Magnit: the Russian Wal-Mart story

Transcription

1 EQUITY RESEARCH: FMCG & RETAIL RESEARCH DEPARTMENT Local shares Recommendation BUY Target price, $ 120 Closing price (as of ), $ Upside potential 37% GDRs Recommendation BUY Target price, $ 27 Closing price (as of ), $ Upside potential 41% PEG ratio (Magnit vs international peers) Carrefour ShopRite Colruyt Sainsbury's Kroger Tesco Wal-Mart WM de Mexico Morrisons Bim Birlesik Magnit Source: Bloomberg, Gazprombank estimates Food retail penetration (share of Top 5) 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Sweden Finland Switzerland France England Germany Hungary Czech Rep. Poland Russia Magnit s margins performance 10% 8% 6% 4% 2% 0% Rustam Shikhakhmedov +7 (495) Rustam.Shikhakhmedov@gazprombank.ru Source: Gazprombank estimates E 2011F 2012F 2013F 2014F 2015F 2016F 2017F Net income margin EBITDA margin Gross margin (Rhs) 24% 23% 22% 21% 20% 19% We initiate coverage of Magnit with a BUY rating. We expect strong top-line growth on new convenience store openings and hypermarkets roll-outs. Substantial momentum behind expansion of retail space, improved cost control and resilience to the downward consumer trading shift should help the retailer post revenue CAGR of 26.4% and EBITDA CAGR of 25.5% over the next five years. However, the company s strategy could be threatened by stricter legislation and, in the short term, by gross margins shrinking as a result of investments into price attractiveness made to foster customer loyalty. The macro environment and consumer sentiment are favoring Magnit s business model. The company deliberately avoids competing against retail majors by focusing on smaller towns, and its winning core convenience store format, the ability to get some of the best terms from suppliers and superior logistics should help maintain the longterm EBITDA margin in the % range. Russia s stronger economic data would also contribute to Magnit s performance. Strong operational cash flows combined with continued organic growth will allow Magnit to finance its aggressive expansion and maintain low leverage. We expect $691 mln net operational cash flows in 2010 and $956 mln in 2011, which should allow the food retailer to continue expansion to the Russian regions with its convenience store format, whose short payback period is seen as a major benefit under the current economic conditions. The company offers the best balance sheet structure among listed food retailers and no foreign currency debt exposure. The lowest debt level in terms of Net Debt/EBITDA, which stood at 0.1 at the end of last year, gives Magnit an advantage in capital markets that remain volatile and enabled it to be the first Russian listed retailer to pay dividends. Zero foreign-currency denominated debt also gives Magnit an advantage over its Russian peers. Magnit maintains strong margins thanks to good logistics, successful private label projects and direct imports. Investment into in-house and innovative logistics, optimization of internal business processes, together with stronger bargaining power have already proved their value for the company and there is still room left for more efficient operations. Magnit has a healthy 23% gross margin and a 27% net income CAGR over the next five years. We derive Magnit s target price using the DCF approach. We adopt the relative valuation for testing purposes only. The latter supports our view that Magnit s shares are significantly undervalued as on financial multiples the company trades with a 16-27% discount to peers in emerging markets. We assign a BUY rating to Magnit with a target price of $120 (RUB 3,700) per share on MICEX and $27 per GDR on LSE. Despite a rally in Magnit shares last year (over 400% growth), they are trading with an average 17% discount to EM peers on 2010E EV/EBITDA. This is unjustified considering Magnit s projected 39% EBIDTA growth in US dollars in 2010 y-o-y EM counterparts are set to post 25% EBIDTA growth. Magnit outperforms X5 (+36% in US dollars in 1Q10), Dixy (+28%) and Seventh Continent (+24%) in terms of sales growth (+46%). We expect this trend to carry on into the middle term. Besides, Magnit shares are more liquid (45% free float) than X5 shares (27%). Key Financials, $ mln E 2011F 2012F 2013F 2014F 2015F 2016F 2017F Sales EBITDA EBITDA margin 7.5% 9.5% 8.9% 8.9% 9.1% 9.1% 9.2% 9.2% 9.1% 9.0% Net income CAPEX Free cash flow (98) 340 (324) (88) Net debt (233) (803) (2 003) Net debt/ebitda neg. neg. neg. Source: company, Gazprombank estimates Copyright «Gazprombank» (Open Joint-Stock Company) 1

2 CONTENTS Investment Summary 3 Consumer sector 5 Growth is back 5 New trade law 7 Competitive environment 8 Corporate overview 12 Background and business model 12 Shareholder structure and dividend policy 13 Ruble appreciation is positive for company shares 14 Zero debt burden 15 Projections 16 Macro environment 16 Expansion 16 Like-for-like growth rates and revenue 17 SG&A performance 17 Margins 18 Valuation 19 DCF model 19 Multiples-based approach 22 Appendices 23 2

