KamLibrary - Market Review

Russia is one of the fastest-growing of the four BRIC countries (Brazil, India, China, and Russia), who are part of the next big thing in retail. By 2020, Russia is projected to surpass France and Germany as the largest food and grocery market in Europe. This market review provides a quick overview of the retail market, the main players, the trends and developments, and the outlook for the road ahead.

Numbers and Trends

Russian retail sales amounted to an estimated US$250bn in 2005, and are estimated to have jumped to US$295bn-US$315m in 2006. Organised retail accounts for just 12% of the country’s total retail sales, and is forecast to reach 16% of the market this year.

Food retail sales in 2006 are estimated to have risen by 25.7% to US$142bn, and now account for 43% of overall retail sales. Analysts expect that by 2011, the volume of food retail will rise to US$310bn-SU$320bn. There are around 110-150 food retailers, who generated sales of US$35.5bn in 2006. And while only three of these retailers are listed on stock exchanges (X5, Sedmoi Kontinent, and Magnit), many others have revealed plans for IPOs in the near future.

However, food retail is one of Russia’s most unconsolidated and underdeveloped sectors. Only 28% of all groceries are purchased in large, Western-style stores, with the top five retailers controlling just 8% of the market. The rest of grocery market (72%) is in the form of "non-organized" venues, such as kiosks, corner stores and open-air markets. A report by UBS said that it expects organized retailers to achieve a 40-45% market share by 2010.

The main concentration of organised retailers is to be found in the major Russian cities and their surrounding regions, such as Moscow, St. Petersburg, and Novosibirsk. However, retailers are now moving to the country’s remoter areas, like Tyumen and Yamalo-Nenets in western Siberia, to tap the growing affluence created by strong economic growth and high oil prices.

Retailers are benefitting from the economic prosperity in the country. Helped by higher salaries, government subsidies for utilities and a flat 13% income tax, the average consumer has a larger discretionary income as a percentage of pay, than those in Europe. And with higher spending, consumers are also trading up from generic products to branded goods.

However, retailers are facing similar problems to those in other emerging markets – bad infrastructure, inadequate regulations, and corruption. They are also perhaps more susceptible to drastic changes in government regulations, such as the recent move which prevents non-Russians from operating retail businesses in the country. The move has caused thousands of foreign retailers to leave the Russian market, causing gaps which organized retailers are trying to fill quickly.

Who’s Who

The biggest chains in the country are local retailers, who have moved quickly to establish themselves, and are expanding at a rapid growth. Several foreign retailers have also made moves into the market, and global giants like Wal-Mart, Carrefour, and Tesco are waiting in the wings.

The largest grocery chain in the country is the X5 Retail Group, created by the merger of local supermarket chains Pyaterochka and Perekrestok in 2006. The other major grocers are Magnit, Paterson, Sedmoi Kontinent (Seventh Continent), Dixy, Kopeika (Kopeyka), Vester, and Kvartal. In 2006, the top five food retailers accounted for 8.0% of the Russian grocery market, with X5 accounting for a 3% share.

Local hypermarket and non-food chains include Karusel, Technosila, M.Video, O'Key, and Start. They are in competition with international rivals like Auchan, Kesko, Ikea, Ramstore, OBI, and the Swiss Realty Group.

Performance of Key Players

All the major chains have been showing strong results, with profits and sales figures enjoying strong double-digit growth in the past few year. Latest results of some of the select retailers are as below -

The X5 Retail Group saw its 2006 net profit grow by 1.2% to US$103m, while net sales rose 49.6% to US$3.55bn. EBITDA rose 55.9% to US$360m, but excluding one-off items, had a margin of 8.3%. In the first-quarter of 2007, like-for-like sales rose 13%, with sales in Moscow up 16%, those in St. Petersburg up 9%, and sales in other cities growing 7%.

Magnit saw its net revenue grow by 58.8% to US$2.5bn. LFL sales rose 18%, whilst the average ticket spend was up 14% in dollar terms. For the first-quarter of 2007, revenue rose 58% to US$781.2m. Sedmoi Kontinent’s net profit rose 64.7% to 2.06bn rubles (US$75.8m), while total sales rose to 29bn rubles (US$1bn). It estimated that 91 million people shopped at its stores in 2006, up 34%, with the average spend rising 2.9% to US$11.8.

Amongst other retailers, discounter Kopeyka saw revenue rise 70.5% to US$980m; Dixy generated consolidated revenue of US$1bn, and a gross profit of US$210m; and Karusel’s revenue more than tripled to US$360.6m, with EBITDA of US$29.8m.

Trading Strategies

The market is going through a period of aggressive expansions and acquisitions, as local retailers build on their first-mover advantage, and entrench themselves against the expected influx of global giants. Recent years have seen a series of consolidations, as the retailers aim to boost scale.

Local retailers - In 2006, the X5 Retail Group acquired the Moscow-based Metronom, through which it got the Merkado supermarket chain, rights for retail trade operations in Russia under the Mercado and Mercadona trademarks, 33,000 sq. m. of premises, a distribution centre and an office centre. It plans to open a new hypermarket chain under the brand name Frank, which will operate in the discount market segment. The group also has an option to buy the Karusel chain on 1 January 2008, and will raise the estimated US$1bn-US$1.5bn needed for the deal through a secondary share offer.

