MAC_494_110508_224346 L&F

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.

Li & Fung HONG KONG

5 November 2008

Inside Excels during macro adversity 3 Valuation, recommendation, risks 8 Beneficiary of outsourcing 12 Key thrust will be the onshore business 16 Financial strength 18

Analyst Mohan Singh 852 3901 1111 [email protected]

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 In this weak economic environment, retailers will be looking to outsource more. Li & Fung’s 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 (1997–2000), 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 value-added 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 & Fung’s management works on three-year forward plans for providing on-going 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 three-year 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 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.

This document is being provided for the exclusive use of BENJAMIN WONG at STANDARD CHARTERED BANK (HK) LIMITE

Macquarie Research Equities - Report Li & Fung

5 November 2008 2

494 HK Outperform Stock price as of 04 Nov 08 HK$ 15.20 12-month target HK$ 20.00 Upside/downside % +31.6 Valuation HK$ 20.08 - DCF (WACC 10.1%) GICS sector retailing Market cap HK$m 55,237 30-day avg turnover HK$m 239.3 Market cap US$m 7,127 Number shares on issue m 3,634

Investment fundamentals Year end 31 Dec 2007A 2008E 2009E 2010E Total revenue bn 92.5 113.6 126.8 135.6 EBIT bn 3.1 4.1 5.1 6.0 EBIT Growth % 35.4 31.5 25.2 16.6 Reported profit bn 3.1 3.4 4.1 4.9 Adjusted profit bn 2.6 3.4 4.1 4.9 EPS rep HK$ 0.88 0.95 1.11 1.31 EPS rep growth % 35.4 7.5 17.1 17.7 EPS adj HK$ 0.76 0.94 1.11 1.31 EPS adj growth % 21.0 24.0 17.4 18.0 PE rep x 17.2 16.0 13.7 11.6 PE adj x 20.0 16.1 13.7 11.6 Total DPS HK$ 0.71 0.75 0.91 1.08 Total div yield % 4.7 4.9 6.0 7.1 ROA % 11.6 11.3 12.1 13.2 ROE % 29.1 27.8 27.0 29.3 EV/EBITDA x 16.5 13.4 10.9 9.4 Net debt/equity % 46.3 21.7 24.3 20.3 Price/book x 5.4 3.9 3.6 3.3

494 HK rel HSI performance, & rec history

Source: Datastream, Macquarie Research, November 2008 (all figures in HKD unless noted)

Li & Fung Company profile Li & Fung’s 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 & Fung’s 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 Germany’s Karstadtquelle, US-based Kohl’s and global brand Tommy Hilfiger. Overall, it works with over 1,000 customers worldwide. The percentage of sales attributable to the group’s 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 open-ended 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 company’s 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.

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 & Fung’s acquisition strategy is its ability to ‘plug in’ an acquired company’s system into its own.



5 November 2008 3

Excels during macro adversity Beneficiary of outsourcing 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 retailer’s FOB costs, depending on the agent’s 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 & Fung’s 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

USA68%

Europe20%

Rest of The World12%

USA66%

Europe25%

Rest of The World

9%

Source: Company data, Macquarie Research, November 2008 Source: Macquarie Research, November 2008

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 & Fung’s revenue base in this segment vis-à-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.

Retailers globally trying to reduce

fixed costs

Li & Fung has made inroads in both softgoods and

hardgoods



5 November 2008 4

Fig 3 FY04 hardgoods/softgoods split

Fig 4 FY08E hardgoods/softgoods split

Softgoods67%

Hardgoods33%

Softgoods68%

Hardgoods32%

Source: Company data, Macquarie Research, November 2008 Source: Macquarie Research, November 2008

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-à-vis the market as it gains market share within its current customer base, as well as new outsourcing customers during these slowdowns.

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 company’s 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 & Fung’s strategy, providing a steady income stream. The operating margin in this core segment is roughly 3.25–3.35% on a normalised basis.

Key thrust will be the onshore business 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 & Fung’s US onshore business.

Core business is quite sticky

New thrust provides better margin



5 November 2008 5

Fig 5 Building on US onshore strategy

Source: Company data, Macquarie Research, November 2008

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 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 & Fung’s 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 (1996–98) Plan Target Results

Profit After Tax HK$455m HK$451mSource: Company data, Macquarie Research, November 2008

The 2001 actuals were also within plan objectives.

Fig 7 Li & Fung – three-year plan (1999–2001) Plan Target Results*

Profit After Tax HK$915m HK$951m* Excluding one-time write off of HK$169m for StudioDirect Source: Company data, Macquarie Research, November 2008

2005: US$350m+

2006: US$700m+

2007: US$1 billion +

Brands Briefly Stated & Licensing, Van Zeeland, AME

Private Label Oxford Ralsey Young Stuff/ISG Rosetti

US Retailers

Proprietary Brands sold via Wal-mart Kohl’s Target

Sets three-year goals with the

current one being aggressive given

current market turmoil



5 November 2008 6

Given the negative multiple negative macro conditions prevailing during the 2002–04 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 Li & Fung – three-year plan (2002–04) Revised Plan Results

EBIT margin 4.00% 3.23%Turnover growth 15% pa 12.7% paTurnover US$6.4bn US$6.0bnProfit After Tax HK$1,564m HK$1,491mSource: 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 Li & Fung – three-year plan (2005–07) Plan Target Results

Turnover US$10.0b US$11.9bSource: Company data, Macquarie Research, November 2008

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 & Fung’s plan objectives.

