18 Jun 2020

X5 Retail CFO Svetlana Demyashkevich: Any crisis is an opportunity for large companies

Dread of the quarantine amid the coronavirus caused the country's population to recall the empty grocery shelves of years ago, providing food retailers with unusually high sales in March. Market leader X5 Retail Group saw retail revenue rise 20% in March, and increase 15.9% overall by the end of the first quarter this year, exceeding the 11% growth of the fourth quarter last year, a time that traditionally has the year's highest sales during the run-up to the holiday season. Interfax interviewed X5's CFO, Svetlana Demyashkevich, who spoke about demand following the shopping frenzy in March, and about how the rules of the game in retail are changing.

Question: How did the company's sales perform in April and May? How did the dynamics of revenue, customer traffic and average bill change?

Answer: We began to notice an increase in the rate of sales back in March, and this trend continued in April and May. Our revenue in April and May significantly exceeded the budget. In April, growth was approximately at the level of the first quarter, that is, above 15%, which was also above our expectations. In May, growth stabilized slightly compared to April and March, but remained quite high and again exceeded our expectations. In early June, we once again see an acceleration relative to May.

If we look at the formats, then the Pyaterochka chain of neighborhood grocery stores is operating very well, as proximity is now important, as are Perekrestok supermarkets located in residential areas. If people previously went to different stores, with one buyer visiting six to seven shops in order to buy groceries, then this number has now reduced. People choose at most one to two grocery stores, so the number of purchases in one basket is growing. The closure of cafes and restaurants has also affected the number of purchases in a shopping basket as well as the selection of additional items. For us, this is of course a good trend, given the number of Pyaterochka stores that are located near consumers.

We also see a continuation of the trend for increased sales in the online supermarket segment of Perekrestok.ru and express delivery. We had growth of 40% in May of this year against April, and 7-fold growth against May of last year. Our total online sales in May reached 2.4 billion rubles, so we are once again among the leaders and are pleased with the result.

If we are talking about the dynamics of traffic and the average bill, then the same trend continued in May from April. Although people now go to grocery stores less often, the number of purchases in a basket is much larger, which offsets the effect of falling foot traffic, placing LfL sales at a good, positive value.

Q.: Is there any reason to expect a strong financial performance for the second quarter?

A.: Yes, we are now looking at the situation much more optimistically than in early April, because there were more risks then that were difficult to assess, and we were rather conservative in estimating these risks. Now we see that we have a good trend, sales are high; and, of course, this has a positive effect on profitability. Moreover, many of the additional expenses that were needed in March, and we provisioned for them for April and May, were not necessary. For example, we expected higher losses as a result of stocktaking, but this did not happen.

Consequently, the financial results now exceed our expectations, and are significantly higher than the budget. We see that the EBITDA margin in the second quarter corresponds to last year, when second quarter financial results were at record highs. Allow me to say that the EBITDA margin then was 8.3%. The quarter is of course not over yet, though we do have April and May results. Based on these, we have every reason to believe that the results of the second quarter will be very strong.

At Pyaterochka, for example, margins for April and May are higher than last year, which, of course, is a very good result amid the current situation.

Another positive factor has been that we were able to reduce the share of promotional items back in January and February of this year compared to the fourth quarter of last year. This decline was planned, and we have managed to maintain a comfortable share of promotional items in the second quarter. These two factors of a reduction in losses and a decline in the share of promotional items have had a positive impact on the gross profit margin.

Q.: How significantly has the pandemic contributed to revenue growth?

A.: We witnessed panic buying only in the last two weeks of March. There is no frenzied shopping nowadays; however, both April and May in terms of growth are significantly higher than our budgets, and there is an overflow of customers from our competitors from traditional retail as well as from the prepared food sector.

When public catering and restaurants are closed, grocery stores receive customers who start cooking more at home; and we still see this trend. So, in my opinion, the growth rate in the second quarter will be very solid, and will possibly continue in the third quarter, as fewer Russians will go on holidays and vacations abroad; and health and safety concerns will continue, while visits to cafes, restaurants or to several grocery stores at a time are likely not to reach the previous levels very soon.

Q.: Given that health and safety measures have been in effect in grocery stores for some time, how will the additional costs affect the financial performance of X5?

A.: Indeed, we have additional costs associated with payments to staff, as well as the purchase of disinfectants and personal protective equipment for our employees in the stores and distribution centers. The total amount of such expenses in March and April was about 1 billion rubles, but these expenses have been offset by positive profitability, owing both to the gross margin and to savings on operating costs.

Meanwhile, we have additional investment in our online services, though this is also covered by the revenue growth that such new services generate. In terms of the profit margins, the results are much better than our expectations and the budget that we set last year.

Q.: Have you factored the risks of tightening regulations in the e-grocery segment into your development plans?

A.: We see only positive initiatives thus far. These are, for example, changes in the requirements for online pharmaceutical drug sales and the potential legalization of online alcohol sales. Of course, both of these will have a positive effect on our results.

Q.: Developing express delivery does not require a large investment; so, how much does X5 plan to invest in its online supermarket in the coming years?

A.: We have invested around 3 billion rubles in capex in Perekrestok.ru since 2017, and about the same 3 billion rubles in the planned loss of the online supermarket and express delivery. For comparison, X5's total capex last year was 81 billion rubles, meaning that costs of 3-6 billion rubles for online over three years are not that significant for us, and they provide us with a leading position in this segment.

