Mac - 494 - 110508 - 224346 L&F

HONG KONG
5 November 2008
Li & Fung
Excels during macro adversity
Initiate with Outperform and TP of HK$20.00
We initiate coverage on Li & Fung (494 HK) with an Outperform rating and a target price of HK$20.00, providing potential upside of 32%. Li & Fung is a unique supply chain sourcing company that has an entrenched position with its current customer base. We believe its sourcing ability amid the current weak economic environment could allow the company to gain new customers.
Beneficiary of outsourcing Inside

Excels during macro adversity Valuation, recommendation, risks Beneficiary of outsourcing Key thrust will be the onshore business Financial strength 3 8 12 16 18
In this weak economic environment, retailers will be looking to outsource more. Li & Fungs smaller rivals do not have its extensive network or sourcing economies of scale that retailers would sorely need in a weak environment. During the Asian crisis (19972000), we estimate that Li & Fung grew its share of all apparel imports into the US by a full percentage point to about 4%. We expect this share to grow to about 11.8% this year. Already in 2008, the company has gained two landmark outsourcing deals: with Timberland apparel and with Kellwood private label. Any drag from the existing customer base, in our view, should be more than offset by new outsourcing contracts.
Key thrust will be the onshore business

Apart from its core agency business, Li & Fung has been focusing on valueadded segments such as licensing products, exclusive proprietary brands and private label business with its customer base. In a span of a few years, the company grew its US onshore business to about US$1bn by 2007, and we expect this segment to grow by substantially more than 30% this year. The segment margins for this business, at 5%+, are superior to those for its core business. With retailers likely to focus more on private label or proprietary brands in this difficult economic environment, Li & Fung should clearly benefit. Retailers can generally obtain better margins on private label or proprietary brands rather than on national brands.
Good track record

Li & Fungs management works on three-year forward plans for providing ongoing targets for its staff. These are flexible targets but generally the company has been able to meet them. Normally, its targets are achieved via new outsourcing deals and acquisitions, on top of the normal organic growth. With these targets as a backdrop, the company has been able to achieve a near 20% CAGR in revenue and earnings for more than a decade. Under the current threeyear plan, the objective is to achieve US$20bn in turnover and US$1bn in operating profit, and we again expect acquisitions and new outsourcing deals to play a key part in achieving this. Our own forward earnings assumptions will only be adjusted as deals are announced, eg, the Van Zeeland acquisition announced in August 2008.
At historically low valuations

Analyst
Mohan Singh 852 3901 1111 mohan.singh@macquarie.com
From a PER multiple point of view, the company is trading at the lower end of its historical range. Note that, as the company has a dividend payout of over 75%, at current price levels, it provides roughly a 5% forward dividend yield.
Please refer to the important disclosures and analyst certification on inside back cover of this document, or on our website www.macquarie.com.au/research/disclosures.
This document is being provided for the exclusive use of BENJAMIN WONG at STANDARD CHARTERED BANK (HK) LIMITE
Macquarie Research Equities - Report
Li & Fung
494 HK
Stock price as of 04 Nov 08 12-month target Upside/downside Valuation
- DCF (WACC 10.1%)
Outperform
HK$ HK$ % HK$ 15.20 20.00 +31.6 20.08 retailing 55,237 239.3 7,127 3,634
Li & Fung
Company profile
Li & Fungs key business is managing the supply chain for retailers and brands worldwide and sourcing consumer goods for them. It sources all types of apparel as well as non-apparel goods or hardwoods, such as fashion accessories, gifts, handicrafts, home products, promotional merchandise, toys, sporting goods, footwear and travel goods. For its key business, Li & Fung earns a fee for the intermediation it provides between the retailer and the factories that produce the goods. If it provides an extra value-added service such as assisting in the design of the product, Li & Fung would obtain an extra fee. The company has also expanded into the US onshore business (licensed brands, proprietary brands and private label brands) where it earns a much higher margin. Li & Fung is headquartered in Hong Kong from where it coordinates the manufacture of goods through a network of 80 sourcing offices in 40 countries and territories with a sourcing network of about 10,000 suppliers. This network is continually being expanded globally to ensure that customers obtain the best prices for their orders as efficiently as possible. The largest five suppliers accounted for less than 30% of the total value of goods sourced in 2007. Li & Fungs clients include retailers of all descriptions, including Coca Cola, American Eagle Outfitters, J.C. Penney, Loblaw, Marks & Spencer, Gymboree, Disney, Myer, Wal-Mart and Limited Brands. Key clients that fall into the US$500m+ revenue pa category include Germanys Karstadtquelle, US-based Kohls and global brand Tommy Hilfiger. Overall, it works with over 1,000 customers worldwide. The percentage of sales attributable to the groups largest customer and the five largest customers combined were 13.6% and 33.8%, respectively. Most of the relationships Li & Fung has with its customers are generally openended with a smaller number of customers that have multi-year contracts ranging between two and ten years but renewable on expiry. However, we do not believe that this is a significant risk as the symbiotic relationship built up between Li & Fung and its clients would be difficult to replicate by others. Also, the companys ability to efficiently source products would tend to make its competitors look relatively uncompetitive by comparison and, as a result, we believe this is one of the reasons Li & Fung has been able to grow both organically and through M&A. To manage such a large number of clients, Li & Fung has organised itself into seven business streams that are categorised by geography and product line.
GICS sector Market cap 30-day avg turnover Market cap Number shares on issue
HK$m HK$m US$m m
Investment fundamentals
Year end 31 Dec Total revenue EBIT EBIT Growth Reported profit Adjusted profit bn bn % bn bn 2007A 92.5 3.1 35.4 3.1 2.6 0.88 35.4 0.76 21.0 17.2 20.0 0.71 4.7 11.6 29.1 16.5 46.3 5.4 2008E 113.6 4.1 31.5 3.4 3.4 0.95 7.5 0.94 24.0 16.0 16.1 0.75 4.9 11.3 27.8 13.4 21.7 3.9 2009E 126.8 5.1 25.2 4.1 4.1 1.11 17.1 1.11 17.4 13.7 13.7 0.91 6.0 12.1 27.0 10.9 24.3 3.6 2010E 135.6 6.0 16.6 4.9 4.9 1.31 17.7 1.31 18.0 11.6 11.6 1.08 7.1 13.2 29.3 9.4 20.3 3.3
EPS rep HK$ EPS rep growth % EPS adj HK$ EPS adj growth % PE rep x PE adj x Total DPS Total div yield ROA ROE EV/EBITDA Net debt/equity Price/book HK$ % % % x % x
494 HK rel HSI performance, & rec history
Source: Datastream, Macquarie Research, November 2008 (all figures in HKD unless noted)
Hardline goods for wholesalers, specialty stores and brands globally. Hardline goods for department stores and mass-market retailers globally. Apparel for wholesalers and brands globally (ex-Europe). Apparel for department stores and mass-market retailers globally (ex-Europe). Apparel for specialty stores globally (ex-Europe). Apparel for the European market. Onshore business. These streams are further subdivided into a total of over 170 divisions. Each division has its own customer team managing the relationship with each customer or a small group of non-competing customers. All of the divisions and streams are run as individual profit centres. Although the front-end (ie, the customer interaction segment) is separate for each division, the back-end (ie, finance, human resources, information technology and logistics) is common and shared by all. Part of the success of Li & Fungs acquisition strategy is its ability to plug in an acquired companys system into its own.
5 November 2008
Li & Fung
Excels during macro adversity

Beneficiary of outsourcing
Retailers globally trying to reduce fixed costs Similar to other businesses, retailers have a choice to reduce overheads whether or not overheads can be reduced depends largely on economies of scale, ie, small retailers in general lack the scale to afford their own buying offices and, as a result, have to depend on wholesalers or sourcing agents for their products. The key element to the equation is that running a proprietary office consists of more fixed costs vs the variable cost of using a third party to manage your needs. Commission rates for agents can vary from 6% to 12% of a retailers FOB costs, depending on the agents range of services. Whether working directly with factories or via agents, retailers need to work with partners that can react quickly to market changes. We estimate that Li & Fungs market share of the US apparel business has grown from roughly 6% in 2004 to a projected near 12% in 2008 (more details follow). In 2008 alone, it has gained a number of outsourcing deals (including Timberland apparel and Kellwood private label), which are expected to add over US$600m in additional turnover on an annualised basis in 2009. Therefore, we believe the company will be able to improve on this share further. Despite the estimated increase in market share, the company has been able to gradually reduce its dependence on the US market, implying significant market share gains in other regions.
Fig 1
FY04 geographic breakdown
Fig 2
FY08E geographic breakdown

Rest of The World 9%
Rest of The World 12%
Europe 20% USA 68%
Europe 25%
USA 66%
Source: Company data, Macquarie Research, November 2008
Source: Macquarie Research, November 2008
Li & Fung has made inroads in both softgoods and hardgoods
The company has gained market share equally in the hardgoods as well as softgoods segments, as seen in the following chart, essentially maintaining its revenue split. With the overall market for hardgoods (eg, toys, furniture) being larger, and with Li & Fungs revenue base in this segment vis--vis its apparel revenue base being smaller, there is also potential for the company to expand market share in hardgoods. We also expect the company to make further inroads into the European and Japanese markets.
5 November 2008
Li & Fung
Fig 3
FY04 hardgoods/softgoods split
Fig 4
FY08E hardgoods/softgoods split
Hardgoods 33%
Hardgoods 32%
Softgoods 67%
Softgoods 68%
The current economic slowdown will affect the company as customers orders slow down especially in the US. However, as has been seen in previous slowdowns, Li & Fung has managed to eke out good growth vis--vis the market as it gains market share within its current customer base, as well as new outsourcing customers during these slowdowns. Core business is quite sticky The core business can be described as quite sticky and the symbiotic relationship built up between Li & Fung and its clients would be difficult to replicate by others. Also, the companys ability to efficiently source products would tend to make its competitors look relatively uncompetitive by comparison. Therefore, we believe that the core business will remain the cornerstone of Li & Fungs strategy, providing a steady income stream. The operating margin in this core segment is roughly 3.253.35% on a normalised basis.