Fig 10 Margin improvement

9.93%9.73%

8.81%

10.60%

3.18%

2.90% 3.30%

2%3%4%5%6%7%8%9%

10%11%12%

FY98 FY99 FY00 FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08E

Gross Margin Operating Margin Net Margin

Source: Bloomberg, Macquarie Research, November 2008

The 2002–04 plan performance was

mediocre

Li & Fung is aiming for US$20b in

revenue and US$1bn in operating

profit under the current plan



5 November 2008 7

We would like to point out one key aspect of our analysis of Li & Fung’s 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 & Fung’s ‘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 & Fung’s 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 management’s ability to continuously add value. We expect this to continue.

Valuation 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 75–80% 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 company’s 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.

What’s the real profitability?

We set a target price of HK$20.00



5 November 2008 8

Valuation, recommendation, risks 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 & Fung’s 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.

Fig 11 L&F – forward PER

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Source: Datastream, Macquarie Research, November 2008

Figures 12 and 13 illustrate our estimated forward PER and P/BV multiple bands for Li & Fung. As shown in these figures, historically, the company’s 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 & Fung’s 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

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PEG and DCF are preferred valuation

methods

Historically, the stock has traded at

a premium to the market

Generally has traded in a defined PEB trading band



5 November 2008 9

Fig 13 P/BV historical trading pattern

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Li & Fung 5.0 6.5 8.0 9.5

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When considering valuation, we do not view PER multiples in isolation. Li & Fung’s 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 company’s 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 L&F – PEG

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Average PEG: 1.26

Source: Datastream, Macquarie Research, November 2008

Although we consider Li & Fung’s 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 & Fung’s 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.

PEG ratio has been an impressive 1.26

in the past

Lends itself to DCF valuation



5 November 2008 10

Fig 15 Discounted cashflow valuation (HK$m) Year-end 31 Dec 2008E 2009E 2010E 2011E 2012E 2013E 2014E 2015E 2016E 2017E 2018E

Free cashflow 4152.3 4318.3 5808.4 6726.6 6962.0 7205.7 7457.9 7681.6 7912.0 8149.4 8563.6 NPV of FCF 40,774.2Terminal value 35,741.5 Total Value 76,515.6 Less Net Debt & Misc Items (3,168.4)Firm Value 73,347.3 Firm Value per Share 20.08 Source: Macquarie Research, November 2008

Fig 16 DCF based fair value per share – sensitivity table 9.5% 10.0% 10.5% 10.6% 11.0% 11.5% 12.0%

0.5% 21.0 19.8 18.7 18.5 17.7 16.8 16.01.0% 21.7 20.4 19.2 19.0 18.1 17.2 16.41.5% 22.4 21.0 19.7 19.5 18.6 17.6 16.72.0% 23.2 21.7 20.3 20.1 19.1 18.1 17.12.5% 24.2 22.5 21.0 20.7 19.7 18.6 17.53.0% 25.3 23.4 21.8 21.5 20.4 19.1 18.0Source: Macquarie Research, November 2008

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 PER Yield P/BV EPS Growth PEG EV/EBITDA Net Margin ROE Latest Price M.Cap FY07 FY08 FY09 FY08 FY08 FY08 FY09 FY09 FY08 FY09 FY08 FY09 FY08 FY09Name Ticker Yr End Curr. (Local) (US$M) (x) (x) (x) (%) (x) (%) (%) (X) (X) (X) (%) (%) (%) (%)