3 Local shares Recommendation BUY Target price, $ 120 Closing price (as of ), $ Upside potential 37% GDRs Recommendation BUY Target price, $ 27 Closing price (as of ), $ Upside potential 41% General information Ticker MGNT Closing price (as of ), $ # of shares outstanding, mln 88,975 Free float approx. 45% Market Cap, $ mln 7,815 Net debt, $ mln 48 Minority Interest, $ mln - EV, $ mln 7, week high week low 34 Source: Bloomberg, Reuters, company data Relative Valuation EV/EBITDA 2011 P/S 2011 Magnit Emerging Markets Developed markets Source: Bloomberg, Reuters, Gazprombank estimates Stock Price Performance 3,000 2,500 2,000 1,500 1, January-09 March-09 May-09 July-09 September-09 Magnit (local shares) November-09 January-10 March-10 May-10 Investment Summary Russian food retailers will outperform their global peers due to low penetration of modern retail formats, especially in the Russian regions. The penetration, by our estimates, reached 41% in 2009 and will grow only to 49% in 2015 vs. more than 80% in DM. Russia s food retail is still a long way from maturity, which means industry leaders will continue to capture market share from other players small regional retailers that struggle to survive in the challenging market environment. No effect from the new retail law. The new trade law that came into force in February 2010, in our opinion, would have little effect on the development of retail chains and no effect on their earnings (see p. 7). There are several key drivers for Magnit s fundamental growth: Economic recovery and consumer sentiment. The company deliberately avoids competing against retail majors by focusing on smaller towns, and we believe its winning core convenience store format in combination the ability to get some of the best terms from suppliers and superior logistics should help maintain the long-term EBITDA margin in the range of %. Russia s stronger economic data would also contribute to Magnit s performance. Strong operational cash flows combined with continued organic growth will allow Magnit to finance its aggressive expansion and maintain low leverage. We expect $691 mln net operational cash flows this year and $956 mln in 2011 which should allow the food retailer to continue expansion to the Russian regions with its convenience store format characterized by short-term payback periods that come in handy in the current economic conditions. Magnit has the best balance sheet structure among listed food retailers and no FOREX exposure. The lowest debt level in term of Net Debt/EBITDA which stood at 0.1 at the end 2009 gives Magnit an advantage in current markets and enabled it to be Russia s first listed retailer to pay dividends to shareholders. Zero foreign-currency denominated debt also gives the retailer an advantage over its Russian peers. The main risk for the stock this year would be on the gross margin side, as last year, the company, unlike other retailers, did not attract customers by investing in prices. But we believe that Magnit would have to invest its gross margin in prices to confront falling traffic. However investments into in-house and innovative logistics, direct imports, optimization of internal business processes and improvements on the cost side would help Magnit minimize the losses on operational profitability. We therefore expect the EBITDA margin to contract by 0.6 p. p. in 2010 while gross margin will lose 1,5 p.p. RTS (Rhs) 2,700 2,300 1,900 1,500 1, PEG ratio (Magnit vs international peers) Carrefour ShopRite Colruyt Sainsbury's Kroger Tesco Wal-Mart WM de Mexico Morrisons Bim Birlesik Magnit Source: Bloomberg Source: Bloomberg, Gazprombank estimates 3

4 Imports account for about 10% of Magnit s revenue and in 2009, according to the management, it has started to directly import these goods into its stores. Also, by our estimates, imports make up about 10-15% of the retailer s gross margin. We expect direct imports of fresh fruit and vegetables to generate about b. p. this year and up to 70 b. p. in the next five to seven years. Strengthening of the ruble is positive for Magnit s shares, especially for GDRs traded in London. We have tested our model and estimated that with every increase in $/RUB exchange rate by one ruble, the target price rises by approximately 5% in US dollars. However with the ruble weakening the downside is limited due to zero foreign currency exposure. Ruble appreciation also stimulates imports of goods and thus drives likefor-like sales in retail trade as their share in all goods sold in Russia is about 50%. We derive Magnit s target price using the DCF approach. We adopt the relative valuation for testing purposes only. The latter supports our view that Magnit s shares are significantly undervalued as company trades with a 17-27% discount to peers in emerging markets. We estimate Magnit s fair value at $27 per GDR, based on an 8-year DCF model which assumes a terminal growth rate of 3% and a WACC of 10.6%. To value the company s local shares, we apply a 10% discount to our fair value for the GDRs to account for the common shares smaller investor base. We derive a fair value of $120 (RUB 3,700) per Magnit common share, implying a 37% potential upside and assign a BUY rating. Magnit s shares are deeply discounted to foreign peers based on financial multiples. Last year, the stock has quadrupled but is still trading with an average 17% discount to EM peers on 2010E EV/EBITDA. This is unjustified considering Magnit s projected 35% EBIDTA growth in US dollars in 2010 y-o-y EM counterparts are set to post 25% EBIDTA growth. Magnit outperforms X5 (+36% in US dollars in 1Q10), Dixy (+28%) and Seventh Continent (+24%) in terms of sales growth (+46%). We expect this trend to carry on into the middle term. Besides, Magnit shares are more liquid (45% free-float) than X5 shares (27%). Recent inclusion in the MSCI Index should serve as a long-time positive factor for the company shares, expanding the investor base and making the stock more liquid. We believe improvements in traffic, especially good numbers in the new hypermarket segment and strong trading updates in the coming months should also serve as share price catalysts. Magnit s margins performance Food retail penetration in Russia (share of the Top 5) 10% 8% 6% 4% 2% 0% E 2011F 2012F 2013F 2014F 2015F 2016F 2017F Net income margin EBITDA margin Gross margin (Rhs) 24% 23% 22% 21% 20% 19% 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Sweden Finland Switzerland France England Germany Hungary Czech Rep. Poland Russia Source: Bloomberg, Gazprombank estimates 4

