O'Key: Another Way To Play Russia's Dynamic Retail Story


We believe Russia's food retailing industry to be among the world's most exciting. It is dominated by Russian companies; with the likes of Walmart and Carrefour in particular so far having failed to enter for a variety of reasons despite their efforts. Organised food retail sales are expected to grow to US$82bn in 2012 - up from US$23bn in 2006, and are forecast to grow past US$300bn by 2017. When you consider that informal retailing still accounts for about half of food retail sales, and that this market remains beyond the net of organised food retailing, the scale of opportunity is phenomenal. We have been particularly bullish on the discount format, and our preferred way of playing this view from an equity market perspective has been Magnit - a pure soft discounter with a market capitalisation of US$13.8bn. A long position on Magnit was entered into BMI 's Macro - Industry Strategy key views table on December 14 2011 , and we are still in the view with it having returned 73 % in price appreciation terms to date.

While we continue to believe that the discount format represents the best way to play Russia's food retailing growth story, particularly as Magnit pursues growth across Russia's vast regions including Siberia, we have been looking at other ways to play the opportunity . The most obvious company to look at would be Magnit's main rival in Russia: X5 . While discount stores form a large portion of its retail business, X5 does also provide exposure to the potentially higher margin hypermarket and supermarkets segments. However, the company has had a particularly challenging 2012 with its London-listed shares down by about 21% so far this year. Following the departure of CEO Lev Khasis in 2011, X5 has posted a number of relatively poor quarterly same-store numbers, which, despite a slowdown in private consumption growth at the macro level, have been at odds with our near-term views on Russian retail. Even though X5's shares are currently cheaper than they have been for a long time, at a trailing 12 months price/earnings (P/E) ratio of about 19 x , we prefer to look elsewhere at this time until a clearer management strategy emerges .

Table: An Overview Of Russia's Food Retailing Industry
Company FY 2010 Net Retail Sales (US$mn) % Market Share In Top 10 % Market Share In Total Market
Source: X5, Rostat
X5 Retail Group 11,280 26.0 5.0
Magnit 7,777 17.9 3.4
Auchan 5,944 13.7 2.6
Metro C& 4,678 10.8 2.1
O'Key 2,690 6.2 1.2
Lenta 2,325 5.4 1.0
Dix 2,131 4.9 0.9
Seventh Continent 1,466 3.4 0.6
Spar 1,278 2.9 0.6
Victoria 1,090 2.5 0.5
Monetka 906 2.1 0.4

The retailer we are going to have a closer look at here is O'Key , which is listed in London following a 2010 initial public offering. With a market capitalisation of about US$2.4bn, it is a lot smaller than Magnit and X5 but also more upscale with a specific focus on convenience in some of the wealthier cities such as Moscow and St. Petersburg. E arlier in 2012 , O'Key announced plans to invest US$500mn over a four-year time span to grow its business in Moscow where it is believed to be planning to launch a further 100 stores. In Moscow in particular, we believe that convenience is going to be a major factor in defining shopping habits. Therefore, while O'Key represents a way to benefit from rising incomes across the larger cities, its upscale business model fits particularly well with how we see food retailing developing in the likes of Moscow. Growing demand for convenience-focused food retailing is a huge theme across a number of emerging retail markets and this is an area where O'Key can differentiate itself from its larger rivals. It has done well in 2012 with its shares up by about 29%, backed up by promising same-store sales growth in particular, which is one of the key indicators we look out for.

Excellent Year For Magnit, Not So For X5
Magnit, X5 and O'Key Re-Based Share Prices (31-12-11=100)

At a trailing P/E ratio of 23 x , O'Key shares are sandwiched between X5 and Magnit. Overall, Russian food retailers are a lot less expensive than they were towards late 2010 in particular , when X5 and Magnit were trading at huge multiples in excess of 40. O'Key's shares are valued similarly in P/E terms as some other emerging Europe focuse d retailers including Jeronimo Martins . As the sixth chart illustrates, O'Key's shares are currently trading close to their 200-day simple moving average.

O'Key Between Russian "Big Two"
Selected Companies Trailing 12M Price/Earnings Ratios

The chart below looks at total debt to earnings before interest, taxes, depreciation and amortisation (EBITDA) for the three Russian retailers we are looking at , as well as for Wal m art and Tesco for comparison purposes. O'Key's debt levels by this measure have come down over the three - year comparison period. A likely explanation for relatively higher debt for a fast growing emerging retailer likely lies in the capital required for expansion. By this measure, O'Key has done a good job bringing down its debt levels. Magnit debt levels have increased but this is not a bad thing when you consider how quickly it is growing, particularly as a first mover in a lot of Russian cities. Compared to these two, X5's debt is more levered and , given its inability recently to grow same-store sales, it does not compare as well.

X5 The Most Levered
Selected Companies Total Debt To EBITDA Ratios

Carrying on from total debt to EBITDA, the current ratio (current assets/current liabilities) comparison clearly underlines Magnit's relatively stronger position against X5 in particular , with a ratio above 1 generally preferred here. While O'Key compared well in total debt to EBITDA terms, it fares less well here with a current ratio of 0.6 in its last financial year.

Magnit Impresses Here
Selected Companies Current Ratios

The next ratio we are going to l ook at is asset turnover (sales/total assets), which is a useful way of looking at how well companies make use of their assets to generate sales. X5 ' s relative weakness and inefficiency compared to Magnit and O'Key is again underlined here. Its asset turnover ratio remains below 2, which leaves it with some work to do as it tackles a number of strategic and competitiveness-related issues. Magnit and O'Key's asset turnover ratios were in line with Wal m art's in the last financial year , and have been stable over the three - year historical period we have used.

Magnit and O'Key Both Impress Here
Selected Companies Asset Turnover Ratios
Trading Near 200-Day, Up 29% Year-To-Date
O'Key Daily Share Price (US$) and 200-Day Simple Moving Average

Taking into account the food and drink team's excellent food retailing outlook for Russia with compound annual growth of 29.3% forecast in headline sales to 2017 , and our view that upscale convenience retailing is going to be a real growth area going forward in the wealthier cities, we really like O'Key ' s long-term prospects. From a relative value perspective, O'Key stood up well in the ratio comparisons we performed. The one red flag perhaps relates to the company's current account ratio, which has remained below 1 over the past three financial years.

Technically, O'Key's shares are trading close to their 200-day simple moving average, which could make for a good entry point, particularly given the fact that O'Key has delivered strong same-store sales growth , in particular through 2012.

This article is tagged to:
Sector: Food & Drink, Retail
Geography: Russia, Russia, Russia, Russia