New thrust provides better margin Li & Fung increased its US onshore business to about 9% of total revenue in 2007. Overall, we estimate that the US onshore business showed a loss in FY04 before turning marginally profitable in FY05. The segment margin exceeded that of its core business in FY07 and we expect the company to achieve a margin nearly double that of its core business segment margin over the next few years a remarkable achievement given the limited amount of time Li & Fung has been involved in the onshore business segment. The following diagram summarises Li & Fungs US onshore business.
5 November 2008
Li & Fung
Fig 5
Building on US onshore strategy

2005: US$350m+ Private Label Oxford Ralsey Young Stuff/ISG Rosetti
2006: US$700m+
2007: US$1 billion +
US Retailers
Brands Briefly Stated & Licensing, Van Zeeland, AME
Proprietary Brands sold via Wal-mart Kohls Target
The onshore model allows the company to diversify away from the core business; longer term, it should provide the company with enhanced margins. This diversification will likely enable the company to achieve its US$1bn operating profit target under its current three-year plan. Retailers will be looking at ways to differentiate their products from those of competitors and we believe that the use of private label and proprietary brands will increase especially during this weak economic environment.
Good track record implies management premium

Sets three-year goals with the current one being aggressive given current market turmoil For its current three-year plan, management is guiding for US$20bn turnover by end-2010 with a core operating profit level of US$1bn. However, management admits that these are stretch targets that are not easy to achieve relying on organic growth. Our own estimates are more conservative than Li & Fungs guidance. A key reason for the difference is that Li & Fung normally achieves its objectives via contributions from new acquisitions, which are difficult to predict and therefore not included in our estimates until they are announced. In its listed history since 1992, the company has generally been able to meet its targets set in each three-year plan.
Fig 6
Li & Fung three-year plan (199698)

Plan Target Results HK$451m HK$455m
Profit After Tax Source: Company data, Macquarie Research, November 2008
The 2001 actuals were also within plan objectives.
Fig 7

Plan Target Results* HK$951m HK$915m
Profit After Tax * Excluding one-time write off of HK$169m for StudioDirect Source: Company data, Macquarie Research, November 2008
5 November 2008
Li & Fung
The 200204 plan performance was mediocre
Given the negative multiple negative macro conditions prevailing during the 200204 plan period (post 911, West Coast strike, SARS), the plan objectives were revised with margins being revised down whilst turnover objectives were revised up. The company was a beneficiary of the weak economic environment by gaining new accounts but margins were generally under pressure. The company was not able to meet its objectives for the revised plan, although the end results were still impressive.
Fig 8

Revised Plan Results 3.23% 12.7% pa US$6.0bn HK$1,491m 4.00% 15% pa US$6.4bn HK$1,564m
EBIT margin Turnover growth Turnover Profit After Tax Source: Company data, Macquarie Research, November 2008
The company set itself a simple objective of turnover growth for the next plan, which it was able to surpass.
Fig 9
Turnover

Plan Target US$10.0b Results US$11.9b
Li & Fung is aiming for US$20b in revenue and US$1bn in operating profit under the current plan
We expect the company, over the current three-year plan, to: Continue to gain market share in its core business. This year, we expect its share will rise by 1ppt to 11.8% for all apparel imports into the US. Gain economies of scale in its US onshore business. In the last three-year plan, the company invested in infrastructure for developing this business. Going forward, the company should gain positive operating leverage. Expand its European onshore business. This, we believe, should lead to margin improvement. We note, however, that our expectations are well-below Li & Fungs plan objectives.
Fig 10 Margin improvement

12% 11% 10% 9% 8% 7% 6% 5% 4% 3% 3.18% 2% FY98 FY99 2.90% 3.30% 9.93% 9.73% 8.81%
10.60%
FY00
FY01
FY02
FY03
FY04
FY05
FY06
FY07
FY08E
Gross Margin
Operating Margin
Net Margin
Source: Bloomberg, Macquarie Research, November 2008
5 November 2008
Li & Fung
Whats the real profitability?
We would like to point out one key aspect of our analysis of Li & Fungs profitability. For its core business, the actual revenues of their business are the commissions and fees that they earn on the business that they transact on behalf of their customers. This actual income would be equivalent to the current gross profit and other income. Re-basing margins using the real revenue of the firm, we believe the market may have overlooked the issue that Li & Fungs real profitability, with re-calculated operating margins of near 30%, on average, based on our estimates, is quite impressive (more details follow). Partly due to such margin strength, we believe that Li & Fungs shares have traded at a premium to the market in PER terms. This factor is separate from the premium achieved due to its consistent above-average earnings track record. In the recent past, Li & Fung shares have consistently traded at a premium to the Hong Kong market due to its consistent superior earnings track record and managements ability to continuously add value. We expect this to continue.
Valuation
We set a target price of HK$20.00 We value Li & Fung using a combination of the PER, adjusted for prospective growth, and DCF methodologies. The company has on average traded on a prospective PER adjusted for growth of 1.26x and down to less than 0.9x in a weak economic environment. Excluding the outlying years, the average trading multiple would be more like 1.05x. Applying this 1.05x multiple to estimated 2009 earnings gives us a PER adjusted for growth fair value of HK$19.95. Li & Fung is a good cash generator and has consistently paid out about 7580% of earnings as dividends, and therefore lends itself to a DCF valuation. We have used a WACC of 10.6% with a terminal growth rate of 2% to provide a DCF valuation. Using these assumptions, we derive a DCF valuation of HK$20.08. However, the stock can trade at a 5% to 10% premium to its DCF valuation as a management premium in a bullish market. This premium also reflects the potential additions emanating from future acquisitions. The companys unique business model means there is a lack of comparable companies for valuation purposes. We have set our target price for Li & Fung at HK$20.00, using the combination of a PER-to-growth and the DCF-derived valuations.
5 November 2008
Li & Fung
Valuation, recommendation, risks

PEG and DCF are preferred valuation methods We value Li & Fung using the combination of a growth-adjusted PER multiple and a DCF valuation. This provides us with a target price of HK$20.00. Risks to our target price and investment outlook include the company failing to grow its US onshore business segment, a sudden and rapid decline in US and European consumer spending leading to lower orders, or some of the larger customers bypassing Li & Fungs services altogether. As shown in Figure 11, since 2001, Li & Fung has consistently traded at a higher PER multiple relative to the local market. As mentioned earlier, this is because it enjoys a management premium due to its consistently strong historical earnings growth.
Historically, the stock has traded at a premium to the market
Fig 11
P/E (x) 45 40 35 30 25 20 15 10 5
L&F forward PER
1/1/2003
5/1/2005
9/1/2005
5/1/2007
9/1/2007
1/1/2008
1/1/2002
1/1/2004
5/1/2004
9/1/2004
5/1/2006
9/1/2006
1/1/2007
1/1/2006
5/1/2001
9/1/2001
5/1/2003
9/1/2003
5/1/2008
Hang Seng Index Forward 12 month P/E
L&F Forward 12 month P/E
Source: Datastream, Macquarie Research, November 2008
Generally has traded in a defined PEB trading band
Figures 12 and 13 illustrate our estimated forward PER and P/BV multiple bands for Li & Fung. As shown in these figures, historically, the companys shares trade between 16x and 45x, and are currently trading toward the low end of the historical range. This implies adverse macro circumstances. That said, we believe Li & Fungs growth prospects remain good mainly on the assumption that the company will continue to make inroads in gaining market share. We estimate that even in this recessionary year, the company will likely gain a full percentage point in market share for all apparel imports into the US.
Fig 12 PER historical trading pattern