5 Russia remains one of the most unsaturated markets in Europe in terms of the number of stores per 10,000 customers Dynamics of average per capita spending groups (RUB/month) 100% 80% 60% 40% 20% Consumer sector Growth is back We see some economic recovery, making the prospects for consumer companies that target domestic demand much clearer. The economic downturn started to affect consumer sentiment and, consequently, retailer performance at the end of However the longterm upward trend in domestic consumption remains, while the after-crisis growth prospects look bright. Currently, low per capita demand leaves room for investing in Russian retailers, based on rising prospects for consumption (expected to grow 3.5% this year, according to our estimates). While the growing purchasing power triggers consumption, it results in a larger scale and enhanced potential of the Russian market saw real double-digit increase (12%) in average annual household consumption while in 2009 there was a decline of 8.1%. In the years before the crisis, the economic boom and a rise in labor productivity spurred the population s well-being and propped up consumer confidence, inciting appreciation of consumer spending that accounted for over 70% of total cash spending. Real disposable income was growing at an average pace of 12% for the previous five years. Near- and mid-term economic issues, given comparably high unemployment, weak consumer lending, salary arrears and corporate cost cuts, will still be affecting consumer recovery in the middle term. 0% Consumer confidence in Russia is improving since 2Q09, indicating that more people believe the economy will improve in the mid-term over 25K 15K - 25K 8K - 15K 4K - 8K up to 4K Source: Rosstat (State Statistics Agency), Gazprombank estimates At the same time, the latest developments in the economy look positive for domestic demand-oriented companies that can spur their revenues: Rising disposable incomes. Real disposable income, according to Rosstat, grew by 7.4% in 1Q10, mainly on slowing down CPI, which rose only by 3.2% in 1Q10 (5.4% a year ago) and 6.5% y-o-y. Retail sales are picking up. According to the Federal Statistics Service, retail sales in Russia grew by 0.3% in real terms in January the first positive number since the beginning of last year and by 1.3% in 1Q10. Rising consumer confidence. Consumer confidence in Russia was substantially affected last year when Rosstat s Consumer Confidence Index, the composite indicator of Russia s expectations, dropped to a neg. 35%. But since 2Q09 it has been significantly improving due to positive changes in the economy and in 1Q10 has stayed at neg. 10%. Stabilizing unemployment. Unemployment (based on the International Labour Organization definition) picked up at 9.5% at the end of 2008 than dropped to 7.6% in 3Q09 and since than is stable. We believe this is a harbinger of recovering demand which we expect to pick up later in the year. 5

6 In , ruble trade was growing at 21% CAGR in nominal terms, expected to grow at 16% CAGR in the next five years Russian food retailers are still in an early stage of development and therefore hold good growth prospects The most evident trend in food retail in 2009 was a consumer shift from supermarkets to discounters (good for Magnit) Consumer confidence in Russia 5.0% 0.0% -5.0% -10.0% -15.0% -20.0% -25.0% -30.0% -35.0% -40.0% 1Q 00 1Q 01 1Q 02 1Q 03 1Q 04 1Q 05 1Q 06 Retail trade We believe that the world financial crisis and last year s downturn in the Russian economy will have less effect on retail trade in 2010, as the worst times are already behind. Rising living standards promote end household consumption (54% of GDP in 2009) partially due to a likely backlog in demand expected at this stage (most obvious in durable goods). However, in the mid-term, retail growth will not catch up with the pre-crisis figures. The year 2009 was hard, but overall, in the recent years, there has been sustained growth in Russia s retail trade. In ruble-denominated trade volume CAGR was at 20.8% (nominal terms), while in 2009 the retail trade volume equaled RUB 14.5 trln ($457 bln). In the next five years ( ), retail trade volume CAGR is expected to slow down to 15.8%, reaching, according to our estimates, RUB 30.2 trln or almost $1 trln in 2014 as the retail market turns more sophisticated. Nonfoods still dominate the turnover. In 2009, foods accounted for 48.6% in the retail turnover, with 51.4% generated by nonfoods (vs s 45.3% and 54.7%, accordingly). Before 2007, the market trended towards increasing nonfoods, due to faster saturation of food products subsector vs. nonfoods. Yet, we believe in 2010 the trend of an increase in food product sales will persist as food sales tend to be more resilient to weak economic conditions, because consumers are more prone to cut nonfoods purchases in favor of foods. Nevertheless, 2004 to 2009 CAGR in foods and nonfoods was at respective 22.3% and 19.5%, signaling stability of both subsectors. The sales breakdown reveals further decline in the share of domestically produced goods (less than 46% in 2008). Food retail Food retail seems unsaturated with the Top 5 retailers holding only 11% (our estimate for 2009) of the market (vs. over 50% in the developed markets). Therefore, we conclude that Russian retailers are in an early stage of development, holding good growth prospects. Although giant chains slow down on the way towards the higher market shares, we expect the top five to ink new M&A deals and new foreign players to enter the market. Major international food retailers have already entered or at least (Wal-Mart) announced their plans of gaining a foothold in Russia. Carrefour has left the market, not because it saw no prospects for Russian food retail, but acting in line with its new strategy to move out from many emerging markets where they don t have the leadership position. Russia started to develop various trade formats relatively late as compared to overseas markets, however, most of them already exist country-wide and the most saturated markets are Moscow and St. Petersburg. The trend towards a consumer flow shift from expensive supermarkets to cheaper discounters and hypermarkets was most evident in key chains sales in Retail revenues throughout 2009 were under pressure from declining personal income. The situation, however, would improve on the back of economic recovery in Q 07 1Q 08 1Q 09 1Q 10 Consumer confidence index Source: Rosstat, Gazprombank estimates Unemployment rate 13.0% 12.0% 11.0% 10.0% 9.0% 8.0% 7.0% 6.0% 5.0% 4.0% 1Q 00 1Q 01 1Q 02 1Q 03 1Q 04 1Q 05 1Q 06 1Q 07 1Q 08 1Q 09 1Q 10 Unemployment rate Source: Rosstat, Gazprombank estimates 6

