Retailing in Russia, hit hard by the crisis, but a good time for foreign entrants.
by Martijn Peeters, Strategy Director, PricewaterhouseCoopers Russia
The Russian retail market has been considered to be a retailer’s paradise. Russian consumers like to spend, they were rapidly becoming wealthier and over 70% of the 142 million live in urban areas, making them accessible to retail chains. As a result there was strong growth across all retail segments driven by rising incomes, low retail penetration, especially outside of Moscow and St Petersburg, and low consolidation in most segments (e.g., food retail top 5 below 10%).
This resulted in revenue growth figures of more than 50% per year due to both strong like-for-like sales growth and rapid store roll-out. In addition, profitability of retailers was relatively high with 6-10% EBITDA margins for the largest grocery retailers such as X5 Retail Group and Magnit, mainly as a result of limited competition. The modern trade format, especially hypermarkets, quickly became popular among Russian consumers.
All non food segments also showed tremendous growth; for example the DIY segment or the consumer electronics retail sector, which has been growing on average by 20% per annum between 2000 and 2008, driven by disposable income growth and increased consumer credit availability as well as residential real estate development.
As a result of low consolidation in most of the segments, expected longer-term growth, potential efficiency gains and a relatively liberal market environment, the retail segment seems very attractive to larger foreign entrants and has received significant interest from international private equity players who also noticed this.
Surprisingly, the presence of large international retail chains has been relatively limited to date. The DIY and furniture segments are dominated by internationals like Castorama, OBI and IKEA, all with very successful formats and financial results. However, in food retail for example the share of foreign players is relatively small with only Metro, Auchan and the Rewe Group having significant positions with larger own-developed formats (C&C and hypermarkets) and to date the consolidation that has taken place in the food retail segment has been driven by the Russian market leader X5. A number of foreign retailers have been testing the water over the years without making a final entry to date, partly due to high prices for existing retailers and real estate.
The crisis: bad for retailers, good for entrants?
The financial crisis in combination with the fall in oil and other commodity prices has hit Russia exceptionally hard. Most Russian retailers were expanding aggressively in a race to penetrate the market, entering a significant part of larger cities as soon as possible. This expansion was financed with debt and from the moment that Lehman Brothers failed, access to capital dried up and interest rates doubled. With leverage of five to six times EBITDA this had an immediate impact on retailers. At the same time, the at least temporary fall in oil prices, driving rouble devaluation and rising unemployment, had a significant impact on consumer expenditure.
In Russia the crisis will lead some retailers to expand significantly while others will go bankrupt or lose their position.
This became a real bump in the road for a Russian retail success story. Retail turnover went down by more than 8% in July 2009 (year-on year in volume terms) with some retail segments such as consumer electronics and DIY being hit tremendously hard with declines in the first half of 2009 of 15-30%, and the speed of store roll-outs has slowed down significantly.
Recent studies also show that in 2009 consumers started to trade down and switch retailers while becoming much more selective and price-sensitive. For example, the discount chain of the multi-format X5 Retail Group became stronger and continues to gain market share, supported by their price leadership campaign, while supermarkets of the same retail chain face a decline in customer traffic. In electronics retailing the online sales channel is becoming increasingly important and key players have already announced significant sales growth through their online stores, although not nearly enough to compensate for their losses in the stores.
In spite of the dour current conditions, stronger retailers can still show healthy growth figures even in the current conditions, benefiting from weak competitors and the penetration potential. Market leaders are going through turn-around, cutting costs, closing down inefficient stores, but still investing in expanding their market share.
In addition, hardly anyone has doubts about the long-term potential of the Russian retail market. The large customer base, low penetration of modern retail formats especially in Russian regions and strong longer-term growth make Russian retail one of the most promising sectors still to explore.
Furthermore, in terms of efficiency, there is still a lot of progress to be made, especially if you compare Russian retailers with their international peers. Typical issues for example are very high stock outs and an assortment that is too high; this is partially driven by a historic focus on revenue growth instead of areas such as cost and inventory management, store optimisation or private label development. There is also less experience in the local market with running larger retail operations. Therefore international retailers have the opportunity to bring in best practices, optimise the operations of existing chains and improve their margins.
In Russia this crisis will lead some retailers to expand significantly while the others will go bankrupt or lose their position. Most likely, the winners will be the current market leaders who have better access to credit and more stable businesses. In addition international companies could act as industry consolidators.