Supply chain management Li & Fung Ltd 494 HK 12/2007 HKD 15.20 7,127 17.2 16.0 13.7 4.9 3.9 7.5 17.1 0.8 13.4 10.9 3.0 3.3 27.8 27.0 Mainly textile Weiqiao Textile Co Ltd-H 2698 HK 12/2007 HKD 1.56 240 6.7 2.7 2.2 11.3 0.1 (67.6) 23.8 0.1 15.1 9.4 3.4 4.0 5.7 7.5 Alok Industries Ltd ALOK IN 03/2008 INR 16.45 66 5.9 5.0 1.3 2.1 0.7 17.4 7.9 0.2 10.1 nmf 9.2 7.2 16.2 12.2 Average (mkt cap weighted) 306 6.5 3.2 2.0 9.3 0.3 (49.4) 20.4 0.1 14.0 9.4 4.6 4.7 7.9 8.5 Mainly garment Shenzhou International Group 2313 HK 12/2007 HKD 1.08 173 9.9 2.3 2.2 17.3 0.5 24.2 4.9 0.5 3.5 3.4 11.8 12.3 20.7 18.1 Top Form International Ltd. 333 HK 06/2008 HKD 0.21 29 10.6 10.2 1.9 2.7 1.1 (56.5) 103.7 0.0 nmf nmf 4.2 7.3 10.5 nmfArvind Mills Ltd ARVND IN 03/2008 INR 14.20 63 10.7 13.9 10.5 1.2 0.2 (22.9) 32.8 0.3 3.1 2.7 0.8 1.0 1.1 1.5 Average (mkt cap weighted) 266 10.2 5.9 4.1 11.9 0.5 4.2 22.3 0.2 3.4 3.2 8.4 9.0 14.9 13.6 Silk garment China Ting Group Hldgs Ltd 3398 HK 12/2007 HKD 0.59 160 9.1 3.5 3.3 17.7 0.6 (21.8) 4.1 0.8 4.2 3.9 16.4 16.3 15.8 18.9 Himatsingka Seide Limited HSS IN 03/2008 INR 30.55 61 21.3 nmf 10.5 0.0 1.0 nmf nmf nmf 174.7 9.6 (10.5) 5.0 (4.4) nmfAverage (mkt cap weighted) 221 12.4 3.5 5.3 12.8 0.7 (21.8) 4.1 1.3 51.3 5.5 9.0 13.2 10.2 18.9 Integrate garment with retail business Texwinca Holdings Ltd 321 HK 03/2008 HKD 3.60 616 11.2 8.0 4.6 7.7 1.9 48.2 11.9 0.4 6.1 4.6 9.6 9.7 26.2 25.8 Glorious Sun Enterprises 393 HK 12/2007 HKD 1.72 235 7.2 6.2 5.4 11.0 0.9 15.5 15.7 0.3 1.3 1.1 6.4 6.7 14.1 15.4 Raymond Ltd RW IN 03/2008 INR 84.10 105 4.9 69.9 21.5 3.6 0.3 (93.0) 225.4 0.1 9.3 9.4 0.4 1.2 0.5 1.7 Average (mkt cap weighted) 956 9.5 14.3 6.6 8.1 1.5 24.7 36.2 0.2 5.2 4.3 7.8 8.0 20.4 20.6 Footwear OEM Yue Yuen Industrial Hldg 551 HK 09/2007 HKD 15.20 3,263 13.9 7.5 7.5 6.3 1.2 21.8 0.0 nmf 9.4 8.6 9.4 8.4 18.0 15.6 Kingmaker Footwear Hldgs Ltd 1170 HK 03/2008 HKD 0.70 59 17.1 12.6 6.4 3.6 0.9 49.2 42.9 0.1 3.4 2.8 3.8 4.6 7.2 9.7 Average (mkt cap weighted) 3,321 13.9 7.5 7.4 6.3 1.2 22.2 0.8 9.8 9.3 8.5 9.3 8.3 17.8 15.5 Textile machinery Fong'S Industries Co Ltd 641 HK 12/2007 HKD 1.40 100 9.6 20.6 28.0 1.4 0.7 (86.2) (26.5) (1.1) 20.8 19.3 1.9 1.1 0.3 0.8

Note:




5 November 2008 11

Risks

Li & Fung’s 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

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Source: Bloomberg, CEIC, Macquarie Research, November 2008

We believe the market in the future will continue to pay a premium for Li & Fung’s 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 company’s 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 Kong’s 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 & Fung’s is a relationship business and a ‘people’s’ business, making a takeover of the company without the Fung family support unviable.

Politically motivated restrictive global trade practices may be negative for Li & Fung’s business.

U.S. business concentration

Growth dependent on continued deal-

making

Hong Kong tax dispute

Minority ownership control

Clampdown on global trade

Margins may not improve



5 November 2008 12

Beneficiary of outsourcing Retailer inventory levels down

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

2.0

2.1

2.2

2.3

2.4

2.5

2.6

1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

Inventory to Sales Ratio

Source: CEIC, Macquarie Research, November 2008

Proliferation of styles

Another fact of modern retailing that needs to be addressed is the growth in product proliferation. For example, a US retailer’s classic pinpoint oxford dress shirt, made of 80s two-ply 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 Land’s 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

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.

Li & Fung ensures delivery on time

Fashion label Zara creates 10,000 designs a year

Some late orders are filled by

neighbouring countries



5 November 2008 13

Fig 20 US apparel imports by country, 2000

Fig 21 US apparel imports by country, 2007

Italy2%

Macau2%

Turkey2%

El Salvador3%

Philippines3%

Taiwan4%

Thailand3%

Others17%

Mexico15%Pakistan

2%

China8%

Hong Kong8%

Dominican Republic

4%Honduras4%Korea, South

4%Bangladesh

4%

Indonesia4%

Guatemala3%

Sri Lanka (Ceylon)

3%

India3%

Canada3%

China31%

Mexico6%

Thailand2%

Hong Kong3%

Philippines2%

El Salvador2%

Indonesia5%Vietnam

6%India4%

Bangladesh4%

Honduras3%

Cambodia3%

Others12%

Guatemala2%Sri Lanka

(Ceylon)2%

Pakistan2%

Dominican Republic

1%

Italy2%

Jordan2%

Canada1%

Taiwan1%

Macau1%

Source: OTEXA, Macquarie Research, November 2008 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 & Fung’s 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 country’s competitiveness Business climate Labour and management Political stability Availability of workers and competition for workers from other sectors Safety of personnel Compensation rates Security of production and shipping Labour skills and productivity Transparent and predictable legal, commercial and regulatory system Availability of qualified managers, including middle management Minimal administrative burden and corruption Compliance with internationally recognised health and labour standards Raw-material inputs Subsidies and tax credits Access to quality and cost-competitive domestic or regional yarn and

fabric production Free trade zones Tariffs on imports of raw materials Real exchange rates Rules of origin for trade preferences Market demand and economic growth Cost and availability of capital to invest in new machinery and

purchase raw materials Infrastructure and proximity to markets Supplier’s level of service and reliability Roads, ports, rail and airports for moving goods into and out of the country Reputation for quality and on-time delivery