In addition, for example, the cost of opening one dark store for an online supermarket is about 500-600 million rubles. Even taking into account the expanded assortment, this is 600-800 million rubles. Usually, we open two or three dark stores a year. In general, for such a large company as X5, this is not a large cost.

Q.: In April, the company updated its 2020 guidance, with capex the same as in 2019, a decrease of 20% in the number of new store openings from the original plan, and a 40% cut in the renovation program. Have any reasons arisen to adjust this forecast, or is the situation developing along the expected scenario? Does X5 plan to speed up the expansion of its network in 2021, taking into account that the stores are the foundation for developing express delivery?

A.: It is true that amid the pandemic, we revised the capital expenditures program for this year downward. These plans have not changed. The program for openings will be reduced by about 20% and the renovation program by about 40%. That said, we are constantly analyzing the results of our new store concept and are very pleased with them. We are seeing that LfL traffic growth in Pyaterochka grocery stores exceeds 10% after renovation. But we realize that the economy in general and our customers are feeling the consequences of the pandemic, so right now we want to be a little more cautious in terms of plans to open and renovate stores.

Meanwhile, we have not stopped investing in digital transformation and in online services, and are even increasing them slightly. For example, we are opening dark stores that last year we had not planned to open; however, in terms of total investment, we expect that they will cost less than last year, that is, less than 80 billion rubles.

It is difficult to talk about 2021 now. We will look at the results of the second half of the year, the situation in the economy, the dynamics of household incomes and the competitive environment. There are many factors here, so we will probably talk more about our plans in the second half of the year.

At the same time, of course, brick-and-mortar retail will continue to develop, and we will increase the volume of sales in our stores by improving quality. Anyway, we are continuing to open new stores quickly and to occupy the best locations in the regions of our presence.

Q.: Does X5 have plans to adjust its dividend policy in the future?

A.: As I have said, our revenue now exceeds expectations, and the financial results are there, too, while we are saving on capex, and we are quite conservative in our approach to investments. These three factors provide us with additional cash flow, which has also exceeded our forecasts.

My personal opinion is that the company has the opportunity to increase dividends payments substantially for this year, partly thanks to our leverage: net debt/EBITDA was below 1.5x for Q1, while usually we are geared towards 1.7-1.8x. We shall be monitoring the situation, discussing it with the supervisory board. The 2019 dividends were around 20% higher than those paid for 2018, and now we see the opportunity to raise dividends for 2020 by up to 50% from the level of 30 billion rubles.

And I think we'll be able to keep dividend payments high going forward. This gives us reason to think about potentially reviewing our dividend policy and making it more transparent. Right now it's fairly conservative, minimal payments are 25% of net profit. But we have always paid much more than that. The first payment for 2017 was 69% of net profit, the second for 2018 was 87% and the dividends for 2019 were nearly 116% of net profit. Both management and the supervisory board currently think the company will be able to increase the amount of dividends in absolute terms on an annual basis, as we grow the business and keep our margins sufficiently high, despite our investments in new business.

Q.: In line with the strategy that X5 presented at Investor Day last year, the company's market share should reach around 20% in 2029, and the share of new businesses, including the online supermarket and express delivery, should account for 20% of X5's revenue. Are these still the company's goals?

A.: Yes, so far we believe that a benchmark of 20% of revenue from new businesses in 10 years is quite realistic; however, this is not a sort of specific goal for management. If we are talking about the total market share of X5, we also believe that 20% is a perfectly achievable figure owing to the quality updating of existing stores, increasing sales volumes, as well as opening new stores and dynamic online development.

Q.: How is the crisis today affecting the retail market overall? Does X5 foresee small, regional players leaving the market? Are there any interesting assets to acquire?

A.: I think that any crisis is an opportunity for large companies. Historically, during crises, market leaders have strengthened, including X5, and we believe that consolidation in the retail market will continue. We think that by 2025, the five largest chains will account for around half of the retail market. This consolidation will likely occur primarily at a cost to traditional retail, with a reduction in the share of less efficient regional chains. We also forecast that the share of hypermarkets will decrease, while the share of neighborhood grocery and convenience stores, supermarkets, and, of course, online sales, will increase.

Moreover, it is not certain that this consolidation will take place in the form of a large number of classic M&A deals. Today, about 55%-60% of our openings take place at the locations of stores of smaller, less efficient players, meaning that they are "organic" M&A. This is a more effective strategy for us to increase our market share than classic M&A, because we open in areas where customers are already used to going, and we do not pay excessively for a premium to acquire a controlling stake.

Structurally, there is still room for consolidation in Russia. If we compare [ourselves] with other countries, then our share of the largest players lags substantially. According data from InfoLine, the top five chains in Russia last year had a 29% market share. If you look at Germany, for example, the share of the five largest retailers was 74%; in Britain, it was 61%; and in France, it was 54%. Therefore, of course, we still have much space in which to expand and consolidate.

The most significant growth, I think, will likely occur in the segment of neighborhood grocery and convenience stores. We have been observing this overall trend for the past few years, where convenience stores are occupying an ever increasing share and are valuable assets, as they provide the most frequent as well as repeated contact with consumers. And, of course, the online segment will grow rapidly; however, brick-and-mortar retail will dominate for a number of years to come, with convenience stores at the forefront. I think that we have every opportunity to remain the market leader, given the addition of the omnichannel format to the cost-value proposition, as well as modern technology, such as self-service checkout and digital marketing.