Share Price (HK$) 40 35 30 25 20 15 10 5 0 Jan 01 Jan 02 Jan 03 Li & Fung Jan 04 16.0 Jan 05 21.3 Jan 06 26.7 Jan 07 32.0 Jan 08 26.7x 21.3x 16.0x
32.0x
5 November 2008
9/1/2008
1/1/2001
5/1/2002
9/1/2002
1/1/2005
Li & Fung
Fig 13 P/BV historical trading pattern

Share Price (HK$) 40 35 30 25 20 15 10 5 0 Jan 01 Jan 02 Jan 03 Jan 04 5.0 Jan 05 6.5 Jan 06 8.0 Jan 07 9.5 Jan 08 9.5x 8.0x 6.5x 5.0x
Li & Fung
PEG ratio has been an impressive 1.26 in the past
When considering valuation, we do not view PER multiples in isolation. Li & Fungs prospective PER is also driven by its forward projected earnings growth. Note that, at most, the company normally provides guidance on top-line growth for the coming year unless its revenue growth is part of the top-line growth projection (for example, doubling revenue in three years). In addition, management does not provide margin guidance unless it is to fulfil a specific objective as part of the companys three-year business plan. Despite this lack of guidance, Li & Fung has generally traded at a premium to PEG of about 1.26x (Figure 14). We argue that since the company is aggressively gaining market share and the economic cycle will turn, the shares should trade at a similar premium in the future. Excluding the outlying years, the stock has traded at about 1.05x and, using this multiple, the PEG valuation is derived as HK$19.95.
Fig 14
PEG 3.0 2.5 2.0 1.5 1.0 0.5 0.0 1/1/2001
L&F PEG
Average PEG: 1.26
5/1/2001
9/1/2001
1/1/2002
5/1/2002
9/1/2002
1/1/2003
9/1/2003
1/1/2004
1/1/2005
5/1/2006
9/1/2006
5/1/2007
9/1/2007
5/1/2008
5/1/2003
1/1/2006
1/1/2007
1/1/2008
Source: Datastream, Macquarie Research, November 2008
Lends itself to DCF valuation
Although we consider Li & Fungs business model to be unique, its business is predictable as existing clients are unlikely to leave due to the symbiotic relationship and, more importantly, it is scalable given the ability to bolt on new clients. Given Li & Fungs strong cashflows, DCF methodology is a good way to value the company. We have used a WACC of 10.6% with a terminal growth rate of 2% to provide a DCF-based valuation of HK$20.08.
5 November 2008
9/1/2008
5/1/2004
9/1/2004
5/1/2005
9/1/2005
Li & Fung
Fig 15
Discounted cashflow valuation (HK$m)

2008E 4152.3 2009E 4318.3 2010E 5808.4 2011E 6726.6 2012E 6962.0 2013E 7205.7 2014E 7457.9 2015E 7681.6 2016E 7912.0 2017E 8149.4 2018E 8563.6 40,774.2 35,741.5 76,515.6 (3,168.4) 73,347.3 20.08
Year-end 31 Dec Free cashflow NPV of FCF Terminal value Total Value Less Net Debt & Misc Items Firm Value Firm Value per Share
Fig 16
0.5% 1.0% 1.5% 2.0% 2.5% 3.0%
DCF based fair value per share sensitivity table

9.5% 21.0 21.7 22.4 23.2 24.2 25.3 10.0% 19.8 20.4 21.0 21.7 22.5 23.4 10.5% 18.7 19.2 19.7 20.3 21.0 21.8 10.6% 18.5 19.0 19.5 20.1 20.7 21.5 11.0% 17.7 18.1 18.6 19.1 19.7 20.4 11.5% 16.8 17.2 17.6 18.1 18.6 19.1 12.0% 16.0 16.4 16.7 17.1 17.5 18.0
There are no direct comparables of the company; however, we have set out a textile apparel supply chain valuation matrix below for your reference.
Fig 17 Apparel and textile supply chain

Prices as of 31/10/2008 Name Supply chain management Li & Fung Ltd Mainly textile Weiqiao Textile Co Ltd-H Alok Industries Ltd Average (mkt cap weighted) Mainly garment Shenzhou International Group Top Form International Ltd. Arvind Mills Ltd Average (mkt cap weighted) Silk garment China Ting Group Hldgs Ltd Himatsingka Seide Limited Average (mkt cap weighted) Ticker Latest Yr End PER Yield P/BV EPS Growth PEG EV/EBITDA Net Margin ROE Price M.Cap FY07 FY08 FY09 FY08 FY08 FY08 FY09 FY09 FY08 FY09 FY08 FY09 FY08 FY09 Curr. (Local) (US$M) (x) (x) (x) (%) (x) (%) (%) (X) (X) (X) (%) (%) (%) (%)
494 HK 2698 HK ALOK IN
12/2007 HKD 12/2007 HKD 03/2008 INR
15.20 1.56 16.45
7,127 240 66 306 173 29 63 266 160 61 221 616 235 105 956 3,263 59 3,321 100
17.2 16.0 13.7 6.7 5.9 6.5 2.7 5.0 3.2
4.9
3.9
7.5 17.1
0.8 0.1 0.2 0.1 0.5 0.0 0.3 0.2
13.4 10.9 15.1 9.4 10.1 nmf 14.0 9.4 3.5 3.4 nmf nmf 3.1 2.7 3.4 3.2
3.0 3.4 9.2 4.6 11.8 4.2 0.8 8.4
3.3 27.8 4.0 5.7 7.2 16.2 4.7 7.9 12.3 20.7 7.3 10.5 1.0 1.1 9.0 14.9 16.3 15.8 5.0 (4.4) 13.2 10.2 9.7 26.2 6.7 14.1 1.2 0.5 8.0 20.4 8.4 18.0 4.6 7.2 8.3 17.8 1.1 0.3
27.0 7.5 12.2 8.5 18.1 nmf 1.5 13.6 18.9 nmf 18.9 25.8 15.4 1.7 20.6 15.6 9.7 15.5 0.8
2.2 11.3 1.3 2.1 2.0 9.3
0.1 (67.6) 23.8 0.7 17.4 7.9 0.3 (49.4) 20.4 0.5 24.2 4.9 1.1 (56.5) 103.7 0.2 (22.9) 32.8 0.5 4.2 22.3 0.6 (21.8) 1.0 nmf 0.7 (21.8) 4.1 nmf 4.1
2313 HK 12/2007 HKD 333 HK 06/2008 HKD ARVND IN 03/2008 INR
1.08 0.21 14.20
9.9 2.3 2.2 17.3 10.6 10.2 1.9 2.7 10.7 13.9 10.5 1.2 10.2 5.9 4.1 11.9 9.1 21.3 12.4 3.5 3.3 17.7 nmf 10.5 0.0 3.5 5.3 12.8
3398 HK HSS IN
12/2007 HKD 03/2008 INR
0.59 30.55
0.8 4.2 nmf 174.7 1.3 51.3 0.4 0.3 0.1 0.2 nmf 0.1 9.8 6.1 1.3 9.3 5.2 9.4 3.4 9.3
3.9 16.4 9.6 (10.5) 5.5 9.0 4.6 1.1 9.4 4.3 8.6 2.8 8.5 9.6 6.4 0.4 7.8 9.4 3.8 9.3 1.9
Integrate garment with retail business Texwinca Holdings Ltd 321 HK Glorious Sun Enterprises 393 HK Raymond Ltd RW IN Average (mkt cap weighted) Footwear OEM Yue Yuen Industrial Hldg Kingmaker Footwear Hldgs Ltd Average (mkt cap weighted) Textile machinery Fong'S Industries Co Ltd
03/2008 HKD 12/2007 HKD 03/2008 INR
3.60 1.72 84.10
11.2 8.0 4.6 7.7 7.2 6.2 5.4 11.0 4.9 69.9 21.5 3.6 9.5 14.3 6.6 8.1 13.9 7.5 17.1 12.6 13.9 7.5 7.5 6.4 7.4 6.3 3.6 6.3 1.4
1.9 48.2 11.9 0.9 15.5 15.7 0.3 (93.0) 225.4 1.5 24.7 36.2 1.2 0.9 1.2 21.8 0.0 49.2 42.9 22.2 0.8
551 HK 1170 HK
09/2007 HKD 03/2008 HKD
15.20 0.70
641 HK
12/2007 HKD
1.40
9.6 20.6 28.0
0.7 (86.2) (26.5) (1.1)
20.8 19.3
Note: Source: Bloomberg, Macquarie Research, November 2008
5 November 2008
10
Li & Fung
Risks
U.S. business concentration Li & Fungs dependence on US customers exposes it to the risks associated with a slowdown in the US economy. While over the long term the company may actually benefit from a pickup in outsourcing, short-term order flow and sentiment may be negatively affected.
Fig 18
Confidence Index and historical share price

