuance of a new US$650 million perpetual note. The company's strong financial flexibility stemming from its well-established banking relationships and good access to capital markets also supports our view of its financial management.

The negative outlook reflects our expectation of uncertain prospects of a turnaround in Li & Fung's core trading business due to ongoing challenging retail conditions in the U.S and geopolitical risks from U.S. trade policies.

We may lower the rating if Li & Fung's trading revenue scale declines more than we expect, which could happen if: (1) ongoing headwinds from intense competition, destocking, and heavy promotions in the retail sector continue to weigh on its ability to retain or win customers; or (2) other material divestments of existing businesses reduce its overall scale and diversity of its product offerings.

We may also lower the rating if the company's debt-to-EBITDA ratio exceeds 3.0x without signs of improvement. This could happen due to underperformance by the company, increased expansion appetite, or more shareholder-friendly financial policies.

We may revise the outlook to stable if Li & Fung's operating results are better than our expectations, signaling a stabilization of the scale of its trading revenues and margins, while maintaining a debt-to-EBITDA ratio below 3.0x. This could happen if: (1) operating conditions in the retail market globally create less headwinds; or (2) the company's current three-year plan drives business growth and margin improvement more than we expect.


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