7 In the middle term, discounters will remain the best performing format in food retail The new trade law that was adopted at the end of last year came into force in February 2010 and will be in full effect from August 2010 The new trade law, in our view, will not have any significant effects on earnings for Russian food retailers Food retailers, especially discounters, would continue to offer an advantage in terms of revenue growth over other retailers, especially in 1H10. Retail chains that operate discounters have fully lived up to our expectations and not only stood up to declining sales, but increased them, as demonstrated by 2009 results. Russia s retail formats Format type Area, sqm Product mix, items Foods/nonfoods, % Average ticket, $ Discounter 300-1, ,000 80/20 10 Supermarket 1,000-5,000 5,000-20,000 80/20 15 Hypermarket 5,000-20,000 20,000-60,000 55/45 30 Cash & Carry 1,000-10,000 15,000-30,000 70/ Convenience store Up to 3,000 85/15 5 Source: Gazprombank estimates New trade law The new trade law that came into force in February 2010, in our opinion, would have little effect on the development of retail chains and their earnings. The State Duma has approved the Retail Law, which was signed by the president at the end of last year. The law took effect from the February 1, 2010 and all of its conditions regarding market dominance will be in full effect from August 1, The most important chapters of the Law include: Market dominance a retail chain (might be a part of a larger retail company) is not allowed to expand within federal regions, as well as municipal or city districts when it reaches a market share of 25%. Payment and contract terms stricter payment terms, including 10 banking days for fresh food and days for other food. Rebates and supplier bonuses (market services) maximum 10% rebates or volume discounts or bonuses for food products. Price regulation the state cap prices for socially important goods for 90 days if they increase by 30% or more within 30 days. We don t see any significant effects from the law on earnings estimates for Russian food retailers: First, the application on the rule restricting the expansion of retail chains would be problematic because a significant market share in the regions is held by food marketplaces, making it difficult to calculate shares controlled by specific retailers. Second, the article that regulates the contract terms with suppliers would have a mild effect on retailers working capital and leave less room for maneuvering. However many retailers, especially public companies, have already adapted supplier payments schedules to this clause of the bill. Third, a 10% limit on bonuses is easy to get around by setting a lower purchase price, but then the manufactures and goods suppliers will suffer, as the retail chain would be less motivated to raise sales of specific products. We believe, food retailers might limit the negative effects stemming from most of the law s provisions by re-negotiating better terms with suppliers. Finally, the rule that allows the government to curb prices if they grow sharply (by over 30% on a given product within one region) would only apply to a small group of basic goods (notably, price restrictions introduced back in 2008 had no effect on retail development). In the longer term, the law sets stricter but rather transparent rules of the game for retailers. 7

8 Food retail is still a highly fragmented market with the Top 5 holding only 11% of market Magnit is Russia s second largest food retailer with a 2.4% market share The Central Federal District is the biggest in terms of food retail value, but other regions have better growth prospects Russian retail turnover breakdown Competitive environment The listed top retailers league in addition to Magnit comprises Х5 (discounters, hypermarkets and supermarkets), the Seventh Continent (supermarkets), and Dixy (mostly hard discounters). There are other retail giants, such as Auchan (hypermarket), Metro (cash & carry format), and O Key (hypermarkets) operating in Russia. Food retail remains highly fragmented, while the crisis provides more consolidation prospects for the sector s giants to contribute to overall concentration. We see Magnit as a runner-up in terms of revenue with its 2.4% share in food retail in Х5 is the leader with a 3.9% market share. Despite Magnit s impressive 2009 results beating those of Х5, the latter seems to retain its leadership position for quite long due to diverse selling formats and scale, while weak penetration of innovative selling formats thwarts tougher competition in food retail. Moreover, unlike Х5 that operates in largest cities Magnit is based in the towns (population of up to 500K people), which we see as a better perspective due to a comparably lower level of penetration. Top 10 food retailers performance in 2009 Company name Revenues, RUB bln Revenues, $ bln Market share Growth rate in RUB, y-o-y Х5 Retail Group % 25.2% Magnit % 28.1% Auchan % n/a Metro % 3.3% O Key % 31.2% Kopeyka % 14.3% Lenta % 9.4% Dixy % 12.2% Seventh Continent % 11.8% Victoria % (4.6%) Industry leaders continue to compete for market share, but the strategies of food retailers have become more prudent after the economic downturn as the market is yet to see a full rebound in consumer demand. Presently, local chains dominate most regions, but the number of those where national players take the lead is growing fast. We expect national retailers to prevail over smaller chains in the mid-term perspective. Typically, the arrival of a national-scale retailer in a small region alters overall market structure, as local companies are not prepared to compete. Magnit s geographical coverage North-West 9% Far East 4% Siberia 11% Central FD 34% Urals 11% Southern FD 13% Volga 18% Source: Rosstat Source: company data 8

