EQUITIES

Li & Fung

Investors turn bullish on Li & Fung after makeover

Options traders are betting on a revival in the American operations of the supplier to Wal-Mart after a 61 per cent slump in its share price

PUBLISHED : Monday, 03 March, 2014, 2:59am
UPDATED : Monday, 03 March, 2014, 2:59am

Options traders are turning bullish on Li & Fung, a supplier to Wal-Mart Stores, betting on a revival of its American operations after the stock lost 61 per cent of its value.

Calls with an exercise price 10 per cent above Li & Fung shares cost two points more than puts, according to three-month options data. The gap, which widens as demand from bulls increases, jumped to 3.18 points on February 21, the most since April 2011.

Li & Fung's profit will climb 21 per cent this year, analysts estimate. The stock closed at HK$10.16 on Friday, down from HK$25.93 in January 2011.

The company has changed management and cut brands to revive its United States unit, buying Lornamead Acquisition, the owner of brands including Finesse and Aqua Net, last year to expand its market share in personal-care products.

Investors are betting that Li & Fung, which gets more than 80 per cent of its revenue from the US and Europe, will benefit from global growth forecast to accelerate this year to the fastest pace since 2011.

"People should be turning more positive on Li & Fung," said Nicholas Studholme, an analyst at Sun Hung Kai Financial. "US consumer spending is improving slowly and will probably get better. There should be an upward drift in the company's profit margins following the acquisition of higher-value-added assets and completion of the US restructuring."

Analysts have raised ratings on Li & Fung since it said on January 6 that its performance last year was solid, matching its forecast, which it did not specify. Mizuho Securities lifted its rating on the stock to buy from neutral on January 13.

Li & Fung said it would announce a three-year plan this month.

Of the 21 brokerages covering the stock, just over half have buy ratings, compared with fewer than a quarter a year ago.

After slumping in the past three years, Li & Fung's shares are trading at 15.5 times estimated earnings. While that is lower than the five-year average multiple of 23.3, the stock is expensive compared with the benchmark Hang Seng Index, which trades at 10.2 times forecast profits.

"I don't think investors would be too interested in Li & Fung for the time being," said Ben Kwong Man-bun, the chief operating officer of KGI Asia. "Valuations still look relatively high. Investors need to see concrete signs of improvement in the company's earnings."

Economists predict global gross domestic product will increase 2.9 per cent this year, up from 2.1 per cent last year, as the US rebounds and Europe exits a recession.

The US economy expanded at a 2.4 per cent pace in the fourth quarter of last year as consumer spending climbed the most in three years, while the unemployment rate fell in January to the lowest level since October 2008.

The ratio of outstanding puts to calls on Li & Fung dropped to 1.3-1 on Wednesday, near the lowest level of the year. There were 17,789 bullish contracts, compared with 23,138 bearish ones.

The cost of Li & Fung calls relative to puts is the second-highest of any stock on the Hang Seng Index. Short interest fell to 7.2 per cent of shares outstanding on Tuesday, the lowest since September last year, according to Markit, a London-based provider of financial information.

Li & Fung said in January that its performance last year was in line with its target to return to 2011 levels, after net income fell in 2012 for the first time since 2008. Earnings will jump 21 per cent this year and 16 per cent next year, analysts estimate.

"There's been a turnaround in sentiment after the management came out [in January] to say 2013 was solid and that they'll be meeting their target [for earnings]," said Vineet Sharma, an analyst at Barclays. "This will continue. I think it can deliver double-digit growth going forward."

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