Li & Fung Ltd. (494)’s unit supplying Wal-Mart Stores Inc. (WMT:US) will be profitable this year after the world’s largest retailer ended an option to buy the subsidiary, which led the Hong Kong company’s shares to fall last week.
Wal-Mart last week terminated an option agreed to 2010 to purchase Direct Sourcing Group Pte. The Li & Fung unit has been supplying Wal-Mart with at least $2 billion of goods annually, Bruce Rockowitz, chief executive officer of the largest supplier of clothes and toys to retailers said in a Sept. 21 telephone interview.
“The size of the business and profitability of the business is growing, and better now than ever,” Rockowitz said. The subsidiary broke even in the first half, will make a profit in the second and be “very profitable” in 2013, he said.
Direct Sourcing Group was set up two years ago when the outsourcer’s relationship with Wal-Mart was new, Rockowitz said. Li & Fung’s relationship with Bentonville, Arkansas-based Wal- Mart is “better than ever,” he said. The amended agreement released to Hong Kong’s stock exchange on Sept. 20 triggered a 2.6 percent share-price decline, the most in two weeks, the following day.
“They thought they needed a call option -- just in case it doesn’t go well they can buy it back,” Rockowitz said. “They were comfortable after the first year that they don’t need it anymore.
‘‘We have a good relationship and there are still opportunities for business,’’ Scott Price, head of Wal-Mart’s Asia operations, said in a Sept. 21 interview.
Li & Fung’s share-price decline on Sept. 21 extended its slide this year to 15 percent, compared with a 12 percent climb for the benchmark Hang Seng Index. The stock last year slumped 36 percent after more than tripling in the decade through 2010.
The new agreement allows for Li & Fung to provide higher- margin design and replenishment services to the world’s largest retailer, Rockowitz said.
‘‘This is positive not only for revenue streams but also for margins as distribution is traditionally a higher-margin business,” Vineet Sharma, an analyst at Barclays Plc in Hong Kong, said in a note to clients dated Sept. 20.
Li & Fung said it will continue to be a primary supplier for Sam’s Club in the U.S. through Direct Sourcing Group and provide buying-agency services to Wal-Mart’s U.S. operations and in some of its international markets. The accord is for five years with an option for a two-year extension and beyond, with no break-out clause, Rockowitz said.
Rockowitz said a Wall Street Journal report that said Wal- Mart canceled “much of a deal” for Li & Fung to supply its international stores and will move to buy more goods directly from factories was “not true.” The newspaper cited people close the company it didn’t identify.
“Over the last two years, both sides really learned to work with each other,” he said. “What Li & Fung should focus on is to help Wal-Mart.”
The Hong Kong company reported in August first-half core operating profit fell 22 percent to $221 million as U.S. consumers curb spending amid a slower economy.
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