HK$ 40 35 30 25 20 15 10 5 0 Jul-01 Jul-02 Jul-03 Jul-04 Jul-05 Jul-06 Jul-07 Jul-08
Confidence Index 160 140 120 100 80 60 40 20 0 Jul-00
Source: Bloomberg, CEIC, Macquarie Research, November 2008
Growth dependent on continued dealmaking Margins may not improve
We believe the market in the future will continue to pay a premium for Li & Fungs ability to acquire new companies to boost growth. Should the company fail to make acquisitions, however, this premium could diminish. We have factored in margin improvement for Li & Fung for the forecast years, on the basis of increased economies of scale and higher margins for the companys US onshore business. However, should Li & Fung fail to grow its total revenue and, in particular, its US onshore revenue, margins would likely fail to improve. The inability to either diversify its customer base or expand its market share with current customers would also have a negative impact on revenue growth. The company is in dispute with Hong Kongs Inland Revenue Department over HK$1,288m (excluding potential interest expenses) in an additional assessed tax to be levied by the tax office for the periods 1992/93 to 2006/07. The dispute remains unresolved. Currently, Li & Fung is roughly 35% held by the Fung family of Hong Kong. This is a minority holding and it is possible that a third party could gain control of the company. However, we believe the scenario is highly unlikely, given that Li & Fungs is a relationship business and a peoples business, making a takeover of the company without the Fung family support unviable. Politically motivated restrictive global trade practices may be negative for Li & Fungs business.
Hong Kong tax dispute Minority ownership control
Clampdown on global trade
5 November 2008
11
Li & Fung
Beneficiary of outsourcing
Retailer inventory levels down
Li & Fung ensures delivery on time Modern retailers have slashed lead times significantly; in some late orders, lead times have dropped to just four to six weeks. Inventory levels are dropping, resulting in improved margins. Li & Fung, with its design-to-delivery model, has been a beneficiary of this trend given its ability to ensure goods are in stores on time. We believe that the rise in inventory levels in 2007 was driven by retailers that were probably caught unawares at the beginning of the current financial crises. In 2008, we believe there will be a strong emphasis on reducing inventory again.
Fig 19
US retailers inventory-to-sales ratio
Inventory to Sales Ratio 2.6 2.5 2.4 2.3 2.2 2.1 2.0 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
Source: CEIC, Macquarie Research, November 2008
Proliferation of styles
Fashion label Zara creates 10,000 designs a year Another fact of modern retailing that needs to be addressed is the growth in product proliferation. For example, a US retailers classic pinpoint oxford dress shirt, made of 80s twoply cotton and available in seven colours, seems, on the face of it, to be quite a simple item to order. However, if we add in different neck sizes and sleeve lengths, plus an option on 13 collar types, three pocket types, seven cuffs, two pleats and two cuts (traditional and tailored), you would end up with over 1,000 combinations available to the consumer for the basic shirt in a range of sizes. This is an example from a Lands End catalogue and the supplier for this item would need to supply any of the options at very short notice. We estimate that a company such as Zara creates 10,000 new designs each year, none of which stays in a store for more than one month. This means the company needs to be able to drop a line that is not doing well or, if a line proves popular, it needs suppliers to ramp up production very quickly.
Room for both China and Mexico

Some late orders are filled by neighbouring countries Evidence suggests that the lead times for delivery from Mexico to the US can range between four and nine weeks, while those from China can range from seven to 16 weeks. Sourcing from China implies risks related to weather and the ports, the risks to both of which are reduced if the goods are sourced from just over the US border from Mexico. Delivery times can be reduced if products are transported by air, although the costs would obviously be much higher.
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Li & Fung
Fig 20
US apparel imports by country, 2000
Fig 21
US apparel imports by country, 2007
Others Pakistan 17% Turkey 2% 2% Macau 2% Italy Sri Lanka 2% (Ceylon) 3% Guatemala 3% El Salvador 3% Canada India 3% 3% Thailand Indonesia 3% Philippines 4% 3%
Mexico 15%
Canada 1% China 8%
Macau Taiwan Others 1% 12% 1% China 31%
Jordan Dominican 2% Italy Republic 2% 1% Pakistan El Salvador 2% 2% Guatemala Sri Lanka 2% (Ceylon) Thailand 2% 2% Philippines Cambodia 2% 3% Hong Kong 3% Honduras 3% Bangladesh 4%
Hong Kong 8% Dominican Republic 4% Honduras 4% Korea, South 4% Taiwan Bangladesh 4% 4%
Mexico 6% Indonesia Vietnam 5% India 6% 4%
Source: OTEXA, Macquarie Research, November 2008
Although since the 2005 textile deregulation, the Asian countries have become dominant suppliers, the closer proximity and the need for quick replenishment of orders implies that there will always be a role for suppliers in countries such as Mexico and Turkey. Each country has their own advantages and disadvantages, and Li & Fungs role is to sort through the myriad factors (some of which are listed in Figure 22) to enable a client to get the best possible price. It sources approximately 48% of its goods from China on behalf of its customers, the balance being sourced from the rest of the world. To give a rough size of the magnitude of its business, it shipped approximately 1.3bn pieces of goods in 1H 2008.
Fig 22
Global sourcing assessing a countrys competitiveness

Labour and management Availability of workers and competition for workers from other sectors Compensation rates Labour skills and productivity Availability of qualified managers, including middle management Raw-material inputs Access to quality and cost-competitive domestic or regional yarn and fabric production Tariffs on imports of raw materials Rules of origin for trade preferences Cost and availability of capital to invest in new machinery and purchase raw materials Suppliers level of service and reliability Reputation for quality and on-time delivery Existing business networks (supply chain linkages, relationship with customers) Level of service provided, eg, full package assembly Flexibility and variety in styles or products and lot sizes offered Lead time and flexibility to respond to quick turnaround orders
Business climate Political stability Safety of personnel Security of production and shipping Transparent and predictable legal, commercial and regulatory system Minimal administrative burden and corruption Compliance with internationally recognised health and labour standards Subsidies and tax credits Free trade zones Real exchange rates Market demand and economic growth
Infrastructure and proximity to markets Roads, ports, rail and airports for moving goods into and out of the country Shipping and other transportation times and costs Proximity to major markets Access to reliable sources of energy, water and telecommunications
Market access Preferential access in major markets Source: U.S. International Trade Commission, Macquarie Research, November 2008
Li & Fung has buying power
A few years ago, larger retailers such as Karstadtquelle used to look down upon agency businesses such as Li & Fungs as their own in-house sourcing operations used to be substantial compared with Li & Fungs sourcing volumes. But with Li & Fung nearly doubling its sourcing volumes in the past three years (by our estimates), even the larger retailers are beginning to call upon Li & Fungs expertise. Despite the rapid growth in Li & Fungs client base over the past decade, we see scope for the company to continue to secure new clients.
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Li & Fung
A one-stop shop
Li & Fung is the largest sourcing company of its kind in the world. Essentially, there are no barriers to entry in this industry. However, Li & Fung remains the obvious candidate for international retailers seeking to outsource their supply chain management function because of its sheer size, economies of scale and better sourcing reach. The company provides crucial support to its customers through product design, raw materials sourcing, production management, quality control, logistics and shipping. Li & Fung has developed its own proprietary order management system, XTS, running on an Oracle database platform. This is accessible in each of its offices worldwide and is also interlinked with customers own systems. This provides the company with the ability to track and update the status of orders continually.
A key player in overall US market

We estimate that Li & Fung has nearly 12% share of all apparel imports into the US To gauge Li & Fungs potential, we look at the size of its US apparel business vis--vis total US apparel imports. Based on our analysis in Figure 23, although Li & Fung has continually gained market share in the US, to an estimated 12% in 2008, potential for further market share gains remains.
Fig 23
Li & Fungs estimated US apparel market share

