Li & Fung unit serving Wal-Mart to be profitable in 2012

Li & Fung Ltd.’s supply unit to Wal-Mart Stores Inc. will be profitable this year, the CEO of the largest supplier of clothes and toys to retailers said in an interview.

“The size of the business and profitability of the business is growing and better now than ever,” CEO Bruce Rockowitz said in a telephone interview yesterday (Sept. 20).

The subsidiary broke even in the first half, will make a profit in the second and be “very profitable” in 2013, he said.

An option agreed in 2010 for Wal-Mart to purchase the unit, Direct Sourcing Group Pte., was terminated, according to an amended agreement released to the Hong Kong’s stock exchange on Sept. 20, triggering Li & Fung’s share price to fall 2.6% yesterday, the most since Sept. 4, to HK$12.20.

The supply unit was set up two years ago when the outsourcer’s relationship with Wal-Mart was new, Rockowitz said.

“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.”

Li & Fung’s relationship with Bentonville-based Wal-Mart is “better than ever,” he said.

“We have a good relationship and there are still opportunities for business,” Scott Price, head of Wal-Mart’s Asia operations, said in an interview yesterday.

The termination of the option to buy the Hong Kong company’s unit was part of a new arrangement that supersedes one made in January 2010, which has allowed Li & Fung to act as buying agent for $2 billion of goods from the first year, Rockowitz said.

The new agreement allows for Li & Fung to provide higher-margin design and replenishment services to the world’s largest retailer, the executive 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.

Yesterday’s share-price decline extended the stock’s slide this year to 15%, compared with a 12% climb for the benchmark Hang Seng Index.

The Hong Kong company reported in August first-half core operating profit fell 22% to $221 million as U.S. consumers curb spending amid a slower economy.