Existing business networks Shipping and other transportation times and costs (supply chain linkages, relationship with customers)

Proximity to major markets Level of service provided, eg, full package assembly Access to reliable sources of energy, water and telecommunications Flexibility and variety in styles or products and lot sizes offered Lead time and flexibility to respond to quick turnaround orders Market access Preferential access in major markets Source: U.S. International Trade Commission, Macquarie Research, November 2008

A few years ago, larger retailers such as Karstadtquelle used to look down upon agency businesses such as Li & Fung’s as their own in-house sourcing operations used to be substantial compared with Li & Fung’s 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 & Fung’s expertise. Despite the rapid growth in Li & Fung’s client base over the past decade, we see scope for the company to continue to secure new clients.

Li & Fung has buying power



5 November 2008 14

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

To gauge Li & Fung’s potential, we look at the size of its US apparel business vis-à-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 & Fung’s estimated US apparel market share

Source: OTEXA, Macquarie Research, November 2008

Li & Fung’s 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 world’s 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 & Fung’s 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 & Fung’s key advantages can be summarised as follows:

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-à-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.

US Apparel Imports 2004 2005 2006 2007 2008E

US Apparel Imports Total (US$m) 64,768 68,713 71,630 73,922 75,770 YoY % Change 5.9% 6.1% 4.2% 3.20% 2.50%

Li & Fung Softgood Turnover (HK$m) 31,461 38,080 46,215 63,867 77,335Li & Fung Softgood Turnover (US$m) 4,033 4,882 5,925 8,188 9,940 YoY % Change 10.8% 21.0% 21.4% 38.2% 21.3%

Assume % Li & Fung Softgood turnover Attributable to the US Market 68.06% 69.10% 72.0% 64.80% 60.00%

Est. Li & Fung US Softgood Turnover (FOB) 2,745 3,374 4,266 5,306 5,965 Est. Li & Fung US Softgood Turnover (CIF = 1.5x FOB) 4,118 5,060 6,399 7,959 8,946

Est. Li & Fung US Softgood Market Share 6.4% 7.4% 8.9% 10.8% 11.8%

We estimate that Li & Fung has nearly

12% share of all apparel imports into

the US

Experienced people



5 November 2008 15

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.

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.

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 & Fung’s turnover. It also took over the outsourcing operations of Helly Hansen, a well-known name in skiwear.

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.

Manages the full supply chain

Provides flexibility

More recent deals include Sanrio

(Hello Kitty) and Timberland apparel

M&A also helps in gaining share



5 November 2008 16

Key thrust will be the onshore business Better margins

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 Growing operating margin for onshore business

-1.0%

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

2004 2005 2006 2007 2008E 2009E

Operating margin for onshore business

Source: Macquarie Research, November 2008

Entered the business in 2005

Li & Fung’s 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 Kohl’s stores in early 2005, followed by rollout in Sear’s 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 & Fung’s 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 Levi’s 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 women’s 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. Rosetti’s business comprises the design and arrangements for the manufacture, import, marketing and sale of women’s handbags, purses and related accessories (with turnover of over US$200m). Rosetti’s main customers include Wal-Mart, Kohl’s, Federated, JC Penney and Nordstrom.

Also in 2006, Li & Fung acquired Oxford Womenswear Group, which sells budget and moderately priced private-label women’s apparel collections in the US. These are sold mainly via mass-market retailers, including Target and Wal-Mart, eg, Wal-Mart’s George line could add over US$250m in turnover.

Initially bought licences for bed and

bath furnishings brands

Then introduced the Levi’s Signature

brand for tops

Supplies Wal-Mart’s George line

Relatively brand new and profitable



5 November 2008 17

In late 2006, Li & Fung acquired Homestead from London Fog Group. The Homestead team will augment Li & Fung’s 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 Kohl’s, 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 kid’s segment and markets its portfolio to leading US retailers such as Wal-Mart, Target and Kohl’s department stores. We believe that this could make Li & Fung a leading player in the children’s 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 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, Macy’s, 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.

More recently bought the Van

Zeeland business



5 November 2008 18

Financial strength Consistent above-average performance

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

-

20,000

40,000

60,000

80,000

100,000

120,000

FY92

FY93

FY94

FY95

FY96

FY97

FY98

FY99

FY00

FY01

FY02

FY03

FY04

FY05

FY06

FY07

FY08

E

HK$ m

CAGR 23.3%


Fig 26 Net profit CAGR

-

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

FY92

FY93

FY94

FY95

FY96

FY97

FY98

FY99

FY00

FY01

FY02

FY03

FY04

FY05

FY06

FY07

FY08

E

HK$ m

CAGR 22.5%


Few companies globally with

comparable track record

Revenue and profits have generally

grown in line



5 November 2008 19

Fig 27 EPS CAGR

0.0

0.10.2

0.3

0.40.5

0.60.7

0.8

0.91.0

FY92

FY93

FY94

FY95

FY96

FY97

FY98

FY99

FY00

FY01

FY02

FY03

FY04

FY05

FY06

FY07

FY08

E

HK$

CAGR 18.8%


As can be seen below, the company has achieved gradual margin improvement in the recent past, and we think that, with the company’s emphasis on value-added businesses, margins will continue to improve.