2004 64,768 5.9% 31,461 4,033 10.8% 2005 68,713 6.1% 38,080 4,882 21.0% 69.10% 3,374 5,060 7.4% 2006 71,630 4.2% 46,215 5,925 21.4% 72.0% 4,266 6,399 8.9% 2007 73,922 3.20% 63,867 8,188 38.2% 64.80% 5,306 7,959 10.8% 2008E 75,770 2.50% 77,335 9,940 21.3% 60.00% 5,965 8,946 11.8%
US Apparel Imports US Apparel Imports Total (US$m) YoY % Change Li & Fung Softgood Turnover (HK$m) Li & Fung Softgood Turnover (US$m) YoY % Change
Assume % Li & Fung Softgood turnover Attributable 68.06% to the US Market Est. Li & Fung US Softgood Turnover (FOB) 2,745 Est. Li & Fung US Softgood Turnover (CIF = 1.5x FOB) 4,118 Est. Li & Fung US Softgood Market Share 6.4%
Li & Fungs market share of the US hardgoods business is low, we estimate, as is its share of the European hardgoods business, offering more potential for growth. Another way to look at the potential is to review a recent study by Deloitte Touche Tomatsu (Source: deloitte.com), which states that the worlds top-250 retailers generated total sales of about US$3.25tr in 2006. Assuming the free-on-board export sales value is 15% of this total, this translates to a potential market for Li & Fung of about US$490bn. Li & Fungs total sales figure of US$8.7bn in 2006 equates to just 2.7% of this potential market, further demonstrating that significant upside potential exists. We believe the company has the ability to continue to increase market share.
Key advantages
With its ability to improve supply chain efficiency, the company becomes an integral player for some retailers. This has enabled Li & Fung to develop long-standing symbiotic relationships that are difficult to dislodge. Li & Fungs key advantages can be summarised as follows: Experienced people A key advantage is its people and extensive network. The company has experienced teams managing complex relationships with different types of retailers. A simple example is managing luxury retailers vis--vis fashion brands. On the one hand, luxury brands are less price sensitive and more quality conscious, therefore they would prefer to source from countries that have an established track record for producing premium-quality products (eg Italy), or they use a sourcing company to ensure that quality control standards are maintained and that the factory will not engage in counterfeiting. On the other hand, fashion brand retailers are very price conscious and in the business of lean retailing, and therefore the sourcing company needs to be able to manage the expectations of different types of retailers efficiently.
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Li & Fung
Manages the full supply chain
Li & Fung possesses the ability to manage the whole supply chain (ie, from designing and sourcing the fabric to delivery of the final product). In design and development, Li & Fung has more than 250 dedicated staff available to assist customers, taking a design concept through to a prototype product. Li & Fung can source globally, especially at short notice. Currencies can fluctuate very quickly, as the recent appreciation of the renminbi demonstrates, meaning that sourcing from China has become costly and retailers are probably seeking alternate sources. A manufacturer would have limited flexibility to manage the process and, with a limited number of production bases in any one country, would find it difficult to compete with sourcing companies such as Li & Fung.
Provides flexibility
Continues to gain outsourcing deals

The most recent deals are sizeable, including the 2007 Tommy Hilfiger outsourcing deal, which adds roughly US$600m to top-line revenue. Li & Fung is supplying not only Tommy Hilfiger apparel in Europe and the US but also the rest of the world. M&A also helps in gaining share Amongst other companies, in 2007, Li & Fung bought CGroup (with an annual revenue base of over US$100m) in the Health Beauty and Cosmetics (HBC) area. This gave the company a base in the HBC area on which it has built further acquisitions. In 2008, it has made three other acquisitions in this segment: CDP Asia, Imagine and RT Sourcing. CDP Asia does all the display cabinets for the cosmetic companies. Imagine is a company that does all the point-of-sale displays for cosmetic companies. RT Sourcing specialises in primary packaging, ie, bottles and containers for beauty customers around the region. The latter had over US$300m in turnover in 2007. Li & Fung also acquired Peter Black International, giving it major access to Marks & Spencer in the UK. This should add roughly US$350m to Li & Fungs turnover. It also took over the outsourcing operations of Helly Hansen, a well-known name in skiwear. More recent deals include Sanrio (Hello Kitty) and Timberland apparel In 2008, the company announced that it has begun sourcing for Sanrio and that it has taken over the buying offices of Timberland. Li & Fung is now doing the sourcing for the Hello Kitty label business for Sanrio. For Timberland, it will be doing all the outsourcing for the apparel segment of the business. The ability to expand the core agency outsourcing despite their large size shows that retailers remain under pressure to outsource, and we believe Li & Fung continues to be in good position to be able to offer them value-for-money service. In addition, smaller rivals are finding that it is advantageous to be absorbed/acquired by Li & Fung as they are able to take advantage of a broader sourcing network for their clients.
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Li & Fung

Better margins
Relatively brand new and profitable The onshore model allows the company to diversify away from the core business. Longer term, it should provide the company with enhanced margins, which we estimate at double those of the core business in a few years. This diversification is the basis for the company to be able to achieve its US$1bn operating profit target for the current three-year plan.
Fig 24
7.0% 6.0% 5.0% 4.0% 3.0% 2.0% 1.0% 0.0%
Growing operating margin for onshore business
-1.0% 2004
2005
2006
2007
2008E
2009E
Operating margin for onshore business
Entered the business in 2005

Initially bought licences for bed and bath furnishings brands Li & Fungs move into the branded business began with the acquisition of the licences of the Royal Velvet and Cannon brands from Official Pillowtex for bed and bath furnishings. Royal Velvet was introduced into Kohls stores in early 2005, followed by rollout in Sears Canada, Belk Stores, Gottschalks and Mervyns. Official Pillowtex is working with Li & Fung on brand management and the main priority is to provide a wide selection of products on a sliding price scale. Li & Fungs representatives stated in a September 2005 press conference: Our thinking is that with Cannon, Cannon Royal Family and Royal Velvet, we present retailers with a good-better-best scenario. The key is for the company to gain expanded shelf-space. At about the same time, Li & Fung introduced licensed Levis Signature brand apparel in the US via mass-market retailers such as Wal-Mart and Target. Subsequently, in 2005, Li & Fung followed with the launch of Levis RedTab tops in the US. In 2005, to further boost its presence in the US onshore business segment, Li & Fung acquired Young Stuff Apparel. This is a private label supplier to mass-market retailers such as Wal-Mart and Target in the plus-size apparel category. Also in 2005, Li & Fung bought Briefly Stated Inc., which licenses brands from Disney, Nickelodeon and Warner Bros., and sells branded merchandise (sleepwear and underwear) through retailers such as Wal-Mart, K-Mart, JC Penney, Sears and Target. In 2006, the company acquired Rosetti Handbags and Accessories Ltd.s handbag business, which sells womens handbags, purses and accessories for its own brand, as well as licensed and private label for US retailers including department stores, mass-merchants and specialty stores. Rosettis business comprises the design and arrangements for the manufacture, import, marketing and sale of womens handbags, purses and related accessories (with turnover of over US$200m). Rosettis main customers include Wal-Mart, Kohls, Federated, JC Penney and Nordstrom. Supplies Wal-Marts George line Also in 2006, Li & Fung acquired Oxford Womenswear Group, which sells budget and moderately priced private-label womens apparel collections in the US. These are sold mainly via mass-market retailers, including Target and Wal-Mart, eg, Wal-Marts George line could add over US$250m in turnover.
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Then introduced the Levis Signature brand for tops
5 November 2008
Li & Fung
In late 2006, Li & Fung acquired Homestead from London Fog Group. The Homestead team will augment Li & Fungs effort with the Cannon and Royal Velvet brands. Homestead has been in the business of home fashion for several years, creating home brands such as Collier Campbell for Kohls, Toscana by Nancy Koltes for Federated and MaryJanesFarm for Belk. In 2007, it acquired American Marketing Enterprises, which has over US$125m in turnover. This company owns over 40 licenses in the kids segment and markets its portfolio to leading US retailers such as Wal-Mart, Target and Kohls department stores. We believe that this could make Li & Fung a leading player in the childrens sleepwear business. The more-notable acquisition in 2007 was that of Regatta (with revenue in excess of US$300m). The company has a number of proprietary brands in the US including the Vera Wang label for Kohls. More recently bought the Van Zeeland business More recently in 2008, it announced a major acquisition in this segment a handbag company called Van Zeeland (with revenue in excess of US$200m). Its clients are primarily US-based department stores (eg, Macys, JC Penney). The company owns brands but it operates more like private labels for department stores. Labels include Kathy Van Zeeland, B. Makowsky and Tignanello. This acquisition would complement that of Rosetti acquired a couple of years earlier whose key client base is in the lower to mid-end department stores.
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Li & Fung
Financial strength
Consistent above-average performance
Few companies globally with comparable track record There are not very many companies that are able to demonstrate nearly 20% CAGR in revenue and earnings for more than a decade. This is one of the main reasons why Li & Fung consistently attracts a management premium (apart from being a leader in its industry and also being in the right segment of the global supply chain at the right time). Although our forecasts our conservative going forward, given the larger base already achieved, we do expect the stock to maintain its management premium going forward.
Fig 25
Turnover CAGR
HK$ m 120,000 100,000 80,000 CAGR 23.3% 60,000 40,000 20,000 FY93 FY94 FY96 FY97 FY99 FY00 FY02 FY03 FY04 FY06 FY07 FY07 FY98 FY01 FY05 FY08E FY08E FY92 FY95
Revenue and profits have generally grown in line
Fig 26
HK$ m 4,000 3,500 3,000 2,500 2,000 1,500 1,000 500 -
Net profit CAGR
CAGR 22.5%
FY92
FY93
FY94
FY96
FY97
FY98
FY99
FY00
FY01
FY02
FY03
FY05
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FY06
FY95
FY04
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Li & Fung
Fig 27 EPS CAGR