9 Most of modern-format grocery stores are in Moscow and St. Petersburg and the latter has the most saturated market in terms of grocery stores per 100,000 people Volga region is the most attractive for food retailers, taking into the account its fastgrowing middle class and compact population density Magnit s strategy to develop its own chain in the Russian regions has proved its efficiency and many other peers are now pursuing the same plans Magnit s monthly sales performance, RUB This is happening in most parts of Central Russia, excluding Moscow and the Moscow region. The majority of modern format grocery stores are located in Moscow and St. Petersburg. The leading retailers in Moscow include X5 Retail Group, Dixy, Kopeyka and Seventh Continent. St Petersburg's retail landscape is almost saturated and is dominated by X5 Retail Group, Lenta and O'Key. Competition in Moscow and St. Petersburg is intense, which prompted retailers to expand into regional citiesand densely populated areas such as Nizhniy Novgorod and the Volga region and industrial cities such as Yekaterinburg in the Urals and Tyumen and Novosibirsk in Siberia. In the Urals, by contrast, local companies are strong enough to compete against federal chains, often taking advantage of their connections in the local administrations. Meanwhile, in Siberia, local companies are growing, with the Holiday chain likely to become a new national retailer that could compete against the existing national chains on equal terms. In general, companies in this region are facing little competition, because logistics are tough here. The most attractive region in terms of geographic expansion is the Volga District: beneficially located with sufficiently high population earning levels in many parts of the district. The district also hosts production facilities of many food companies, making it much easier to maintain supplies of a wide range of products compared to other regions. Volga District, however, is characterized by strong competition from numerous local players that form buying pools and various unions against national retailers. Additionally, income levels vary significantly across different parts of the district, as does the number of food markets. South of Russia also has an uneven distribution of earnings: many parts of the district are dominated by the gray economy, as demonstrated by high retail turnover despite average and below-average population income. Competition here is low or average, as retail chains account for a rather small portion of total retail turnover with food markets still holding a strong position. By contrast, outside of Moscow, St. Petersburg and certain other denselypopulated areas of Russia, people mainly buy groceries in small neighborhood stores and open markets. The majority of retailers pursued a multi-format strategy. However, this trend has been partially reversed following the onset of the current financial and economic crisis. Currently, retailers are focusing on developing the formats with the lowest payback periods as they lack funds to invest broadly performance In 2009, food retailers posted weak results due to disposable income shrinkage (real retail trade turnover plunged by 4.0% y-o-y). All listed retailers have already released their 1Q10 trading updates, and we see sales recovering at a slow but stable pace. Magnit s market share 20,000 45% 4.5% ,000 36% 4.0% ,000 27% 3.5% 400 8,000 18% 3.0% 300 4,000 0 Jan-09 Feb-09 Mar-09 Apr-09 May-09 Sales Jun-09 Jul-09 Aug-09 Sep-09 Oct-09 Nov-09 Dec-09 Jan-10 Feb-10 Mar-10 Growth rates y-o-y (Rhs) 9% 0% 2.5% 2.0% 1.5% E 2010E 2011E 2012E Food retail turnover in $bln (Rhs) 2013E 2014E 2015E Magnit's share