Fig 28 Margin history

9.93%9.73%

8.81%

10.60%

3.18%

2.90% 3.30%

2%3%4%5%6%7%8%9%

10%11%12%

FY98 FY99 FY00 FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08E

Gross Margin Operating Margin Net Margin


Fig 29 Li & Fung – margin analysis HK$m FY03 FY04 FY05 FY06 FY07 FY08E

Revenue 42,631 47,171 55,617 68,010 92,460 113,629Gross Profit 3,777 4,323 5,661 7,335 9,768 13,381Other Income 166 223 264 312 518 622Operating Profit 1,286 1,293 1,853 2,302 3,118 4,099Reported Net Profit 1,223 1,491 1,790 2,202 3,060 3,416 Gross Margin 8.86% 9.16% 10.18% 10.79% 10.6% 11.8%Operating Margin 3.02% 2.74% 3.33% 3.38% 3.37% 3.61%Reported Net Margin 2.87% 3.16% 3.22% 3.24% 3.3% 3.0%Source: Bloomberg, Macquarie Research, November 2008

Margin improvement has been masked by

ongoing acquisitions



5 November 2008 20

Li & Fung’s 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 & Fung’s 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 & Fung’s ‘real’ profitability HK$m FY03 FY04 FY05 FY06 FY07 FY08E

Gross Profit + Other Income 3,943 4,546 5,925 7,647 10,286 14,003Operating Profit 1,286 1,293 1,853 2,302 3,118 4,099Reported Net Profit 1,223 1,491 1,790 2,202 3,060 3,416 Adjusted Operating Margin 32.4% 28.4% 31.3% 30.1% 30.3% 29.3%Adjusted Reported Net Margin 31.0% 32.8% 30.2% 28.8% 29.7% 24.3%Source: Bloomberg, Macquarie Research, November 2008

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 & Fung’s margins appear to be on the decline over the past couple of years, this is due to the acquisition of low-margin 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.

Real profitability picture



5 November 2008 21

Li & Fung (494 HK, Outperform, Target price: HK$20.00)Interim Results 1H/08A 2H/08E 1H/09E 2H/09E Profit & Loss 2007A 2008E 2009E 2010E

Revenue m 47,393 66,236 52,883 73,908 Revenue m 92,460 113,629 126,792 135,620Gross Profit m 5,287 8,095 6,237 9,499 Gross Profit m 9,768 13,381 15,736 17,210Cost of Goods Sold m 42,107 58,141 46,646 64,409 Cost of Goods Sold m 82,693 100,248 111,056 118,411EBITDA m 1,755 2,790 2,197 3,416 EBITDA m 3,542 4,546 5,613 6,491Depreciation m 117 117 135 135 Depreciation m 198 235 270 297Amortisation of Goodwill m 0 0 0 0 Amortisation of Goodwill m 0 0 0 0Other Amortisation m 106 106 106 106 Other Amortisation m 226 212 213 213EBIT m 1,532 2,567 1,956 3,175 EBIT m 3,118 4,099 5,131 5,980Net Interest Income m -195 -147 -214 -214 Net Interest Income m -222 -342 -428 -307Associates m 11 2 11 2 Associates m 5 12 13 13Exceptionals m 6 0 0 0 Exceptionals m 413 6 0 0Forex Gains / Losses m 0 0 0 0 Forex Gains / Losses m 0 0 0 0Other Pre-Tax Income m 0 0 0 0 Other Pre-Tax Income m 0 0 0 0Pre-Tax Profit m 1,354 2,421 1,752 2,963 Pre-Tax Profit m 3,314 3,775 4,715 5,686Tax Expense m -116 -243 -183 -383 Tax Expense m -253 -359 -566 -739Net Profit m 1,238 2,179 1,569 2,580 Net Profit m 3,061 3,417 4,149 4,947Minority Interests m -0 -1 -0 -1 Minority Interests m -1 -1 -1 -1

Reported Earnings m 1,238 2,178 1,569 2,579 Reported Earnings m 3,060 3,416 4,149 4,946Adjusted Earnings m 1,232 2,178 1,569 2,579 Adjusted Earnings m 2,647 3,410 4,149 4,946

EPS (rep) 0.35 0.60 0.42 0.68 EPS (rep) 0.88 0.95 1.11 1.31EPS (adj) 0.35 0.60 0.42 0.68 EPS (adj) 0.76 0.94 1.11 1.31EPS Growth yoy (adj) % 12.4 31.9 22.5 14.4 EPS Growth (adj) % 21.0 24.0 17.4 18.0