HK$ 1.0 0.9 0.8 0.7 0.6 0.5 0.4 0.3 0.2 0.1 0.0 FY95 FY00 FY05 FY92 FY94 FY96 FY97 FY99 FY01 FY02 FY04 FY06 FY07 3.30% FY08E FY08E FY93 FY98 FY03 CAGR 18.8%
Margin improvement has been masked by ongoing acquisitions
As can be seen below, the company has achieved gradual margin improvement in the recent past, and we think that, with the companys emphasis on value-added businesses, margins will continue to improve.
Fig 28 Margin history

12% 11% 10% 9% 8% 7% 6% 5% 4% 3% 3.18% 2% FY98 FY99 2.90% 9.93% 9.73% 8.81%
10.60%
FY00
FY01
FY02
FY03
FY04
FY05
FY06
FY07
Gross Margin
Operating Margin
Net Margin
Fig 29
HK$m
Li & Fung margin analysis

FY03 42,631 3,777 166 1,286 1,223 8.86% 3.02% 2.87% FY04 47,171 4,323 223 1,293 1,491 9.16% 2.74% 3.16% FY05 55,617 5,661 264 1,853 1,790 10.18% 3.33% 3.22% FY06 68,010 7,335 312 2,302 2,202 10.79% 3.38% 3.24% FY07 92,460 9,768 518 3,118 3,060 10.6% 3.37% 3.3% FY08E 113,629 13,381 622 4,099 3,416 11.8% 3.61% 3.0%
Revenue Gross Profit Other Income Operating Profit Reported Net Profit Gross Margin Operating Margin Reported Net Margin
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Li & Fung
Real profitability picture
Li & Fungs net margins look slim, but this is because the company treats the goods being shipped as the revenue line. However, if we rework the profit and loss account to treat the commission and fees that Li & Fung receives as the real revenue for the company, it would be immediately apparent how profitable the business is. The reasoning behind this is that Li & Fungs core business is the agency business, ie, the company does not take title of the goods, the title remains with the retailer. The actual agreement is for the factory to ship the goods to the retailer and Li & Fung ensures that this occurs. Converted into real profitability, the margins would appear as follows, based on our analysis
Fig 30 Li & Fungs real profitability

HK$m Gross Profit + Other Income Operating Profit Reported Net Profit Adjusted Operating Margin Adjusted Reported Net Margin FY03 3,943 1,286 1,223 32.4% 31.0% FY04 4,546 1,293 1,491 28.4% 32.8% FY05 5,925 1,853 1,790 31.3% 30.2% FY06 7,647 2,302 2,202 30.1% 28.8% FY07 10,286 3,118 3,060 30.3% 29.7% FY08E 14,003 4,099 3,416 29.3% 24.3%
Moreover, although Li & Fung has expanded into the US onshore business segment, our analysis of real profitability would not be materially affected because the company mostly places back-to-back orders and sourcing to mitigate against any risks. This real net margin is likely to be the envy of any business. Although Li & Fungs margins appear to be on the decline over the past couple of years, this is due to the acquisition of lowmargin businesses, the company spending more to build up its back-office infrastructure to cope with a larger revenue base, and a larger US onshore business. Looking ahead, we can expect margins to improve as the company gains further economies of scale in its onshore business plus improves on the margins of the acquired businesses.
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Li & Fung
Li & Fung (494 HK, Outperform, Target price: HK$20.00)

Interim Results Revenue Gross Profit Cost of Goods Sold EBITDA Depreciation Amortisation of Goodwill Other Amortisation EBIT Net Interest Income Associates Exceptionals Forex Gains / Losses Other Pre-Tax Income Pre-Tax Profit Tax Expense Net Profit Minority Interests Reported Earnings Adjusted Earnings EPS (rep) EPS (adj) EPS Growth yoy (adj) m m m m m m m m m m m m m m m m m m m 1H/08A 47,393 5,287 42,107 1,755 117 0 106 1,532 -195 11 6 0 0 1,354 -116 1,238 -0 1,238 1,232 0.35 0.35 12.4 2H/08E 66,236 8,095 58,141 2,790 117 0 106 2,567 -147 2 0 0 0 2,421 -243 2,179 -1 2,178 2,178 0.60 0.60 31.9 1H/09E 52,883 6,237 46,646 2,197 135 0 106 1,956 -214 11 0 0 0 1,752 -183 1,569 -0 1,569 1,569 0.42 0.42 22.5 2H/09E 73,908 9,499 64,409 3,416 135 0 106 3,175 -214 2 0 0 0 2,963 -383 2,580 -1 2,579 2,579 0.68 0.68 14.4 Profit & Loss Revenue Gross Profit Cost of Goods Sold EBITDA Depreciation Amortisation of Goodwill Other Amortisation EBIT Net Interest Income Associates Exceptionals Forex Gains / Losses Other Pre-Tax Income Pre-Tax Profit Tax Expense Net Profit Minority Interests Reported Earnings Adjusted Earnings EPS (rep) EPS (adj) EPS Growth (adj) PE (rep) PE (adj) Total DPS Total Div Yield Weighted Average Shares Period End Shares m m m m m m m m m m m m m m m m m m m 2007A 92,460 9,768 82,693 3,542 198 0 226 3,118 -222 5 413 0 0 3,314 -253 3,061 -1 3,060 2,647 0.88 0.76 21.0 17.2 20.0 0.71 4.7 3,472 3,528 2008E 113,629 13,381 100,248 4,546 235 0 212 4,099 -342 12 6 0 0 3,775 -359 3,417 -1 3,416 3,410 0.95 0.94 24.0 16.0 16.1 0.75 4.9 3,605 3,779 2009E 126,792 15,736 111,056 5,613 270 0 213 5,131 -428 13 0 0 0 4,715 -566 4,149 -1 4,149 4,149 1.11 1.11 17.4 13.7 13.7 0.91 6.0 3,740 3,785 2010E 135,620 17,210 118,411 6,491 297 0 213 5,980 -307 13 0 0 0 5,686 -739 4,947 -1 4,946 4,946 1.31 1.31 18.0 11.6 11.6 1.08 7.1 3,788 3,791
% x x
EBITDA Margin EBIT Margin Earnings Split Revenue Growth EBIT Growth Profit and Loss Ratios Revenue Growth EBITDA Growth EBIT Growth Gross Profit Margin EBITDA Margin EBIT Margin Net Profit Margin Payout Ratio EV/EBITDA EV/EBIT Balance Sheet Ratios ROE ROA ROIC Net Debt/Equity Interest Cover Price/Book Book Value per Share
% % % % %
3.7 3.2 36.1 25.5 29.9 2007A
4.2 3.9 63.9 21.1 32.4 2008E 22.9 28.3 31.5 11.8 4.0 3.6 3.0 79.3 13.4 14.9
4.2 3.7 37.8 11.6 27.6 2009E 11.6 23.5 25.2 12.4 4.4 4.0 3.3 81.9 10.9 11.9
4.6 4.3 62.2 11.6 23.7 2010E 7.0 15.6 16.6 12.7 4.8 4.4 3.6 82.6 9.4 10.2
% m m
Cashflow Analysis EBITDA Tax Paid Chgs in Working Cap Net Interest Paid Other Operating Cashflow Acquisitions Capex Asset Sales Other Investing Cashflow Dividend (Ordinary) Equity Raised Debt Movements Other Financing Cashflow Net Chg in Cash/Debt m m m m m m m m m m m m m m m m m
2007A 3,542 -193 664 -291 -133 3,589 -4,933 -320 0 227 -5,026 -2,771 275 1,126 710 -660 -2,017
2008E 4,546 -233 374 -342 -210 4,135 -3,808 -415 0 165 -4,058 -3,390 3,879 0 832 1,321 1,398
2009E 5,613 -410 -456 -428 -94 4,225 -2,039 -273 0 49 -2,263 -3,830 162 0 973 -2,695 -733
2010E 6,491 -573 330 -307 -94 5,847 -1,981 -273 0 50 -2,204 -4,645 162 0 1,160 -3,323 319
% % % % % % % % x x
36.0 35.2 35.4 10.6 3.8 3.4 3.3 93.7 16.5 18.7
% % % % x x
29.1 11.6 36.6 46.3 14.0 5.4 2.8
27.8 11.3 25.7 21.7 12.0 3.9 3.9
27.0 12.1 25.4 24.3 12.0 3.6 4.2
29.3 13.2 26.1 20.3 19.5 3.3 4.7
Balance Sheet Cash Receivables Inventories Investments Fixed Assets Intangibles Other Assets Total Assets Payables Short Term Debt Long Term Debt Provisions Other Liabilities Total Liabilities Shareholders' Funds Minority Interests Other Total S/H Equity Total Liab & S/H Funds All figures in HKD unless noted. Source: Company data, Macquarie Research, November 2008 m m m m m m m m m m m m m m m m m m m
2007A 1,472 13,716 2,060 0 1,133 0 13,409 31,789 11,231 975 5,064 0 4,655 21,925 9,895 -31 0 9,864 31,789
2008E 2,870 16,604 2,531 0 1,292 0 17,464 40,761 13,615 975 5,064 0 6,506 26,161 14,632 -31 0 14,601 40,761
2009E 2,138 18,064 2,824 0 1,274 0 19,511 43,811 15,083 975 5,064 0 6,633 27,756 16,085 -30 0 16,055 43,811
2010E 2,457 18,356 3,021 0 1,229 0 21,401 46,464 16,082 975 5,064 0 6,665 28,786 17,708 -30 0 17,678 46,464
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Li & Fung
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Macquarie Research Equities - Report Important disclosures:

Recommendation definitions
Macquarie - Australia/New Zealand Outperform return >5% in excess of benchmark return (>2.5% in excess for listed property trusts) Neutral return within 5% of benchmark return (within 2.5% for listed property trusts) Underperform return >5% below benchmark return (>2.5% below for listed property trusts) Macquarie Asia/Europe Outperform expected return >+10% Neutral expected return from -10% to +10% Underperform expected return <-10% Macquarie First South - South Africa Outperform expected return >+10% Neutral expected return from -10% to +10% Underperform expected return <-10% Macquarie Canada Outperform return >5% in excess of benchmark return Neutral return within 5% of benchmark return Underperform return >5% below benchmark return Macquarie USA Outperform (Buy) return >5% in excess of benchmark return Neutral (Hold) return within 5% of benchmark return Underperform (Sell) return >5% below benchmark return Recommendations 12 months Note: Quant recommendations may differ from Fundamental Analyst recommendations
Li & Fung
Volatility index definition*
This is calculated from the volatility of historic price movements.
Very highhighest risk Stock should be expected to move up or down 60100% in a year investors should be aware this stock is highly speculative. High stock should be expected to move up or down at least 4060% in a year investors should be aware this stock could be speculative. Medium stock should be expected to move up or down at least 3040% in a year. Lowmedium stock should be expected to move up or down at least 2530% in a year. Low stock should be expected to move up or down at least 1525% in a year. * Applicable to Australian/NZ stocks only
Financial definitions
All "Adjusted" data items have had the following adjustments made: Added back: goodwill amortisation, provision for catastrophe reserves, IFRS derivatives & hedging, IFRS impairments & IFRS interest expense Excluded: non recurring items, asset revals, property revals, appraisal value uplift, preference dividends & minority interests
EPS = adjusted net profit / efpowa* ROA = adjusted ebit / average total assets ROA Banks/Insurance = adjusted net profit /average total assets ROE = adjusted net profit / average shareholders funds Gross cashflow = adjusted net profit + depreciation *equivalent fully paid ordinary weighted average number of shares
All Reported numbers for Australian/NZ listed stocks are modelled under IFRS (International Financial Reporting Standards).
Recommendation proportions For quarter ending 30 September 2008

Outperform Neutral Underperform
AU/NZ 43.17% 41.37% 15.47% Asia 61.57% 16.43% 22.00% RSA 63.08% 30.77% 6.15% USA 53.60% 37.60% 8.80% CA 71.54% 24.61% 3.85% EUR 43.00% 48.00% 9.00%
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Available to clients on the world wide web at www.macquarie.com/research and through Thomson Financial, FactSet, Reuters and Bloomberg.
5 November 2008
23
Asia Research
Head of Equity Research
Stephen OSullivan (852) 2823 3566 (9122) 6653 3157 (6221) 515 7343 (813) 3512 6050 (822) 3705 8644 (8862) 2734 7521 (65) 6231 2840 (852) 2823 4774 (8621) 2412 9035 (9122) 6653 3053 (6221) 515 7335 (65) 6231 2837 (632) 857 0890 (8862) 2734 7514 (662) 694 7741 (8862) 2734 7512 (9122) 6653 3040 (822) 3705 8670 (603) 2059 8993 (852) 2823 3557 (8621) 2412 9020 (6221) 515 7343 (65) 6231 2830 (852) 3901 1111 (852) 2823 3568 (8621) 2412 9033 (9122) 6653 3042 (6221) 515 7339 (813) 3512 7867 (813) 3512 7392 (822) 3705 8677 (822) 3705 8678 (603) 2059 8982 (632) 857 0899 (8862) 2734 7521 (8621) 2412 9007 (852) 2823 4704 (813) 3512 6058 (813) 3512 7853 (822) 3705 8677 (8862) 2734 7512 (8621) 2412 9006 (9122) 6653 3166 (813) 3512 7432 (813) 3512 7475 (822) 2095 7222 (603) 2059 8993 (662) 694 7753
Insurance
Mark Kellock (Asia) Seshadri Sen (Asia, India) Makarim Salman (Japan) (852) 2823 3567 (9122) 6653 3053 (813) 3512 7421 (852) 2823 3568 (9122) 6653 3049 (603) 2059 8989 (632) 857 0899 (852) 2823 4691 (8862) 2734 7512 (9122) 6653 3040 (822) 3705 8670 (603) 2059 8982 (603) 2059 8993 (65) 6231 2830 (662) 694 7728 (9122) 6653 3052 (813) 3512 7474 (822) 3705 8670 (852) 2823 4731 (852) 2823 3573 (852) 2823 4077 (9122) 6653 3042 (813) 3512 7885 (813) 3512 7433 (65) 6231 2838 (65) 6231 2839 (8862) 2734 7522 (662) 694 7727 (852) 2823 3587 (852) 2823 3562 (9122) 6653 3054 (6221) 515 7338 (813) 3512 7886 (822) 3705 8670 (8862) 2734 7512 (852) 2823 3592 (9122) 6653 3046 (813) 3512 7877 (813) 3512 7880 (813) 3512 7854 (813) 3512 7862 (813) 3512 5984 (822) 3705 8641 (822) 3705 8659 (65) 6231 2835 (8862) 2734 7534 (8862) 2734 7526 (8862) 2734 7516 (8862) 2734 7517 (8862) 2734 7523 (852) 2823 3565 (9122) 6653 3049 (6221) 515 7343 (813) 3512 7875 (603) 2059 8989 (65) 6231 2842
Transport & Infrastructure

Anderson Chow (Asia, China) Jonathan Windham (Asia, China) Tim Bacchus (Asia, China) Wei Sim (China, Hong Kong) Eunsook Kwak (Korea) Sunaina Dhanuka (Malaysia) (852) 2823 4773 (852) 2823 5417 (852) 2823 3586 (852) 2823 3598 (822) 3705 8644 (603) 2059 8993 (852) 2823 4075 (9122) 6653 3157 (6221) 515 7338 (603) 2059 8989 (632) 857 0899 (4420) 7065 2014 (4420) 7065 2013 (4420) 7065 5938 (4420) 7065 2000 (8621) 2412 9008 (8621) 2412 9005 (9122) 6653 3054 (852) 2823 4076 (852) 2823 4636 (65) 6231 2841 (612) 8232 3935 (852) 2823 3570 (813) 3512 7855 (852) 2823 3582 (852) 2823 4735 (612) 8232 6539 (612) 8232 8388 (813) 3512 7560 (852) 2823 3585 (852) 2823 4073 (852) 2823 3564 (852) 2823 3576 (852) 2823 4068 (8621) 2412 9002 (9122) 6653 3053 (6221) 515 7335 (813) 3512 7878 (813) 3512 7850 (822) 3705 8643 (603) 2059 8989 (603) 2059 8982 (632) 857 0899 (65) 6231 2838 (8862) 2734 7516 (662) 694 7741
Automobiles/Auto Parts
Deepak Jain (India) Kenneth Yap (Indonesia) Dan Lucas (Japan) Eunsook Kwak (Korea) Linda Huang (Taiwan) Ismael Pili (Asia) Nick Lord (Asia, China, Hong Kong) Sarah Wu (China) Seshadri Sen (India) Ferry Wong (Indonesia) Chin Seng Tay (Malaysia, Spore) Nadine Javellana (Philippines) Matthew Smith (Taiwan) Alastair Macdonald (Thailand)
Media
Jessie Qian (China, Hong Kong) Shubham Majumder (India) Prem Jearajasingam (Malaysia) Alex Pomento (Philippines)
Utilities
Carol Cao (China, Hong Kong) Deepak Jain (India) Adam Worthington (Indonesia) Prem Jearajasingam (Malaysia) Alex Pomento (Philippines)
Banks and Non-Bank Financials
Oil and Gas

