The end of 2015: Retail – attack from all sides

The end of 2015: Retail – attack from all sides

Moscow. December 29. Russian retailers in 2015, caught between a rock and a hard place. On the one hand, the population reduced the consumption, which was reflected in this stable, it would seem that the sector, as food. Searching for the best price, consumers tend to visit more stores, have switched to cheaper brands. All this has forced retailers to invest in the reduction of retail prices at the expense of margin to restore customer traffic and increase sales.

On the other hand, as real disposable incomes are reduced, increasing the government’s attention to the retail sector – namely, the prices in the shops. Along with populist calls to limit mark new legislative initiatives regulating the relations in the industry. In addition, retailers must be ready at any time to quickly rebuild the supply chain in the event of another food Samosata and – once again – to keep prices as required by officials.

Pressure on margins “from the bottom” and “top-down” reduces the investment attractiveness of the industry, which, however, still retains a significant margin of safety.

Controversial bonuses

“Today, unfounded, frankly, the speculative increase in the cost of products, goods and services leads to a decline in living standards of people”, – stated in December 2015, Vladimir Putin, urging to use all available market tools to curb the growth of prices. One such market instruments can be actively discussed in the past year, amendments to the trade act, which limits the size of bonuses that retailers charge suppliers.

In January 2015 a group of deputies and senators in the Duma introduced a bill suggesting a reduction in the cumulative size of up to 3% of the delivery quantity. Now legal petrobonus (remuneration for delivered goods) is 10%, the amount of the remaining payments is not regulated. For the calculation of bonuses was offered to use the net purchase price of the goods (excluding indirect taxes). The bill, according to its authors, aimed at “strengthening the foundations of national food security, promoting additional measures to support the interests of domestic producers and unfair competition”.

Against this background, since the beginning of the year unfolding of the conflict the producers of vodka “the synergy” and Roust with the retailer Dixy. Producers claimed that “Dixie” requires bonuses for the products they supply almost three times more than the law “About trade” (10%). In the beginning of the year contracts on delivery of production “Synergy” and Roust in retail stores were not renewed. In may the parties announced the settlement of differences. The adoption of the trade act in 2009 also took place against the backdrop of the crisis, albeit on a smaller scale, and was accompanied by the conflict of networks with suppliers, in particular, with “Mosselprom” Sergei Lisovsky, who has since managed to sell the business to the Cherkizovo group and has become one of the sponsors of the new bill.

In may the state Duma passed amendments to the trade law in the first reading. Then the Ministry of industry and trade proposed not to reset the bonuses and put the margin of retailers margin, and then the government proposed another option – to cut bonuses up to 5%.

However, in discussions with industry representatives it became clear that the bonuses are not only additional enrichment retailers – they allow small producers to break into Federal networks and to compete with the big brands for shelf space.

The cancellation of the bonus will result in that own-brand retailers (private labels) and conditional Coca-Cola or “Baltika”, which will remain in stores, in any regulation that would displace local producers, and will reduce the range in the stores.

Radical reduction of bonuses will have an impact primarily on small networks and suppliers (those most domestic players, calling legislators), celebrated in the Union of independent networks of Russia.

As a result before the second reading of the bill last year never made it, in 2016 we are waiting for the continuation of this story.

The leader slowed down

Largest on the Russian market retailer in terms of sales and number of stores – Krasnodar “the Magnet” in November slowed revenue growth to 17% from 19.4% in October. It is not only the worst result for the year, but also record for all of its public history.

The inhibition of the growth took place amid the aggressive expansion of the network “Magnet” for 11 months, revenue increased by 25.3%, retail space by 24.3%. “Magnet” significantly increased its pace of network expansion compared to 2014 is primarily due to the format of shops of cosmetics. In January-November, the company opened 2 thousand 214 new stores, including 965 cosmetics stores (previous year: 1 thousand 414 thousand shops and 329 respectively).

The “Magnet” is ready to reduce the pace of expansion to maintain profitability. “We are focused on the right balance between profitability and growth,” said in October the General Director and the basic owner “the Magnet” Sergey Galitsky, who has previously promised that 2015 will be a record from the standpoint of network growth.