PE (rep) x 17.2 16.0 13.7 11.6 PE (adj) x 20.0 16.1 13.7 11.6

EBITDA Margin % 3.7 4.2 4.2 4.6 Total DPS 0.71 0.75 0.91 1.08EBIT Margin % 3.2 3.9 3.7 4.3 Total Div Yield % 4.7 4.9 6.0 7.1Earnings Split % 36.1 63.9 37.8 62.2 Weighted Average Shares m 3,472 3,605 3,740 3,788Revenue Growth % 25.5 21.1 11.6 11.6 Period End Shares m 3,528 3,779 3,785 3,791EBIT Growth % 29.9 32.4 27.6 23.7

Profit and Loss Ratios 2007A 2008E 2009E 2010E Cashflow Analysis 2007A 2008E 2009E 2010E

Revenue Growth % 36.0 22.9 11.6 7.0 EBITDA m 3,542 4,546 5,613 6,491EBITDA Growth % 35.2 28.3 23.5 15.6 Tax Paid m -193 -233 -410 -573EBIT Growth % 35.4 31.5 25.2 16.6 Chgs in Working Cap m 664 374 -456 330Gross Profit Margin % 10.6 11.8 12.4 12.7 Net Interest Paid m -291 -342 -428 -307EBITDA Margin % 3.8 4.0 4.4 4.8 Other m -133 -210 -94 -94EBIT Margin % 3.4 3.6 4.0 4.4 Operating Cashflow m 3,589 4,135 4,225 5,847Net Profit Margin % 3.3 3.0 3.3 3.6 Acquisitions m -4,933 -3,808 -2,039 -1,981Payout Ratio % 93.7 79.3 81.9 82.6 Capex m -320 -415 -273 -273EV/EBITDA x 16.5 13.4 10.9 9.4 Asset Sales m 0 0 0 0EV/EBIT x 18.7 14.9 11.9 10.2 Other m 227 165 49 50

Investing Cashflow m -5,026 -4,058 -2,263 -2,204Balance Sheet Ratios Dividend (Ordinary) m -2,771 -3,390 -3,830 -4,645ROE % 29.1 27.8 27.0 29.3 Equity Raised m 275 3,879 162 162ROA % 11.6 11.3 12.1 13.2 Debt Movements m 1,126 0 0 0ROIC % 36.6 25.7 25.4 26.1 Other m 710 832 973 1,160Net Debt/Equity % 46.3 21.7 24.3 20.3 Financing Cashflow m -660 1,321 -2,695 -3,323Interest Cover x 14.0 12.0 12.0 19.5 Price/Book x 5.4 3.9 3.6 3.3 Net Chg in Cash/Debt m -2,017 1,398 -733 319Book Value per Share 2.8 3.9 4.2 4.7

Balance Sheet 2007A 2008E 2009E 2010E Cash m 1,472 2,870 2,138 2,457 Receivables m 13,716 16,604 18,064 18,356 Inventories m 2,060 2,531 2,824 3,021 Investments m 0 0 0 0 Fixed Assets m 1,133 1,292 1,274 1,229 Intangibles m 0 0 0 0 Other Assets m 13,409 17,464 19,511 21,401 Total Assets m 31,789 40,761 43,811 46,464 Payables m 11,231 13,615 15,083 16,082 Short Term Debt m 975 975 975 975 Long Term Debt m 5,064 5,064 5,064 5,064 Provisions m 0 0 0 0 Other Liabilities m 4,655 6,506 6,633 6,665 Total Liabilities m 21,925 26,161 27,756 28,786 Shareholders' Funds m 9,895 14,632 16,085 17,708 Minority Interests m -31 -31 -30 -30 Other m 0 0 0 0 Total S/H Equity m 9,864 14,601 16,055 17,678 Total Liab & S/H Funds m 31,789 40,761 43,811 46,464

All figures in HKD unless noted. Source: Company data, Macquarie Research, November 2008



5 November 2008 22



5 November 2008 23

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

Volatility index definition* This is calculated from the volatility of historic price movements. Very high–highest risk – Stock should be expected to move up or down 60–100% in a year – investors should be aware this stock is highly speculative. High – stock should be expected to move up or down at least 40–60% in a year – investors should be aware this stock could be speculative. Medium – stock should be expected to move up or down at least 30–40% in a year. Low–medium – stock should be expected to move up or down at least 25–30% in a year. Low – stock should be expected to move up or down at least 15–25% 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 AU/NZ Asia RSA USA CA EUR Outperform 43.17% 61.57% 63.08% 53.60% 71.54% 43.00% Neutral 41.37% 16.43% 30.77% 37.60% 24.61% 48.00% Underperform 15.47% 22.00% 6.15% 8.80% 3.85% 9.00%

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October 08

Asia Research Head of Equity Research Stephen O’Sullivan (852) 2823 3566

Automobiles/Auto Parts Deepak Jain (India) (9122) 6653 3157 Kenneth Yap (Indonesia) (6221) 515 7343 Dan Lucas (Japan) (813) 3512 6050 Eunsook Kwak (Korea) (822) 3705 8644 Linda Huang (Taiwan) (8862) 2734 7521

