By  on December 4, 2013

Li & Fung LTD.'s distribution business is beginning to weigh on its credit rating.

Moody’s Investors Service cut the sourcing giant’s rating to “Baa1” from “A3.” Despite the notch down, the company’s rating is still solidly investment grade, three steps away from “junk bond” status.

Lina Choi, vice president and senior credit analyst at Moody’s, pinned the company’s downgrade on “increased business risk from its distribution business, which we expect to have a slow recovery due to uncertainties in the global macroeconomic environment.”

The distribution business includes LF USA, LF Europe and LF Asia and serves principally as a wholesale distributor to major retailers, providing design, products and other services. For the first half ended June 30, the division saw core operating profits fall 53 percent to $5.5 million as sales remained flat at $2.93 billion.

“The distribution business, which has expanded significantly over the last three years and relies on growth of the private label and branded business, has incurred losses from one-time discontinuation of brands, sluggish consumption in the U.S., challenges associated with integrating acquired businesses and ramp-up issues,” Moody’s said. “While Li & Fung has taken significant steps to restructure its U.S. distribution platform over the course of 2013, including write-downs and a decelerated acquisition pace, Moody’s sees higher risk in this business model compared with the commission-based trading business.”

Weighing in Li & Fung’s favor is a strong liquidity position. The debt watchdog noted Li & Fung ended the first half with $419 million in cash, which was more than sufficient to cover its short-term debt of $142 million.

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