Magnit has seen strong growth rates, and opened a large number of stores over the last year. Most of its stores are located on rented premises, and Magnit had to shut down some stores due to steep rises in rent. It has now decided to focus on owning its own stores, and its share of own stores has risen from 8% in 2004, to 24% in 2006. The ownership of stores primarily concerns its hypermarket chain, but analysts are concerned that it risks falling short of its growth target.

Amongst other players, Seventh Continent paid US$150m to acquire United Commercial Real Estate, which owns 29 non-chain retail stores in Moscow. It also purchased a controlling stake in discount chain Citimarket for US$10m. Dixy is hoping to raise US$300-$400m through an IPO on Russian exchanges. Vester plans an IPO of its shares in 2011, when it expects its sales to have grown to US$2.8bn-3.0bn, from US$200m in 2006.

International retailers - The Swiss Realty Group has launched an investment project to create Russia's largest convenient food network. The stores will have an area of 150 to 200 sq.m., with a limited range of staple foods and an average bill of US$10. Private label goods will make up 90% of the product offer.

European giants like Auchan (France), Metro AG and Rewe (Germany), Kesko (Finland), and Spar have also set up extensive networks in the country. Most of these conglomerates have launched a mixture of their store formats, including hypermarkets and supermarkets, both in food and non-food.

Carrefour plans to come to the Russian market and appears likely to open stores in its own name. Wal-Mart said it is interested in entering the market, but does not have specific plans yet. It said it has been watching the Russian retail market for several years and expects to enter the market in the near term. Tesco has also been linked to a market entry in the near future, and is expected to look to acquire one of the smaller players first.

Store Numbers:

Food retailers - X5 Retail operated 1224 stores, including 1045 Pyaterochka stores, and 179 Perekryostok food stores as of 31 March. It opened 58 Pyaterochka outlets and 4 Perekryostok supermarkets in the first quarter, and rebranded three Perekryostok outlets as Pyaterochka. In the next five to seven years, it wants to open over 70 new supermarkets.

As of the end of the first quarter of 2007, Magnit operated 1,930 supermarkets and hypermarkets. It has 14 hypermarket outlets under construction, and 40 more have been bought for refurbishment. It has a growth target of opening 250 new stores annually by 2010.

Paterson plans to expand its network to 119 supermarkets by the end of the 2007, 12 of which will be franchise stores. As part of its plans, it will open 10 new supermarkets in the Moscow region. Seventh Continent boosted its selling space by 24% in 2006 to 138,000 sq.m, after it opened 12 new stores, including four hypermarkets. As of 15 April, Dixy operated 333 discount stores, supermarkets and small hypermarkets located in Moscow, St. Petersburg and regional cities.

Kopeyka opened 34 stores in the January-March period, taking its total number of outlets to 363 as of 1 April. Vester plans to start building hypermarkets actively from 2008, and said it “will need to open” at least 100 hypermarkets by 2012. Technosila currently operates 99 stores in 55 Russian cities.

Kvartal plans to open 30 shops in Moscow by the end of 2007, in three formats - supermarkets (trading area of 600 sq.m.), convenience stores (150-200 sq.m.), and mini-markets (50-150 sq.m.). The smaller shops will be opened in leased areas, while supermarkets will be owned.

International retailers -Metro plans to invest €150m in its Cash & Carry stores, of which it already has 31 country outlets, and plans to build 55 more. It also operates six Real hypermarkets, and three Media Markt and Saturn outlets. French group Auchan has 20 outlets - 14 Auchan hypermarkets, and six Atak supermarkets. Germany’s Rewe has over 20 stores through its Billa subsidiary, and also plans to open its Selgros supermarket this year. while Spar International is trying to unify its retail and cash & carry format stores. Spar has one hypermarket, and plans to open at least three more in 2007.

Kesko plans to invest about €200m to develop its K-Rauta DIY chain, and plans to add 24 news stores to its existing seven outlets, by 2010. German chain OBI also plans to open five to 10 stores in Russia in the 2007 fiscal year, to add to the 11 stores it currently operates. They are joined by Germany’s Globus, which has one outlet in Moscow, and plans to build at least five hypermarkets.

Outlook:

The Russian market is set to grow by leaps and bounds, assuming no major shake-ups on the political front. Organised retail too will expand, and by 2011, Magnit and X5 Retail Group alone are expected to account for 10-12% of the food retail market. A report by UBS said that it expects organized retailers to achieve a 40-45% market share by 2010. However, analysts are also predicting that by 2008, the concentration of organized trade in Moscow is likely to trigger more intense competition on prices, which will lead to a fall in prices and profitability after 2008.

It is generally agreed that for foreign retailers, acquisition is safer tactic than greenfield constructions or franchising, mainly because of non-transparent land codes. A case in point being IKEA, which has invested over $2bn in 6 years, and has yet to turn a profit. Acquiring an established firm would also bring with it loyal customer base and a local partner to help navigate the infamous red tape.

However, underlying all the boom is an uneasiness caused by the possibility of sudden shifts in government regulations. After the new law banning non-Russian citizens was implemented, it was estimated that only 68% of market stalls in the country are occupied, in Moscow, around 10,000 of the estimated 60,000 market stalls were vacant. This has led to acute shortages and price increases in some regions, and in one market in Chelyabinsk, the government said that prices for non-food items rose 16%. Retailers entering the country will have to remember that they will still have to deal with the political uncertainty.

Date article published: 01/05/2007

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