Banks and Non-Bank Financials Ismael Pili (Asia) (65) 6231 2840 Nick Lord (Asia, China, Hong Kong) (852) 2823 4774 Sarah Wu (China) (8621) 2412 9035 Seshadri Sen (India) (9122) 6653 3053 Ferry Wong (Indonesia) (6221) 515 7335 Chin Seng Tay (Malaysia, S’pore) (65) 6231 2837 Nadine Javellana (Philippines) (632) 857 0890 Matthew Smith (Taiwan) (8862) 2734 7514 Alastair Macdonald (Thailand) (662) 694 7741

Chemicals/Textiles Scott Weaver (Taiwan) (8862) 2734 7512 Jal Irani (India) (9122) 6653 3040 Christina Lee (Korea) (822) 3705 8670 Sunaina Dhanuka (Malaysia) (603) 2059 8993

Conglomerates Gary Pinge (Asia) (852) 2823 3557 Leah Jiang (China) (8621) 2412 9020 Kenneth Yap (Indonesia) (6221) 515 7343 Ashwin Sanketh (Singapore) (65) 6231 2830

Consumer Mohan Singh (Asia) (852) 3901 1111 Jessie Qian (China, Hong Kong) (852) 2823 3568 Charles Yan (China) (8621) 2412 9033 Unmesh Sharma (India) (9122) 6653 3042 Sarina Lesmina (Indonesia) (6221) 515 7339 Duane Sandberg (Japan) (813) 3512 7867 Toby Williams (Japan) (813) 3512 7392 Heather Kang (Korea) (822) 3705 8677 HongSuk Na (Korea) (822) 3705 8678 Edward Ong (Malaysia) (603) 2059 8982 Alex Pomento (Philippines) (632) 857 0899 Linda Huang (Taiwan) (8862) 2734 7521 Emerging Leaders Jake Lynch (Asia) (8621) 2412 9007 Hiu-Lui Ko (China) (852) 2823 4704 Minoru Tayama (Japan) (813) 3512 6058 Robert Burghart (Japan) (813) 3512 7853 Heather Kang (Korea) (822) 3705 8677 Scott Weaver (Taiwan) (8862) 2734 7512

Industrials Bin Liu (China) (8621) 2412 9006 Inderjeetsingh Bhatia (India) (9122) 6653 3166 Christopher Cintavey (Japan) (813) 3512 7432 Janet Lewis (Japan) (813) 3512 7475 Michael Na (Korea) (822) 2095 7222 Sunaina Dhanuka (Malaysia) (603) 2059 8993 David Gambrill (Thailand) (662) 694 7753

Insurance Mark Kellock (Asia) (852) 2823 3567 Seshadri Sen (Asia, India) (9122) 6653 3053 Makarim Salman (Japan) (813) 3512 7421 Media Jessie Qian (China, Hong Kong) (852) 2823 3568 Shubham Majumder (India) (9122) 6653 3049 Prem Jearajasingam (Malaysia) (603) 2059 8989 Alex Pomento (Philippines) (632) 857 0899 Oil and Gas David Johnson (Asia, China) (852) 2823 4691 Scott Weaver (Taiwan) (8862) 2734 7512 Jal Irani (India) (9122) 6653 3040 Christina Lee (Korea) (822) 3705 8670 Edward Ong (Malaysia) (603) 2059 8982 Sunaina Dhanuka (Malaysia) (603) 2059 8993 Ashwin Sanketh (Singapore) (65) 6231 2830 Trevor Buchinski (Thailand) (662) 694 7728 Pharmaceuticals Abhishek Singhal (India) (9122) 6653 3052 Naomi Kumagai (Japan) (813) 3512 7474 Christina Lee (Korea) (822) 3705 8670 Property Matt Nacard (Asia) (852) 2823 4731 Eva Lee (China, Hong Kong) (852) 2823 3573 Tata Goeyardi (Hong Kong) (852) 2823 4077 Unmesh Sharma (India) (9122) 6653 3042 Chang Han Joo (Japan) (813) 3512 7885 Hiroshi Okubo (Japan) (813) 3512 7433 Tuck Yin Soong (Singapore) (65) 6231 2838 Elaine Cheong (Singapore) (65) 6231 2839 Corinne Jian (Taiwan) (8862) 2734 7522 Patti Tomaitrichitr (Thailand) (662) 694 7727 Resources / Metals and Mining Andrew Dale (Asia) (852) 2823 3587 YeeMan Chin (China) (852) 2823 3562 Rakesh Arora (India) (9122) 6653 3054 Adam Worthington (Indonesia) (6221) 515 7338 Polina Diyachkina (Japan) (813) 3512 7886 Christina Lee (Korea) (822) 3705 8670 Scott Weaver (Taiwan) (8862) 2734 7512 Technology Warren Lau (Asia) (852) 2823 3592 Kishore Belai (India) (9122) 6653 3046 Damian Thong (Japan) (813) 3512 7877 David Gibson (Japan) (813) 3512 7880 George Chang (Japan) (813) 3512 7854 Yoshihiro Shimada (Japan) (813) 3512 7862 Yukihiro Goto (Japan) (813) 3512 5984 Do Hoon Lee (Korea) (822) 3705 8641 Michael Bang (Korea) (822) 3705 8659 Patrick Yau (Singapore) (65) 6231 2835 Andy Kung (Taiwan) (8862) 2734 7534 Chia-Lin Lu (Taiwan) (8862) 2734 7526 Daniel Chang (Taiwan) (8862) 2734 7516 James Chiu (Taiwan) (8862) 2734 7517 Nicholas Teo (Taiwan) (8862) 2734 7523 Telecoms Tim Smart (Asia, China) (852) 2823 3565 Shubham Majumder (India) (9122) 6653 3049 Kenneth Yap (Indonesia) (6221) 515 7343 Nathan Ramler (Japan) (813) 3512 7875 Prem Jearajasingam (Malaysia) (603) 2059 8989 Ramakrishna Maruvada (Philippines, Singapore, Thailand) (65) 6231 2842

