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Russian Consumer – Short-Term Woes Versus Long-Term Strength

Posted by Editor on Wednesday, 02 November 2011 14:43 | Published in Retail & Consumer Goods
Russian Consumer – Short-Term Woes Versus Long-Term Strength

A vigorous de-rating of the retail sector has created an opportunity to buy growth stories at a fraction of their fair value. The aggregated capitalization of our covered companies is now at 1Q10 levels (despite 55% higher EBITDA generation), which represents an average 34% discount to EM peers on 2012E EV/EBITDA. We believe that fears over the deterioration of sector growth and profitability are overplayed, and the sector should resume steady expansion from 1Q12, once the high-base effect is exhausted. We reduce our target prices by 4-15% to reflect higher COE and lower 2011 revenues, but reiterate our BUY recommendation on all our covered stocks.

> Economic backdrop supportive for the sector. The unemployment rate dropped to 6.0% in September, in line with the pre-crisis average, while decelerating food inflation boosted real disposable income growth (3.2% versus 0.4% in July). Along with consumer confidence, which improved Q-o-Q despite ruble volatility, we forecast food retail turnover to return to steady 4.5% growth in real terms, contributing to stabilization in the sector's LFL sales.

> Key factors depressing top-line growth to fade by end 2011... The massive top-line deceleration reported in 3Q11 by the two largest retailers can, to a major extent, be attributed to the high base of 2010 and, to a lesser extent, to lower inflation and cannibalization. These factors should be exhausted by end 2011 and companies' top-line generation is to accelerate.

> ...as such, the market will start pricing in positive developments. These developments - historically high expansion rates, upside risks to capex projections and outperformance relative to EM peers - have been ignored. Furthermore, additional upside may come from the reduced social tax next year.

> Current valuations imply an overly somber scenario. Our sensitivity analysis shows that current valuations imply a long-term exchange rate of R37/$1 or average LFL sales of 3.8%, substantially lagging anticipated inflation. Even accounting for diverging profitability trends in 2H11 (already guided by the companies), it is far more sinister scenario than one could assume, thus we foresee more upside risks than disappointments.

> Both X5 Retail Group and Magnit trade at discounts to EM peers. At respective discounts of 45% and 20% to EM peers on 2012E EV/EBITDA, we like both names but see more value in X5 Retail Group after a heavy correction. At the same time, we are positive on Magnit's local shares, which now offer a 9% discount to the GDRs.

> Less liquid names offer the cheapest exposure to the sector. M.Video and Dixy Group are trading at respective discounts of 17% and 51% to EM peers on 2012E EV/EBITDA (at 4.9 and 6.5). M.Video's margin is not set to contract due to a weaker ruble (contrary to widespread belief), whereas Dixy Group should exhibit decent progress with its Viktoria integration.

Mikhail Krasnoperov, Georgy Tarakanov, Artur Galimov or Maria Sukhanova

Russian Consumer – Short-Term Woes Versus Long-Term Strength
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