Russian retail colossus Magnit has overtaken X5 Retail Group to become the country’s largest by sales. While anticipated, speculation is now likely to turn to whether Magnit can extend its lead, or if X5 has what it takes to up its game and claw back the number one position.

Magnit has a lot to smile about. The retailer, which has for years clung to the coat tails of its rival X5 Retail Group, has finally reached the summit. It can now call itself the number one grocer in Russia by sales. 

The retail group, owned by Russian billionaire Sergey Galitskiy, had been touted for some time by analysts to overtake its closest rival at some point this year. Investor relations director Timothy Post had also hinted to just-food last week on the release of its results that such an announcement was imminent.

And when you look at the statistics you can understand why. Magnit, Russia’s largest food retailer by number of stores and now sales, is opening shops at a rate of three per day. Its store count stands at around 5,700. And according to Business Monitor International, the group has a market valuation to rival that of Europe’s largest retailer Carrefour.

Having started out in the city of Krasnodar in the south of Russia, it has quickly grabbed business in provincial towns from outdoor markets and kiosks, and now has a presence in almost all major cities in Russia. Indeed, only today the group announced the opening of its first convenience store above the Arctic Circle in the Murmansk region.

This growth has no doubt been helped by Russia’s expanding retail scene. The Russian retail market has achieved dynamic growth over the past few years as disposable incomes have increased and the expanding middle class has emulated Western patterns of consumption.

Magnit has clearly fed off this as it has worked away at its expansion. The retailer saw profits almost double in 2012 when net profit totalled US$803.9m, up from $418.7m in 2011. During the year, it opened more than 1,500 stores during the year.

In contrast, X5, controlled by billionaire Mikhail Fridman’s Alfa Group, has revealed a less inspiring performance. While X5 has not yet published full-year earnings for 2013, its sales growth was up 8.4% to $16.2bn last year, a figure dwarfed by Magnit’s full-year sales gain of 34% to $14.29bn.

Again, in this month’s first-quarter results, Magnit and X5 booked sales gains of 30.4% and 8.1%, respectively.

X5’s gowth in this year’s first quarter was quicker than in the corressponding period last year but the results disappointed the market as the retailer saw an outflow of customers from all its formats, particularly in hypermarkets, where traffic was down 7.9%.

There is no doubt X5 had been struggling to defend its market share. It has been having problems digesting its acquisitions and managing stores. It has also been less aggressive at opening new stores, opening 800 in 2012.

“X5 was a proponent of an M&A development strategy, which appears to be a challenge with each particular acquisition – as the company needed to integrate the acquired retail chain into its own operational system, spending a lot of time and effort,” Raiffeisen analyst Natalya Kolupaeva tells just-food.

“At the same time, the company itself recognised the problem of insufficient investments into store modernisation, enhancing efficiency of logistics, etc.., which led to the deterioration of consumer perception of X5’s stores and on the back of increasing competition negatively affected the consumer traffic flow.”

Magnit, however, has worked to a different strategy. Its extensive programme of new store openings has enabled it to exact more competitive terms from suppliers, resulting in margin improvements and enabling it to close its gap on its rival.

“Magnit has been consistently developing its store base in accordance with the organic growth strategy – step by step, prioritising growth but also focusing on operating efficiency at every level – at the store level and throughout the supply channel,” Kolupaeva says. “The company started its business at the right time and chose right – convenience stores and hypermarkets.”

She says the successful formula for Magnit’s growth lies in its “efficient” management team, its store opening process and “very good administrative and financial discipline”.

“Going forward, if Magnit is able to deliver on its ambitious store opening plan, which assumes doubling of its selling space by 2017-2018, thus, if things remain as they are – the gap between Magnit and X5 is likely to continue to expand.”

Magnit does have ambitious targets. Its capex this year has been set at $1.8bn, compared with $1.6-1.7bn in 2012. Of the $1.8bn, 80-85% will be covered by free cash flow. Next year’s capex is expected to be the same, but 100% will be covered by free cash flow. By 2015 Magnit expects to be net free cash flow positive, meaning the retailer will be almost able to self finance its growth.

Post told just-food last week that, by 2017, it will look to open around 11-12,000 convenience stores and 500-650 hypermarkets.

Novirost analyst Ian Luyt believes Magnit’s success and its ability to continue to expand, in comparison to X5, is down to its leadership. X5 has seen a succession of high-level appointments, including the exit of CEO Andrei Gusev last July. Since then, the company has replaced the majority of its high-level managers. The disruption, he argues, could have played a role in X5’s lacklustre performance. 

“X5 seems to have lost its way in recent years and is still recently going through key management changes,” Luyt observes. 

This is a view shared by Otkritie Capital analyst Mikhail Terentiev.

“[Magnit’s] success is a function of many things, but in the first place it is run by it owner, which is unusual. However, for the most part, this is good. You have a good owner with good vision and one that is focused and determined. That is very good for the company.”

Terentiev believes Galitskiy is completely focused on sustainable long-term results.

“Ten years ago they probably invested a bit more than they had to, they put in more effort than they should have. If you look back to 2007 when they became public, there were questions regarding whether they should invest that much, whether they should pursue less capital intensive growth. But what we’re seeing now is all these accumulative efforts paying off. They had a good 2012 because they’ve done a good job over the past ten years.”

Terentiev, however, also points to Magnit’s “very balanced” growth model, which has included store openings also accompanied by an expansion in logistics, infrastructure, IT and management capabilities. Innovation has also been key, he points out, particularly in technology and developing tools to support changes.

“This is important in retailing because it is a particularly transaction intensive business. You have millions of transactions, thousands of suppliers and to control this you have to have very strong and very reliable platforms in place.”

For Terentiev, the final string to Magnit’s bow is the retailer’s financial position and its discipline in not taking on too much debt. “That is one of their features as a business. “When the crisis hit in 2008/09 they were in a great market position and they were able to gain market share.”

Does X5 have the ability to continue to compete effectively and ultimately regain its pole position as kingpin of the Russian retail scene?

Various initiatives X5 has implemented over the past year such as 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.

It has also made a significant strategic shift that will see its growth move away from the reliance on acquisitions, and instead focus on organic growth and new store openings.

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

These could all provide opportunities for X5 to make a play for its old title. Kolupaeva and Luyt both believe this is possible with the right strategy in place.

For Kolupaeva, building an “efficient” management team will be key and she also says M&A could help the business. Luyt believes the right management team could offer it “significant scope for growth and no impediment to getting back to number one”.

For Terentiev, however, the number one position may now be out of its reach.

“Under certain circumstances X5 could regain its number one position but I don’t think it’s likely. In the absence of mature M&A on the part of X5, I think Magnit’s leadership should be maintained.”

Let’s not forget, X5 is only in the early stages of its turnaround cycle and only just beginning to make some measures to fix its growth problems. These initiatives will take both time and money to yield meaningful results.

“If they pull [the turnaround] off, eventually they should be in a position to re-accelerate growth and probably pursue more M&A. But the problem is, M&A is part of the reason why they got into trouble. From my numbers, Magnit will be the market leader forever.”