10 Magnit s sales growth is recovering at a much faster rate than for peers All listed retailers are expected to show falling gross margins this year due to investments in price attractiveness the main focus will be on the cost side This year, Magnit has the biggest CAPEX program of all Russian food retailers $1 bln budgeted The Seventh Continent was the weakest with the ruble-denominated sales growth of 11.4% (y-o-y) and LFL increase of 4.2%. Dixy s sales rose 12.3% on the back of an 8% expansion of its sales space and LFL sales growth of only 4.1%. Magnit retains leadership in the sector: annualized sales were up 28% (LFL +3%) vs. 25% (LFL +7%) organic sales growth at Х5 Retail Group. The crisis peaked in 2009, therefore we expect better financials this year as the economy recovers. Margins Historically, the Seventh Continent that operates supermarkets posts the highest margins among public retailers (30% gross margin in 2008). However, as competition in large cities gets tougher, the Seventh Continent s margins get lower, while weak OPEX efficiency would exert a downward pressure on the EBITDA margin in the middle term (9.8% for 2008). Magnit and Dixy, focusing on affordable outlets, show respective 23.5% and 25% gross margins, while the latter lags behind the former in terms of EBITDA margins (9.5% in 2009 vs. 5.4% in 9M09). Despite recent years of Magnit s upward curved margins based on strong logistics, good negotiation position with suppliers and tighter OPEX control, the retailer s concentration on hypermarkets (which have lower gross margins) would be restricting its margin expansion. Х5 Retail Group showed the EBITDA margin of 8.4% vs. 9% in Gross margin was down 140 b. p. to 24.2% due to heavy investment in prices to promote sales in the stores, especially Pyaterochka discounters (which showed impressive 17% LFL sales growth). Thanks to tighter OPEX control and optimization the retailer managed to maintain a healthy EBITDA margin for full year 2009, despite higher competition in big Russian cities caused by economic stagnation. Regional expansion in seems to be the first year when Х5 Retail Group might lose its leadership in the CAPEX volume plans to Magnit. While CAPEX cutting seemed to have become a common trend among food retailers last year, we should see positive changes in Magnit is going to launch convenience stores, hypermarkets and 2 DCs this year, with CAPEX allocations at ca. RUB 30 bln ($1 bln), becoming the leading Russian food retailer in terms of the CAPEX program. The trend is unlikely to change in 2010, while X5 s organic development is impeded by higher leverage and M&A deals (up to RUB 18 bln CAPEX). Dixy might allocate RUB 3.5 bln to the launch of outlets vs. RUB 3 bln spent on opening 79 stores in The Seventh Continent has not posted its previous fiscal year results, but details of its 2010 CAPEX plan were revealed with the operational results for The company is to open 3 hypermarkets and 12 supermarkets this year, yet no stores were launched in 1Q10. Dixy s monthly sales performance, RUB Seventh Continent s monthly sales performance, RUB 6,000 30% 6,000 24% 5,000 25% 5,000 20% 4,000 20% 4,000 16% 3,000 15% 3,000 12% 2,000 10% 2,000 8% 1,000 5% 1,000 4% 0 0% 0 0% Jan-09 Feb-09 Mar-09 Apr-09 May-09 Jun-09 Jul-09 Aug-09 Sep-09 Oct-09 Nov-09 Dec-09 Jan-10 Feb-10 Mar-10 Jan-09 Feb-09 Mar-09 Apr-09 May-09 Jun-09 Jul-09 Aug-09 Sep-09 Oct-09 Nov-09 Dec-09 Jan-10 Feb-10 Mar-10 Sales Growth rates y-o-y (Rhs) Sales Growth rates y-o-y (Rhs) 10

11 The economic recovery and rising real disposable incomes should be the main driver for consumer stories in Russia and Magnit is one of the best We see the main risks in state regulation and rising taxation in Russia that could boost costs and also in prolonged economic recovery Traded food retailers Like-for-Like sales growth, RUB Last year, according to senior managers statements, the Seventh Continent planed to spend RUB 4 bln on expansion (according to our estimates, its 2009 CAPEX were at less than RUB 1 bln). Main drivers We believe in the following long-term fundamental drivers for food retailers: Real disposable income rising on economic recovery, enhanced labor productivity (attributable to more balanced structure of the economy) and through forced, but essential reforms in the post-crisis environment. Low penetration of modern selling formats in Russia: the level of penetration in 2009 was at 41% and, according to our estimates, will only reach 49% in 2015 vs. more than 80% in Western European countries. Low level of concentration. By our estimates, the Top 5 held about 11% of the market in 2009, which is very low compared to other countries (more than 50% in developed markets). Thus we foresee a lot of M&A deals in the middle term. Managerial innovations. We see a lot of opportunities for food retail companies to drive margins up by focusing on innovations, such as optimized logistics and high-end storage facilities. Key risks State regulation. Inflation curbing measures, including pricing restrictions, as well as any serious surprises in interpretation of the newly approved Russian Retail Law could affect sector growth. Rising taxation. Russia has readopted insurance payments in place of the unified social tax (UST) starting from Insurance payments made up 26% (per employee on annual income of up to RUB 415K) of gross payroll this year and are expected to rise to 34% in This corresponds to a nearly 10% increase in salary expenses, which may have a negative effect on the cost structure of companies, especially those with high salary expenses. Lengthy economic recovery. New slowdown in global economy or a W-shaped recovery might cause oil and other commodity prices to drop and lead to further stagnation of the Russian economy, consequently bringing down the buying capacity as well as establishing extended trading down trends in consumer behavior. Social stratification. The scale of social stratification in terms of disposable income is relatively high and is constantly increasing. In 2007, the funds ratio referring to the difference between incomes of the richest vs. those of the poorest reached 16.8х, primarily attributable to Russia s flat taxation of PIs. Traded food retailers revenue performance, RUB 25% 20% 15% 10% 5% 0% -5% 2008 Q12009 H M Q12010 Magnit X5 Dixy Seventh Continent 45% 40% 35% 30% 25% 20% 15% 10% 5% 2008 Q12009 H M Q12010 Magnit X5 Dixy Seventh Continent 11

