CONSUMER GOODS AND RETAIL: A Hint of Things to Come

11/10/2011
Magnit released its operating data for October today (10 Nov). The 10M figures look strong but the monthly data suggests that LfL sales slowed significantly with revenue growth dropping to 33% YoY in rouble terms (27% YoY in dollars) in October vs 44% YoY in roubles (53% in dollars) in 9M10. Rosinter released weak October operating figures: revenue growth was only 3.6% YoY, fully attributable to rising prices, while LfL traffic plunged 9.5% YoY.
 
Neither report came as a surprise to us. The figures suggest that consumers have started to trim their expenditures rapidly and this is not the first indication of a slowdown in consumer demand.
Implications for the Sector
Magnit showed itself to be the most resilient company in the Russian consumer sector in terms of LfL sales growth during the 2008 crisis. We believe it is now the best positioned to resist another downturn. Furthermore, if Magnit records a slowdown in growth, our view is that other food retailers are likely to report even weaker data:
 
X5 lost traffic in 3Q11 and the process will likely persist into 4Q11. The company may address this decline with prices cuts and new marketing initiatives but the effect on its bottom line should be the same: revenue growth can be expected to slow even further and margins should drop in 4Q11.
n After acquiring Victoria, Dixy looks much better in terms of leverage over suppliers and profitability. However, its LfL traffic decline will undoubtedly accelerate given its plans to rebrand Victoria stores (which involves closing them for a time). Margins should remain resilient thanks to Victoria but we expect Dixy’s operating margins to remain low until consolidation is complete.
n We think O’Key will continue to disappoint. Opening new stores while consumers are trading down (which will demand price cuts and new promotions) can be expected to put strain on the company’s top line and result in considerable margin contraction.
Valuations
The Russian consumer sector is a growth story which was discovered by investors years ago. This is the main reason consumer stocks are priced at premiums to their DM peers based on our updated and more conservative forecasts (for details, please see our report on food retailers A Word of Caution released 27 Oct). We are increasingly concerned that any growth slowdown could trigger a wave of multiples contractions and operating data suggests this deceleration is underway.
 
Bottom line
We stick to our selective approach to the sector and reiterate our positive stance on Magnit (sustainable margins, strong cash flows, moderate leverage), neutral view on X5 (high leverage, falling margins) and negative view on Dixy (high leverage, low margins, weak cash flow, 25% of its debt is short term) and O’Key (poor execution in good times is a harbinger of trouble ahead).

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