In 2016, according to preliminary forecast, the retailer will be able to access more than 1 thousand stores (the main format of the company), and about 100 hypermarkets and 1.3 thousand stores cosmetics, but with a 2017 “Magnet” can slow down the rate of expansion of the network of stores, made Galitsky. “If we feel that we can no longer manage this mass, we will stop at the discoveries, because we have sharpened management on profitability”, – he explained.

In July, Magnit cut its forecast of revenue growth for 2015 to 26-28%, 28-32%. In October, the CEO of the company said that growth will be closer to the bottom of the range, “plus or minus half a percent”. The November sales results caused analysts to doubt that the company will be able to perform its annual forecast. According to analysts Sberbank CIB to reach the bottom border of the forecast range (25,5-26,5%), in December the company needs to show revenue growth at least 27%, and this implies growth rates of 10 percentage points compared with November, which is hardly possible, given the significant slowdown in food inflation and a high base of comparison from the previous year.

On the results of December sales may have a negative impact of warm weather in the second half of the month in the European part of Russia, contributing to the intensification of competition from open markets and fairs. The weather factor had once worked against the “Magnet” in December 2013.

Overall this year fully realized the trend of decrease in consumer activity of households, of which the “Magnet” warned a long time ago. “The consumer looks at more aggressive prices than two years ago, and it will last quite a long time, because wages are not growing and inflation is quite high. So we see that the selectivity of the buyer in shops is very high, the buyer has never focused on price. I think it will continue for some time, although probably some stabilization processes”, – said Galitsky in October.

X5 feels better

“Magnet” is keenly aware of the decline in consumer demand, not least because of its geography – about two-thirds of its stores are operating in towns with population less than 500 thousand people, mainly in southern, North-Caucasian, Central and Volga Federal districts. On the one hand, it helps the retailer to grow quickly – can open small shops and competition from national chains is weaker than in megacities. The reverse side of the coin – in small towns the more modest incomes of consumers, the crisis they are beginning to save more and not even to shift to other retail formats, and in their own gardens.

But slow down and other retailers. The group “Dixie” in November lowered the pace of growth of revenue to 17.9% from 19.2% in October, while in January the growth rate exceeded 30%. The deterioration in consumer demand forced the company to invest aggressively in prices, as a result, in the third quarter gross margin of Dixy decreased to 28.7% from 30.1% a year earlier, and the EBITDA margin to 3.9% from 7.5%. By the end of July-September, Dixy had a net loss in the amount of 843 million rubles, as against 1,19 billion profit in the third quarter of last year.

Slowed the growth of sales of comparable stores (LfL) of the company: from 11.7% in the first quarter to 2.3% in the second quarter and in third quarter like-for-Like revenue of the retailer is declined by 1.8%. LfL traffic demonstrated a negative trend in the second quarter (minus 5%), and in July-September, the decline accelerated to 7.5%.

Amid the deteriorating operating and financial performance of the company its main shareholder, the group “mercury” has refused idea to sell “Dixie” another asset retail – chain stores of alcohol and tobacco Bristol. In may, structure “Dixie” has acquired from its shareholder to 31.8% in the operating company’s network Bristol for 1,78 billion roubles in the summer and planned to increase the share to 100%. But in December, Dixy announced that it has sold the share in “Bristol” (33% in a small package, which the retailer owned up to the may transaction) the structure, affiliated with one of the shareholders of “mercury”, for 1.83 billion rubles. Among the reasons for refraining from acquisitions “Bristol” – changes in market demand, the company explained.

Next year Dixy plans to introduce a new strategy aimed at increasing the efficiency, and to announce a new growth forecast for the business for the medium term. To introduce a new strategy will have a new CEO net is the representative of “mercury” Sergei Belyakov, who succeeded Elijah Jacobson as President of “Dixy” in December.

Retailer Lenta, whose key format are hypermarkets (“Magnet” and “Dixie” basic sales bring the stores), has also retarded the growth of revenue this year. If in the first quarter of sales “the Tape” has grown on 37,7% in the second quarter growth slowed to 30.4% and in III quarter – to 29.3%. In October “amid the volatile behaviour of customers” the company has reduced the annual forecast revenue growth of up to 29-33% 34-38%, which she hoped in the beginning of the year.