12 Corporate overview Magnit is Russia s largest food retailer in terms of the number of stores and second in terms of sales Discounters, despite rapid hypermarket segment growth, still generate over 90% of the company s revenues Background and business model JSC Tander (former Magnit) was established by Sergey Galitsky (majority shareholder) in 1994 as a wholesaler which was distributing household products and cosmetics. In 1996, the chain consisted of 30 outlets located in Krasnodar region and the next year it was reorganized into a grocery retail network. After the 1998 financial crisis, Tander began to operate as a discount chain by opening the first store in Krasnodar. Eight years later, in 2006, Tander was transformed into OJSC Magnit. Today Magnit is: The market leader according to the number of outlets and geography: it has 56 branches, over 3,000 stores in more than 900 locations across Russia. Currently at least one store opens each day More than 70,000 employees A chain of distribution centers across the European part of Russia that receive the goods from big suppliers and prepare them for delivery to the stores The company with a large fleet of vehicles carrying cargo across the European part of Russia Over 560 names of private label goods Open Joint Stock Company Magnit (MGNT) is one of the leading food retailers in Russia, operating under the Magnit brand. As of the end of 2009, Magnit had 3,204 convenience stores, 24 hypermarkets and 9 distribution centers, up from 2,568, 14 and 9, respectively, a year ago. After the recent SPO that was organized at the end of 2009 on the LSE, Mr. Galitsky remains the largest shareholders with a voting stake of about 47%. Each GDR represents 0.2 of an ordinary share, with five GDRs equaling one share. Corporate Strategy Magnit is pursuing an aggressive geographic expansion strategy in Russia. The company has taken the organic route to expand its presence mostly in Russian regions: small cities and towns with population of less than 500K people. The company s main focus is on convenience stores, but in the recent years it started to build hypermarkets. In the middle and long term the management plans to aggressively expand its hypermarket chain. Historical number of stores Magnit s monthly sales, $ mln 3,600 6,000 20,000 50% 3,000 2,400 5,000 4,000 18,500 17,000 15,500 40% 30% 20% 1,800 1,200 3,000 2,000 14,000 12,500 11,000 10% 0% -10% 600 1,000 9,500-20% ,000 Sep-08 Nov-08 Jan-09 Mar-09 May-09 Jul-09 Sep-09 Nov-09 Jan-10 Mar-10-30% Revenue, $mn Number of stores (Rhs) Source: Gazprombank estimates Monthly sales (Lhs) YoY Growth rates MoM Growth rates 12

13 Discounters are still the best-performing format among food retailers, making Magnit well-positioned RTScr (Russian consumer and retail companies index) has more than tripled last year Market Profile Our fundamental outlook for the Russian food retail sector is positive. We expect modern food retail average sales growth of 25% in ruble terms to be achieved over the next 12 months (vs. food retail turnover growth of 16%) reflecting traffic improvement due to competitively priced offerings, new store openings and recovering consumer demand. Discounters reported improved y-o-y same-store sales growth in We believe Magnit's same-store sales over the next 12 months will continue to be mostly driven by strength in consumables, while its home category experiences growth, despite our expectation for flat apparel sales. Meanwhile, we see hypermarket operators experiencing samestore sales growth in the low- to mid-single digits, as their low-priced leadership is partially offset by soft discretionary product demand. We expect foreign currency exchange rates to be favorable over the next 12 months due to ruble appreciation, benefiting companies oriented at domestic demand. We also look for Magnit profitability comparisons to ease over the next 12 months, as the macroeconomic environment stabilizes and as earnings comparisons become more favorable. We believe that hypermarkets and discounters should generally appeal to price-sensitive consumers. Also, because of the extent to which they sell such consumer staples as food and beverages, their sales are less sensitive to changing fashions and demand for other discretionary goods than those of some other retailers. Last year, RTS Consumer & Retail Index has grown 231% vs. a 121% increase in the MICEX. Food retailers rose by 242% on average in Yet, valuations of food retailers were still weaker than in pre-crisis years as investors reacted to the global financial crisis which undermined economic stability, despite strong balance sheets and an attractive mix of consumables and basic merchandise of a number of companies. Shareholder structure and dividend policy Last year s SPO has changed the shareholder structure of Magnit. Sergei Galitsky remains the largest shareholder with a 47% stake, Vladimir Gordeychuk controls 2.9% of the company s shares, while we estimate 45% to be in free float and another 5% in the hands of management and other persons and 0.15% to be treasury stock. Last year, Magnit paid dividends to its shareholders two times: one ordinary payment for 2008 and a supplementary one for 1Q09. The dividends amounted to RUB 1.46 and RUB 4.76, respectively (both dividends paid on August 24, 2009). This represents a 2.6% dividend payout ratio for 2008 and 22% for 1Q09. Revenue structure performance Shareholders structure 100% 80% 5.1% 47.0% Sergey Galitsky 60% 40% 45.0% Vladimir Gordeychuk 20% Free-float 0% E 2011F Hypermarket sales 2012F 2013F 2014F 2015F 2016F 2017F Convenience store sales 2.9% Others 13

