Barclays slashes Li & Fung's operating profit estimate by a hefty 21-24%

Is the firm's huge 1H15 miss a reason for this?

Despite big cuts to Barclays' numbers, it has upgraded the stock of Li & Fung from EW to OW with a revised price target of HK$7.00.

According to a research note from Barclays, it has three reasons why. First, it believes earnings cuts have bottomed out.

Second, even a slight revenue recovery can drive reasonable earnings growth, given high operating leverage.

Lastly, there is strong dividend yield support at these levels of c.7% that essentially pays the investor to wait.

Here's more from Barclays:

1H performance resilient despite the big miss: We significantly cut our core operating profit (COP) estimates for FY15/16 by 21%/24%.

While 1H looks like a huge miss, we note that 1% revenue growth translates into 4% COP growth and 6% earnings growth. Therefore, this cut is almost entirely due to revenue being down 1% y/y vs our previous estimate of 5% growth.

This decline was due to 3% deflation and Euro depreciation which affected 16% of revenue from Europe. We are not saying these numbers are pretty but they do offer a perspective on how stark the miss was.

Earnings cuts are probably done: We forecast 2% revenue growth in 2H15 and 3-4% thereafter. We do not factor in the c5% of COP that management expects to earn from vendor support services in 2016. Despite that, the stock's free cash flow yield is c.8% for FY15/16.

The interim DPS was not cut and we believe that even with its full year dividend down 20%, this puts the stock at a decent yield of over 6-7% for the next two years, which we believe is sustainable. Investors are being paid to wait for a revenue rebound, in our opinion.

Valuation and risks: Our revised price target of HK$7.0 is based on a one-year forward P/E of 18x for a business that could grow earnings in the mid-teens for the next two years.

Adding c.US$50mn to the bottom line on a top line of over US$19bn should not be too tough with a slightly better operating environment. Key risks are continued deflation (especially after recent RMB depreciation) currency weakness and US retailers coming under more pressure from online.