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Crisis-struck, Russian retail lures global majors

  Russia’s retailers faces a hard landing in 2009 as the country lurches toward recession but the downturn also offers global majors an easier entry into a sector with more potential than many mature markets.

Analysts anticipate faster growth in Russia than in most European countries although the global crisis has now spread into the real economy, ending one of the longest consumer booms in Russian history. The economic crisis has led to rising unemployment, slower income growth and limited credit access for most consumers.

“While we acknowledge that growth is likely to fall short of previous expectations over coming years, we nevertheless expect Russia to deliver some of the fastest growth in the global retail sector,” Marat Ibragimov, analyst at Citigroup said. As a result, many retail giants that missed earlier chances to participate in the 15-year spending boom - and whose balance sheets still provide financial firepower for deal-making - can now opt to enter at a time when Russian assets are cheaper.

“Everything is less expensive now and we expect M&A activities in food retailing,” Natalia Smirnova, consumer market analyst with UralSib Financial Corporation said. “Obviously purchasing power is also declining, but discount chains such as Wal-Mart are well placed to profit from the situation as their formats will be very popular in the crisis.”

A credit squeeze triggered by the global crisis has hit both the food and non-food retail sectors, which some analysts say could accelerate consolidation inside the fragmented industries. For example, Russia’s largest food retailer in revenue terms, the X5 group, is widely expected to buy up smaller chains threatened with bankruptcy.

X5 and rivals Magnit, Dixy Group and Seventh Continent have lost 60 to 80% in value over the past six months as Russian stocks were hit by the falling oil price and capital flight from emerging markets.

Based on the ratio of enterprise value (EV) to earnings before interest, tax, depreciation and amortization (EBITDA), the sector will this year underperform emerging market peers by around 40%, according to Citigroup. Leslie Fletcher, consumer goods and retail analyst at A.T. Kearney, said lower oil prices and a weaker ruble could make some Western firms delay their entry into the Russian market.

“However, the crisis also provides a great opportunity to capitalize on lower valuations for M&A targets and lower costs of land acquisition. Deals in this environment may outweigh exchange rate risk -- especially if these rates come back in line in 2009 as some economists expect,” she said.

WEAKENING CONFIDENCE

Many Russian retailers are cutting capital expenditure and expansion this year to free up cash for debt repayments. They also anticipate a deterioration in consumer sentiment in Russia. Analysts polled by Reuters forecast retail sales growth of 4% in 2009 after a 16% rise in 2007. Official data for all of 2008 is not yet available.

November monthly data showed Russian retail sales were up 8.0% year-on-year. This was the slowest annual growth rate in five years and a 3.4% fall on October. “We believe the data shows obvious signs of consumer confidence weakening. In our view, the slowdown in retail sales ... is the beginning of a trend in growth rates (in ruble terms) which we think will hold next year,” VTB Capital said.

In November, real disposable income contracted by 6.2% compared with a year earlier. Wage arrears doubled between October and November, affecting 600,000 people.

“The current crisis situation has brought to an end the consumer boom in Russia and will lead to almost zero real disposable income growth in the near future, as companies are laying off people and reducing salaries,” UralSib said in a strategy note called “Darkest Before Dawn.” “Other non-economic, but no less important factors, that also make us bearish on consumer spending include people’s uncertainty over financial stability and job security.”

Analysts warily forecast the market may begin to recover in the second half of 2009 if a global turnaround takes off. “We could see dramatic sales increases as early as mid-late this year due to deferred demand, should the economic situation stabilize,” Fletcher said.

MARKET OF INTEREST

Analysts say some grocers, notably the low-price chains, are better placed to weather tough condition than retailers of discretionary items such as cars and electronic items.

“Customers may now switch back to previous shopping patterns as their disposable income shrinks. Much like how Wal-Mart wins customers from Target in a recession (in the United States),” said Fletcher, a former Senior Director of International Strategy at world number one retailer Wal-Mart.

Wal-Mart, which is increasingly looking overseas to fuel expansion, last year joined the Russian retail lobby group, after hiring an executive to head its efforts to explore business opportunities in Russia and neighboring markets. Sources have said Wal-Mart hired 30 Russian office staff and is in acquisition talks with local chains that may need a cash injection to cope with the financial crisis.

“Russia remains a market of interest for Wal-Mart. We recognize that our success in this market will depend upon our ability to meet customers’ needs in all economic conditions,” Richard J. Coyle, Wal-Mart senior director for international corporate affairs, told Reuters.

French hypermarket chain Carrefour, the world’s no. 2 retailer, plans to open its first Russian store in 2009 while other operators are reviewing the country’s potential. “Russia is still a large retail market that cannot and will not be ignored by global retailers. Despite current crisis conditions, Russia is still among the fastest growing retail markets, with population sizable enough to influence the portfolio of a global retailer,” Fletcher said. (Reuters)