Transport & Infrastructure Anderson Chow (Asia, China) (852) 2823 4773 Jonathan Windham (Asia, China) (852) 2823 5417 Tim Bacchus (Asia, China) (852) 2823 3586 Wei Sim (China, Hong Kong) (852) 2823 3598 Eunsook Kwak (Korea) (822) 3705 8644 Sunaina Dhanuka (Malaysia) (603) 2059 8993

Utilities Carol Cao (China, Hong Kong) (852) 2823 4075 Deepak Jain (India) (9122) 6653 3157 Adam Worthington (Indonesia) (6221) 515 7338 Prem Jearajasingam (Malaysia) (603) 2059 8989 Alex Pomento (Philippines) (632) 857 0899

Commodities Jim Lennon (4420) 7065 2014 Adam Rowley (4420) 7065 2013 Jonathan Butcher (4420) 7065 5938 Max Layton (4420) 7065 2000 Bonnie Liu (8621) 2412 9008 Henry Liu (8621) 2412 9005 Rakesh Arora (9122) 6653 3054

Data Services Andrea Clohessy (Asia) (852) 2823 4076

Economics Bill Belchere (Asia) (852) 2823 4636 Rajeev Malik (ASEAN, India) (65) 6231 2841 Richard Gibbs (Australia) (612) 8232 3935 Paul Cavey (China) (852) 2823 3570 Richard Jerram (Japan) (813) 3512 7855

Quantitative Martin Emery (Asia) (852) 2823 3582 Viking Kwok (Asia) (852) 2823 4735 George Platt (Australia) (612) 8232 6539 Raelene de Souza (Australia) (612) 8232 8388 Tsumugi Akiba (Japan) (813) 3512 7560

Strategy/Country Tim Rocks (Asia) (852) 2823 3585 Daniel McCormack (Asia) (852) 2823 4073 Desh Peramunetilleke (Asia) (852) 2823 3564 Mahesh Kedia (Asia) (852) 2823 3576 Stewart Ferns (Asia) (852) 2823 4068 Michael Kurtz (China) (8621) 2412 9002 Seshadri Sen (India) (9122) 6653 3053 Ferry Wong (Indonesia) (6221) 515 7335 Chris Hunt (Japan) (813) 3512 7878 Peter Eadon-Clarke (Japan) (813) 3512 7850 Eugene Ha (Korea) (822) 3705 8643 Prem Jearajasingam (Malaysia) (603) 2059 8989 Edward Ong (Malaysia) (603) 2059 8982 Alex Pomento (Philippines) (632) 857 0899 Tuck Yin Soong (ASEAN, Singapore) (65) 6231 2838 Daniel Chang (Taiwan) (8862) 2734 7516 Alastair Macdonald (Thailand) (662) 694 7741 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 [email protected] for access

Sales Regional Heads of Sales Peter Slater (Boston) (1 617) 217 2103 Michelle Paisley (China, Hong Kong) (852) 2823 3516 Ulrike Pollak-Tsutsumi (Frankfurt) (49) 69 7593 8747 Thomas Renz (Geneva) (41) 22 818 7712 Ajay Bhatia (India) (9122) 6653 3200 Stuart Smythe (India) (9122) 6653 3200 Chris Gray (Indonesia) (6221) 515 7304 K.Y. Nam (Korea) (822) 3705 8607 Lena Yong (Malaysia) (603) 2059 8888 Gino C Rojas (Philippines) (632) 857 0761 Greg Norton-Kidd (New York) (1 212) 231 2527 Luke Sullivan (New York) (1 212) 231 2507

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

Sales Trading Adam Zaki (North Asia) (852) 2823 3528 Duncan Rutherford (ASEAN, India) (65) 6231 2888 Mona Lee (Hong Kong) (852) 2823 3519

Sales Trading cont’d Stuart Goddard (Europe) (44) 20 7065 2033 Brendan Rake (India) (9122) 6653 3204 Edward Robinson (London) (44) 20 7065 5883 Robert Risman (New York) (1 212) 231 2555 Isaac Huang (Taiwan) (8862) 2734 7582 Jon Omori (Tokyo) (813) 3512 7838

Alternative Strategies Convertibles - Roland Sharman (852) 2823 4628 Depository Receipts - Robert Ansell (852) 2823 4688 Derivatives - Tim Connolly (852) 2249 3380 Futures - Tim Smith (852) 2823 4637 Hedge Fund Sales - Darin Lester (852) 2823 4736 Structured Products - Andrew Terlich (852) 2249 3225


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