“Okay”, competing with “Ribbon” in the segment of hypermarkets in the first half increased revenue is only 4.4%, as comparable retailer sales decreased by 1.7% due to the outflow of buyers. However, in the III quarter the company has managed to accelerate revenue growth to 7.9% due to investments in price and assortment optimization. O’key has announced that in 2016 will concentrate on development of new chain of discounters, which hopes to accelerate the growth of sales for the year to 15-16%. This year the retailer is expecting revenue growth of 6%.

X5 Retail Group in 2015 looked more confident competitors. In II quarter the company has outperformed on revenue growth “Magnet”, and in the third quarter secured the success If the growth of sales of “Magnet” in July-September slowed to 21.5% from 27.3% in the second quarter and 33.1% in the first quarter, X5 accelerated to 28.3 percent in July-September from 28.1% in the second quarter and 26.5% in the first quarter.

The success of the X5 is the result of the transformation of its business, which the company launched in 2013. The retailer has realigned the logistics and began to upgrade their stores, starting with a key format, the network “Pyaterochka”. The company has updated the position, refusing to accept the concept of the classic discounter in favor of stores with items supermarkets. The changes affected the range, the logo and the trading floor. As a result, “roundabout” has become the locomotive of growth of revenue of the retailer: if in September, X5’s total revenue increased by 28.2%, the brand increased its sales by 33.7%.

X5’s goal is to double size of business over three to four years, said the former CEO Stephan Ducharme (left his post in November). In 2016 X5 will need to prove that the acceleration of sales growth – the sustainable trend, because in 2015 the revenues of the retailer increased against a relatively low base in 2014 (revenue growth in 2014 amounted to 18.6%).

Not so profitable but still attractive

Investment in prices and rising costs reduced the profitability of retail companies. “Magnet” in the third quarter reduced the EBITDA margin to 11.2% from 12.4% a year earlier, Dixy reduced this figure to 3.9% (from 7.5% the previous year) – the lowest level in the last five years (less margin for “Dixie” was in 2010, before the acquisition of the Victoria group). Only the X5, despite the acceleration of growth, managed to hold the margin at last year’s level (7.3% in the third quarter).

Depositary receipts “Magnet” on the London stock exchange since the beginning of the year fell by 11.4%, to $39.1 per share and GDR O’key Group fell more than twice, up to $2.02 for a receipt. Rose GDR “Tape” (6.8%, to $6.9), and the leaders – X5 Retail: its quotations have grown by half, to $18.8 for a receipt (24 December). Index FTSE Russia IOB from the beginning of year has grown on 0,9%, MSCI Emerging Markets Index fell by 15.7%.

The dynamics of Russian shares continue to influence the economic challenges, and many analysts predict that Russia’s economy will continue to shrink amid falling oil prices. The retail sector of the Russian Federation has long maintained the attractiveness for international investors, and their main favorite was “Magnet”.

“Unlike many emerging markets, Russia is more and more closed in itself, and, given the high level of support for Vladimir Putin and the weak opposition, we are not optimistic that the authorities will conduct the necessary economic reforms in the near future”, – stated in the annual report of T. Rowe Price Institutional International Funds. At the same time, the Fund continues to believe in “the Magnet” and believes that the retailer can increase its market share due to decreased competition. On the 31st of October, the Fund owned a 0.1% stake in the retailer by $23 million.

Artisan Emerging Markets Fund called the paper “the Magnet” one of the emerging investment opportunities.

While almost all Russian public retailers manage to maintain a relatively high level of profitability compared to peers abroad. So, the profitability of Turkish Migros EBITDA in the third quarter was 7%, during the year the company will result in range 6,-6,5%. The same indicator Polish Eurocash Group for the third quarter was 2.46%, for the first 9 months and 1.9%. African Shoprite Holdings and Woolworths Food, which analysts also compare the Russian retailers cannot boast a high growth rate of their income for the financial year ended at the end of June, increased by 7% and 13.5% respectively.

The continuing interest of investors in Russian FMCG sector confirm SPO “the Magnet” and “Ribbon” – the majority of Russian companies last year about this and could not dream. However, in all transactions as an anchor investor took part state-owned Russian direct investment Fund.