Katy Askew

BRICs and beyond: Russia's X5 struggles to deliver on strategic objectives

By Katy Askew | 22 August 2012

X5s pricing policy has seen it lose traffic to rivals

X5's pricing policy has seen it lose traffic to rivals

X5 Retail Group has had a turbulent year. Management changes and a significant strategic shift that has sidelined the importance of M&A to the group's expansion plans have combined with an intensely competitive market to leave Russia's largest retailer losing share to its peers. Katy Askew suggests the next 12 months will be telling for the company.

X5 Retail Group revealed its sales and margins are trailing its Russian retail peers when reported its first-half numbers yesterday (21 August).

The company said consolidated net sales increased by 9.7% in rouble terms, boosted by store openings and inflation, which averaged 3.85% during the six month period.

However, sales growth came in significantly lower than X5's peers, with O'Key reporting sales expansion of 26% in the first half, while Magnit's sales were up 33% in the first six months of the year.

X5's like-for-like sales dropped by 2.5% in the second quarter, its third consecutive quarter of like-for-like decline.

Like-for-like trends were hit by X5's pricing policy, management conceded during a conference call with analysts. Failure to maintain a competitive price positioning meant X5 lost traffic to rivals in major - and highly competitive - urban markets, such as St Petersburg and Moscow, management said.

"X5 is currently underperforming both in terms of revenue and in terms of EBITDA/net margins," Aton analyst Alexey Evstratenkov tells just-food.

The group's EBITDA profit margin declined to 7% in the second quarter, down from 7.1% in the comparable period of last year, while net profit margin slid to 1.7%, down from 1.8% last year.

X5 management said margins were hit by higher logistical costs in the second quarter associated with its opening of a new distribution centre and the transfer to a direct import model. However, management insisted during the conference call held after the release of its results, these initiatives would have long-term benefits that will ultimately boost margins and help set it apart from rivals.

According to Evstratenkov, X5's weak performance during the first half means - unless there is a sudden and drastic improvement in performance - the company could be forced to downgrade its outlook for the full year.

"Management is planning 15% year-on-year growth on the top line for fiscal 2012. However, so far this year they are pretty far from their target and might revise it downward in the second half of the year," Evstratenkov warns.

X5's performance has been hit by a number of factors, including a management shake-up that has seen the retailer replace almost all of its top executive team.

In a bid to foster the long-term development of its various formats, the retailer announced a number of high-level appointments designed to drive growth and expand the group's talent pool. These included the recruitment of Rewe executive Jan Fuchs to head up its hypermarket arm, while Frank Michael Mros - formerly the head of Lidl's operations in Germany and the UK - took on responsibility for the company's discount business. Meanwhile, former Tesco and Casino executive Paul Martins was appointed commercial director.

However, hot on the heels of these appointments came the shock announcement in July that X5 CEO Andrei Gusev would stand down. Stephan DuCharme, an independent member of the X5's supervisory board, has taken on the role of CEO on a temporary basis while the company conducts a search for a replacement.  

The succession of high-level appointments and disruption caused by Gusev's exit could have played a role in X5's lacklustre results, Natalya Kolupaeva, senior analyst at Raiffeisenbank tells just-food.

"The operational underperformance versus its rivals can also be explained by the massive management reshuffle over the past year, which triggered changes to internal business processes," she suggests.

However, according to Kolupaeva, various X5 initiatives - such as its investment in the establishment of direct imports, its logistical overhaul and its new pricing strategy - could see the firm improving its sales and profitability in the coming year.

"The new management team needs time to deliver on its objectives, and only one year has elapsed since the operational transformation. Next year, the company is expected to demonstrate the results of the measures taken this year, including the greater focus on logistics development, revised marketing and assortment policy and the launch of direct imports," she says.

The company has also made a significant strategic shift that will see its growth move away from the reliance on acquisitions that has marked X5's path to becoming Russia's largest retailer by sales. Instead, X5 indicated it will focus on organic growth and new store openings.

Through new stores, X5 plans to continue to diversify, expanding its presence as a multi-format retailer in burgeoning categories such as convenience and online. X5 revealed it plans to open 100 outlets in its convenience format this year.

With this new strategic direction in place and a "full understanding" of the trials ahead, Kolupaeva says the coming year is one not only of challenges but also of opportunities for X5.

However, should the newly established management team - which is currently minus a permanent CEO - fail to deliver in the coming months, X5 could risk losing its position as kingpin of the Russian retail scene.

"If the company loses out in the competitive race for market share expansion next year, it will be hard to turnaround the story because the market is changing rapidly, and its competitors are developing more ambitious expansion plans," Kolupaeva warns. 

In this context, it is clear that when X5 does appoint a new CEO the person that takes the helm will need to hit the ground running.

Sectors: Emerging markets, Financials, Multichannel, Retail

Companies: X5 Retail Group, O’Key, Magnit, Rewe, Lidl, Tesco, Casino

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