Have investors fallen out of love with Magnit, the star of Russia’s retail sector for many years and one of the most profitable retailers in the world?

The stock was a must-have as the retailer that uniquely shunned Moscow went from strength to strength, driving up earnings which were over $10bn last year. However, last year the stock was flat between January and December, while the market as a whole was up over 50%.

In London, the company’s share price went down throughout 2015 and kept fluttering in 2016, losing serious ground to its main competitor, X5: in April 2015, Magnit’s shares were worth $58, while X5’s shares sold at $18. Today, the price is closer to $40 and $30 respectively. Shares in Magnit have also been on a downward trend at the ruble-denominated Moscow Interbank Currency Exchange (MICEX) since the beginning of the year.

Magnit’s troubles aren’t new: in 2014, the company’s London-listed GDRs dipped nearly 20% following worse than expected results, prompting CEO Sergey Galitsky, who refuses to move to Moscow as he finds it too materialistic, to lash out against investors. “I don’t know what [they] fantasise about,” he told the Financial Times at the time. “If they want to continue to make 60% to 70% per year all the time, that is not Magnit, that is Las Vegas.”

But things have not gone better since, and 2016 was especially tough for the company based in Krasnodar, Galitsky’s hometown in southern Russia. The company’s market capitalisation fell by around 14% over the past year to stand at around $16bn, according to Reuters.

Net profit went down nearly 8% (and 15% in the fourth quarter), with revenue growing by 12.8%, the lowest growth in 11 years, Russian information portal RBK reported. Meanwhile, X5 boasted a 27.5% revenue growth in 2016, “the highest growth since 2011”.

Regional troubles

So what is going on with Russia’s poster boy for modern retail? Is it due to bad management or has the company and/or the sector simply reached saturation? Magnit’s sheer size and its presence in crisis-stricken parts of Russia means the company has been more exposed than other retailers to the economic slowdown of the last years, analysts told bne IntelliNews.

With low consumer confidence and falling disposable income (despite an uptick in January), retail sales have been hit across the board; they fell 5.9% in December, and 4.1% the month before, although the pace of the contraction has been slowing since the start of 2017 and economists believe retail sales will start growing again this year.

But Magnit took a heavier hit because most of its 14,059 stores are located in small regional cities, where household wages were most affected, according to Renaissance Capital research analyst David Ferguson. “If you are in Moscow, maybe you delay upgrading your car, but in some regions people are so desperate they are cutting back on food,” he says.

Meanwhile, X5’s expansion – the company has expanded from 4,544 outlets in 2013 to about 9,000 today – means the bulk of its business is based in the big regional cities where incomes have been hurt less and it has been cherry picking amongst those regional cities where Magnit used to stand alone. This competition will only increase with time, analysts believe, though it may first come at the expense of regional chains and independent stores, which have been forced to sell to the big boys as part of a crisis-inspired consolidation.

From chemicals to sausage

From its start as a wholesale chemical products company launched in the southern city of Krasnodar in 1994, Magnit counts as one of Russia’s best success stories. From a standing start in Russia’s regional backwaters, Magnit grew into a retail empire covering all of Russia’s territory and employing 260,000 people. By 2016 the company was still the country’s biggest retailer by revenue, though X5 overtook it the fourth quarter of last year on a quarterly basis with RUB291.29bn ($4.903bn) against Magnit’s RUB282.4bn ($4.751bn).

Magnit would not comment on the company’s results or future plans, but even if it concedes its top slot ranking it remains a formidable company with a reputation for pearly white corporate governance and up to the minute management skills.

But it still has issues. While analysts see the recession, Magnit’s regional exposure and the increasing competition from X5 as the main factors behind the company’s troubles, the poor reputation of its stores has also been brought up as an explanation. “The value proposition of Magnit’s convenience stores… doesn’t look very compelling,” Marat Ibragimov, an analyst at BCS Global Markets, says.

The company seems to have acknowledged the problem, focusing in recent years on closing inefficient outlets and refurbishing existing stores. It plans to refurbish up to 1,500 stores in 2017. “However, it would most likely take 2-3 quarters to have meaningful impact on the operations, so I see Magnit as a structurally underperforming story in this period,” Ibragimov adds.