David Johnson (Asia, China) Scott Weaver (Taiwan) Jal Irani (India) Christina Lee (Korea) Edward Ong (Malaysia) Sunaina Dhanuka (Malaysia) Ashwin Sanketh (Singapore) Trevor Buchinski (Thailand)
Commodities
Jim Lennon Adam Rowley Jonathan Butcher Max Layton Bonnie Liu Henry Liu Rakesh Arora
Chemicals/Textiles
Scott Weaver (Taiwan) Jal Irani (India) Christina Lee (Korea) Sunaina Dhanuka (Malaysia)
Pharmaceuticals
Abhishek Singhal (India) Naomi Kumagai (Japan) Christina Lee (Korea)
Property
Matt Nacard (Asia) Eva Lee (China, Hong Kong) Tata Goeyardi (Hong Kong) Unmesh Sharma (India) Chang Han Joo (Japan) Hiroshi Okubo (Japan) Tuck Yin Soong (Singapore) Elaine Cheong (Singapore) Corinne Jian (Taiwan) Patti Tomaitrichitr (Thailand) Andrew Dale (Asia) YeeMan Chin (China) Rakesh Arora (India) Adam Worthington (Indonesia) Polina Diyachkina (Japan) Christina Lee (Korea) Scott Weaver (Taiwan)
Data Services
Andrea Clohessy (Asia)
Conglomerates
Gary Pinge (Asia) Leah Jiang (China) Kenneth Yap (Indonesia) Ashwin Sanketh (Singapore)
Economics
Bill Belchere (Asia) Rajeev Malik (ASEAN, India) Richard Gibbs (Australia) Paul Cavey (China) Richard Jerram (Japan)
Consumer
Mohan Singh (Asia) Jessie Qian (China, Hong Kong) Charles Yan (China) Unmesh Sharma (India) Sarina Lesmina (Indonesia) Duane Sandberg (Japan) Toby Williams (Japan) Heather Kang (Korea) HongSuk Na (Korea) Edward Ong (Malaysia) Alex Pomento (Philippines) Linda Huang (Taiwan)
Quantitative
Martin Emery (Asia) Viking Kwok (Asia) George Platt (Australia) Raelene de Souza (Australia) Tsumugi Akiba (Japan)
Resources / Metals and Mining
Strategy/Country
Tim Rocks (Asia) Daniel McCormack (Asia) Desh Peramunetilleke (Asia) Mahesh Kedia (Asia) Stewart Ferns (Asia) Michael Kurtz (China) Seshadri Sen (India) Ferry Wong (Indonesia) Chris Hunt (Japan) Peter Eadon-Clarke (Japan) Eugene Ha (Korea) Prem Jearajasingam (Malaysia) Edward Ong (Malaysia) Alex Pomento (Philippines) Tuck Yin Soong (ASEAN, Singapore) Daniel Chang (Taiwan) Alastair Macdonald (Thailand)
Technology
Warren Lau (Asia) Kishore Belai (India) Damian Thong (Japan) David Gibson (Japan) George Chang (Japan) Yoshihiro Shimada (Japan) Yukihiro Goto (Japan) Do Hoon Lee (Korea) Michael Bang (Korea) Patrick Yau (Singapore) Andy Kung (Taiwan) Chia-Lin Lu (Taiwan) Daniel Chang (Taiwan) James Chiu (Taiwan) Nicholas Teo (Taiwan)
Emerging Leaders
Jake Lynch (Asia) Hiu-Lui Ko (China) Minoru Tayama (Japan) Robert Burghart (Japan) Heather Kang (Korea) Scott Weaver (Taiwan)
Industrials
Bin Liu (China) Inderjeetsingh Bhatia (India) Christopher Cintavey (Japan) Janet Lewis (Japan) Michael Na (Korea) Sunaina Dhanuka (Malaysia) David Gambrill (Thailand)
Telecoms
Tim Smart (Asia, China) Shubham Majumder (India) Kenneth Yap (Indonesia) Nathan Ramler (Japan) Prem Jearajasingam (Malaysia) Ramakrishna Maruvada (Philippines, Singapore, Thailand)
Find our research at

Macquarie: www.macquarie.com.au/research Thomson: www.thomson.com/financial Reuters: www.knowledge.reuters.com Bloomberg: MAC GO Factset: http://www.factset.com/home.aspx Email macresearch@macquarie.com for access
Sales
Regional Heads of Sales
Peter Slater (Boston) Michelle Paisley (China, Hong Kong) Ulrike Pollak-Tsutsumi (Frankfurt) Thomas Renz (Geneva) Ajay Bhatia (India) Stuart Smythe (India) Chris Gray (Indonesia) K.Y. Nam (Korea) Lena Yong (Malaysia) Gino C Rojas (Philippines) Greg Norton-Kidd (New York) Luke Sullivan (New York) (1 617) 217 2103 (852) 2823 3516 (49) 69 7593 8747 (41) 22 818 7712 (9122) 6653 3200 (9122) 6653 3200 (6221) 515 7304 (822) 3705 8607 (603) 2059 8888 (632) 857 0761 (1 212) 231 2527 (1 212) 231 2507
Regional Heads of Sales contd

Scot Mackie (New York) Sheila Schroeder (San Francisco) Giles Heyring (Singapore) Mark Duncan (Taiwan) Angus Kent (Thailand) Michael Newman (Tokyo) Charles Nelson (UK/Europe) Rob Fabbro (UK/Europe) (1 212) 231 2848 (1 415) 835 1235 (65) 6231 2888 (8862) 2734 7510 (662) 694 7601 (813) 3512 7920 (44) 20 7065 2032 (44) 20 7065 2031 (852) 2823 3528 (65) 6231 2888 (852) 2823 3519
Sales Trading contd

Stuart Goddard (Europe) Brendan Rake (India) Edward Robinson (London) Robert Risman (New York) Isaac Huang (Taiwan) Jon Omori (Tokyo) (44) 20 7065 2033 (9122) 6653 3204 (44) 20 7065 5883 (1 212) 231 2555 (8862) 2734 7582 (813) 3512 7838 (852) 2823 4628 (852) 2823 4688 (852) 2249 3380 (852) 2823 4637 (852) 2823 4736 (852) 2249 3225
Alternative Strategies
Convertibles - Roland Sharman Depository Receipts - Robert Ansell Derivatives - Tim Connolly Futures - Tim Smith Hedge Fund Sales - Darin Lester Structured Products - Andrew Terlich
Sales Trading
Adam Zaki (North Asia) Duncan Rutherford (ASEAN, India) Mona Lee (Hong Kong)
October 08

Mac - 494 - 110508 - 224346 L&F

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HONG KONG

Beneficiary of outsourcing Inside

Key thrust will be the onshore business

Good track record

At historically low valuations

Macquarie Research Equities - Report

HK$m HK$m US$m m

494 HK rel HSI performance, & rec history

Macquarie Research Equities - Report

Excels during macro adversity

FY04 geographic breakdown

FY08E geographic breakdown

Rest of The World 12%

Europe 20% USA 68%

Source: Company data, Macquarie Research, November 2008

Source: Macquarie Research, November 2008

Li & Fung has made inroads in both softgoods and hardgoods

Macquarie Research Equities - Report

FY04 hardgoods/softgoods split

FY08E hardgoods/softgoods split

Source: Company data, Macquarie Research, November 2008

Source: Macquarie Research, November 2008

Key thrust will be the onshore business

Macquarie Research Equities - Report

Building on US onshore strategy

2007: US$1 billion +

Brands Briefly Stated & Licensing, Van Zeeland, AME

Proprietary Brands sold via Wal-mart Kohls Target

Source: Company data, Macquarie Research, November 2008

Good track record implies management premium

Li & Fung three-year plan (199698)

The 2001 actuals were also within plan objectives.

Li & Fung three-year plan (19992001)

Macquarie Research Equities - Report

The 200204 plan performance was mediocre

Li & Fung three-year plan (200204)

Li & Fung three-year plan (200507)

Source: Company data, Macquarie Research, November 2008

Fig 10 Margin improvement

Source: Bloomberg, Macquarie Research, November 2008

Macquarie Research Equities - Report

Whats the real profitability?

Macquarie Research Equities - Report

Valuation, recommendation, risks

Historically, the stock has traded at a premium to the market

L&F forward PER

Hang Seng Index Forward 12 month P/E

L&F Forward 12 month P/E

Source: Datastream, Macquarie Research, November 2008

Generally has traded in a defined PEB trading band

Fig 12 PER historical trading pattern

Source: Bloomberg, Macquarie Research, November 2008

Macquarie Research Equities - Report

Fig 13 P/BV historical trading pattern

Source: Bloomberg, Macquarie Research, November 2008

PEG ratio has been an impressive 1.26 in the past

Average PEG: 1.26

Source: Datastream, Macquarie Research, November 2008

Lends itself to DCF valuation

Macquarie Research Equities - Report

Discounted cashflow valuation (HK$m)

Source: Macquarie Research, November 2008