Russian retail titans prepare for battle

By bne IntelliNews February 5, 2010

Tim Gosling in Moscow -

Pundits leapt on French retailer Carrefour decision to pull out of Russia last autumn as more evidence of "foreigners flee Russia" as the economy tanked. The company had only just set up shop and opened its doors in the full gale of a global crisis that kept many Russian consumers indoors until the weather improved. But lost in the hailstorm of bad news was the fact that Carrefour's rival, fellow French supermarket chain Auchan, was not only staying, but has continued to expand.

Carrefour was not alone in its retreat. In 2007, Edeka Zentrale closed its Marktkauf hypermarket, while Turkish company Ramenka spent most of the last couple of years gradually closing its chain of Ramstore hypermarkets and supermarkets. However, other international players are thriving; after all, cornflakes don't enjoy the same geo-political significance as oil and gas.

Auchan has been the most active of the burgeoning number of foreign companies hoping to cash in on Russia's 142m-strong consumer market. It nipped in to buy Ramenka's hypermarkets and continues to expand its operations in Russia (just as it has next door in China). Rapidly earning a strong reputation in emerging markets, the privately-held retailer from Lille entered Russia early and is now one of the most popular anchors among real estate developers, according to Jacob Grapengiesser from East Capital, a investment house concentrating on Central and Eastern Europe and a significant holder of shares in Magnit, Russia's second largest grocery retailer.

Auchan currently has 38 stores in Russia, and plans to open six new hypermarkets in 2010. Jean-Pierre Germain, CEO of Auchan Russia, said the company is willing to "adapt to different markets in different regions of Russia." By way of illustration, a roll out of Raduga stores - a new, low-cost concept - has begun in smaller cities with populations of under half a million people. The company suggests it could open up to 100 of these stores this year. According to Natasha Zagvozdina from investment bank Renaissance Capital, the French company is joined in the list of the country's top five grocery retailers by Germany's Metro which has been expanding aggressively across the region, alongside three Russian operators; foreign retailers are now the third and fourth largest retailers in the Russian market.

Perfect storm

Carrefour blames poor prospects of achieving a market-leading position for the withdrawal, but most of the business press noted rumours that minority shareholders were demanding the company cut costs in the face of the economic crisis. In reality, the retailer met a perfect storm: strong established competitors, in a country vast but with under developed infrastructure, with a global economic crisis the straw to break the camel's back.

Of course, it's also the size and early development of Russia that makes the prize so tempting; Grapengiesser predicts that modern grocery chains "will continue to grow for many years."

In fact, despite continuing to capture business from outdoor markets and other independent operators, grocery chains still enjoy less than a 40% share of food sales across Russia, according to Zagrozdina. "The consolidation opportunity in Russia is absolutely huge," she states, a view backed by the claim of Lev Khasis, CEO of the leading grocery retailer X5, that over the next decade his company hopes to double revenue every three years.

Magnit's deputy CEO Oleg Goncharnov tells bne: "Today, the Russian retail sector has a turnover of $200bn a year. We are the second largest player, but we only have a 3% market share. There is an enormous potential and Russia is one of the most dynamically developing retail markets in the world." Not only did Magnit leave its expansion plans for 2009 unchanged, it even saw revenues increase that year by a third, easily beating 2008 (a record year for the company) and despite Russia's overall economic decline of just under 9%.

But there is a lot of work still to do. The sheer scale of Russia, its poor transport infrastructure, and an absence of experienced third-party logistics operators make the supply chain and distribution conundrum a key element. Those activist investors believed to have pressured Carrefour? Try convincing them to live with five years of losses whilst distribution networks are built.

This leaves acquisition the only realistic route these days for new entrants, according to Marat Ibragimov, an analyst in Citigroup's Moscow office. But whilst no one is counting out a large deal in the coming years, it looks unlikely in 2010. X5 and Magnit have seen their share prices lead the recovery on the stock markets as their lower-priced formats have benefited from the fall in disposable income levels, making an acquisition frighteningly expensive, especially looking at the fragmentation of the market.

Like Magnit, supermarket leader X5 has a massive turnover on the back of a teenie market share; the company's market capitalization is around $7bn, but it controls only 4% of overall food retail business in Russia. Buying a company as large and prospective as X5 could only be funded by debt, which means that unless the buyer can improve operational efficiency at the purchased company, then profitability, impacted by the cost of that debt, will drop. "I don't think that if a large international player bought either X5 or Magnit tomorrow, that they could improve their efficiency in the slightest," says Zagrozdina.

Left on their own, the titans of the Russian food halls are battling it out for more market share and there's everything still to play for. The crisis has led to rationalisation in the sector and the survivors are looking forward to a recovery in consumer spending. "We need to see three or four quarters of improved GDP before consumer confidence really starts to recover properly," says Grapengiesser, "but companies are now starting to position themselves to take advantage when it does."

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