Nevertheless, “for convenience stores, where you go to buy everyday items, location and price remain the two biggest factors, everything else is secondary,” Ferguson argues. And because Magnit came early, its 10,000 convenience stores across Russia often enjoy good locations.

Despite slower revenue growth and falling stock price, there is little doubt that Magnit remains a very strong company. “It is one of the most cost-efficient companies in Russia,” according to Ibragimov, with a logistics network that boasts “by far the biggest truck fleet in the country”.

The comparison with X5, while unavoidable, is also flawed, Ferguson says, because X5 makes a 7% margin on each sale against Magnit’s 10% margin. Magnit should therefore remain the most profitable retailer even if it gets outperformed by X5 in terms of sales, something that Galitsky claims is part of the company’s strategy: “The top spot is not for us. We are for profit, we are for money, we are for a profitable business,” he told analysts and investors.

“Magnit is still a phenomenal company. For many years it used to deliver incredible growth, and it’s true that it’s difficult to keep delivering that.” says Ferguson. “But by comparison, X5 was a disaster for years. They started to fire on all cylinders recently but once they fix the low-hanging fruits, investors will wonder how they can sustain that growth.”

 

Magnit Key Financials Fiscal year end	Dec-15	12/16F	12/17F	12/18F
P/E, x	23.8x	21.8x	18.7x	17.2x
EV/EBITDA, x	14.4x	12.1x	10.6x	9.8x
P/B, x	8.5x	6.2x	5.0x	4.4x
FCF yield, %	1.30%	0.30%	-0.40%	-0.50%
DY (ords), %	2.50%	2.40%	2.70%	2.90%
Net sales,	950,613	1,074,812	1,196,467	1,364,107
RUB mn
EBITDA, RUB mn	103,973	107,749	119,535	133,467
Net income,	59,061	54,363	59,483	64,669
RUB mn
Net sales, chg	25%	13%	11%	14%
EBITDA, chg	21%	4%	11%	12%
Net income, chg	24%	-8%	9%	9%
EPS, RUB	124.9	115	125.8	136.8
DPS (ord.), RUB	74.56	59.67	62.9	68.39
BPS, RUB	349.3	404.6	467.5	535.9
EBITDA margin, %	10.90%	10.00%	10.00%	9.80%
ROE, %	36%	28%	27%	26%
Net Debt, RUB mn	95,837	120,523	154,703	192,942
ND/EBITDA, x	0.9x	1.1x	1.3x	1.4x
Net int. cover, x	7.0x	6.2x	6.1x	5.9x
Source: Bloomberg, Company data, VTB Capital Research

 

X5 Key Financials Fiscal year end	Dec-14	12/15F	12/16F	12/17F
P/E, x	14.7x	15.8x	14.2x	10.7x
EV/EBITDA, x	6.4x	7.1x	6.9x	5.6x
P/B, x	2.1x	2.6x	2.7x	2.2x
FCF yield, %	0.60%	-11.20%	-2.30%	1.30%
DY (ords), %	-	-	-	-
Net sales, RUB mn	633,873	812,177	1,019,935	1,242,958
EBITDA, RUB mn	45,860	58,790	73,399	89,592
Net income, RUB	12,692	17,852	25,344	33,806
mn
Net sales, chg	19%	28%	26%	22%
EBITDA, chg	20%	28%	25%	22%
Net income, chg	16%	41%	42%	33%
EPS, RUB	46.75	65.76	93.35	124.5
DPS (ord.), RUB	-	-	-	-
BPS, RUB	333.6	399.3	492.7	617.2
EBITDA margin, %	7.20%	7.20%	7.20%	7.20%
ROE, %	14%	16%	19%	20%
Net Debt, RUB mn	105,363	136,950	145,373	140,726
ND/EBITDA, x	2.3x	2.3x	2.0x	1.6x
Net int. cover, x	2.3x	2.4x	3.0x	3.7x
Source: Bloomberg, Company data, VTB Capital Research