14 Magnit is moving from a pure discounter (convenience store) format to the larger format of hypermarkets Since last year s SPO, Magnit s shares are up 45% The strengthening ruble is positive for the company s GDRs that trade on the LSE Investments needed for further expansion of modern food retail stores in Russia will not allow Magnit to pay solid dividends in the middle term. We modeled in a payout ratio of 10% for the next five years, 15% in 2015 and 20% starting from ESOP program Recently Magnit launched an ESOP program to motivate its personnel to achieve the corporate goals. The maximum value of the program is 147,357 shares of the company (number of securities with the total value as of the date of the decision, announcement date) of no more than 7% of the net profit of the company for 2008 in accordance with IFRS). The current stage of the program will be completed in Participants of the program can include employees who have been working for the company for no less than 8 years, including at least two years in executive positions, department head and higher, as well as key employees who deliver high growth. We view the launch of the program as a positive factor and also the cost is much less than the ESOP in X5. For comparison, X5 employment stock options program costs for 2009 alone amounted to $59.3 mln, which corresponds to 8.5% of payroll. Magnit ESOP, according to our estimates, will stand at $10.6 mln or 1.9% of payroll costs for In 2011, the program is expected be completed, and we are modeling same cost amounts for 2010 and Last year SPO results At the end of 2009, Magnit placed its shares on the London Stock Exchange bringing about $370 mln to the company and $210 mln to existing shareholders. Total free-float by our estimates increased to 45% from the previous 40%. The secondary placement allows Magnit to finance aggressive expansion in 2010 without hurting its debt profile. Ruble appreciation is positive for company shares The strengthening ruble is positive for Magnit shares, especially for GDRs traded in London. We have tested our model and estimated that with every increase in $/RUB exchange rate by 1 ruble, the target price rises by approx. 5% in US dollars. However with the ruble weakening the downside is limited due to zero foreign exposure of the company s debt. Ruble appreciation also stimulates imports and thus drives like-for-like sales in retail trade as their share in all traded goods in Russia is about 50%. Target price sensitivity to average USD/RUB exchange rate changes RUB Devaluation RUB Appreciation TP on GDRs, $ (Rhs) TP on local shares, $ -4 14

15 1Q10 trade update In 1Q10, Magnit published operational results with a LFL sales up 2.9% in 1Q10. Magnit s LFL sales were up 2.9% in 1Q10, breakdown by convenience store and hypermarket with hypermarkets showing impressive 12.2% y-o-y growth. The average formats ticket was up both for convenience stores and hypermarkets (3.2% and 2.7%, respectively) and growth is now in positive territory (+3.4%), compared to a 2.3% y-o-y decline in 4Q09. This looks even better, given the effects of: Magnit expansion rate stands at around 30% per annum Magnit has almost zero debt exposure thanks to strong net cash flows from operations and SPO results In the middle term, we expect Magnit s debt to grow as a result of aggressive expansion plans the high base from last year Magnit s LFL sales grew 13.7% y-o-y in 1Q09 moderating food inflation the average in 1Q10 was 3.8% vs. 5.0% in 1Q09 Magnit s traffic also recovered to -0.6% y-o-y vs. -2.9% in 4Q09. The real decline in Magnit s average LFL ticket was 0.4% vs. 7.3% decline in real terms in 1Q09. For comparison, Food retail sales in Russia in January March 2010 grew 1.3% in real terms vs. 0.4% real growth in 1Q09 and 5.5% decline in 4Q09. Outstanding expansion rates: selling area for the last 12 months expanded by 28% at the end of 1Q10. Magnit s nominal sales in 1Q10 rose 28.4% y-o-y in RUB to $1,657 mln, including selling space growth of 28% y-o-y. During the first quarter, Magnit opened around 90 small stores and a hypermarket. Overall, Magnit added 238k sqm of selling space in the last 12 months (to 1.09 mln sqm) and 236k in 2009, demonstrating an almost twofold expansion compared to X5 Retail Group (126k sqm). Zero debt burden Zero debt burden and access to cheap financing. Magnit s total debt as of the end of 2009 equaled $418 mln of which $56 mln was in finance lease liabilities. All Magnit s lease payments and all of its debt are denominated in rubles. The total amount of short-term debt, including finance lease payments due in 2010, stands at $266.5 mln. Magnit made $376 mln in cash from operating activities in 2009 and our model indicates that it will generate sufficient cash flow (more than $670 mln in 2010) to cover its short-term liabilities and to finance its impressive expansion program. 15

16 Projections Our model is based on the assumptions in the following areas: Macroeconomic environment Expansion Same store sales (SSS) growth rates Macro environment In 2009, the Russian economy shrank by 7.9% due to some external and internal factors. Inflation was down to 8.8% and is continuing to slow down. On the annual basis it was down to 5.9% at the end of May This year we expect Russian GDP to grow by 4% bringing real household income up by 4.4% y-o-y. Inflation should pick up later in 2H10 due to high budget deficit, growing economy and money supply (up 33% y-o-y in nominal terms at the end of April). We think that all factors including economy, household income and inflation favor all Russian retail stocks, including Magnit. Macro assumptions E 2011F 2012F 2013F 2014F 2015F 2016F 2017F Real GDP growth rate, % -7.9% 3.4% 4.7% 6.1% 6.0% 5.9% 5.5% 5.5% 5.5% Industrial production growth rate, % -10.6% 5.4% 5.0% 5.0% 5.4% 5.0% 5.0% 5.0% 5.0% Wage inflation, % -3.0% 2.0% 4.5% 3.0% 2.0% 2.0% 2.0% 2.0% 2.0% US inflation rate, % 3.0% 3.0% 3.0% 3.0% 3.0% 3.0% 3.0% 3.0% 3.0% Rubles inflation rate (CPI), % 8.8% 8.8% 8.5% 8.1% 8.3% 7.5% 6.2% 5.2% 4.5% PPI in RUB, % 10.6% 9.5% 9.8% 8.1% 9.3% 7.5% 6.2% 5.2% 4.5% Lease inflation in RUB, % -5.0% 5.0% 6.0% 5.0% 5.0% 5.0% 4.5% 4.5% 4.5% Construction price index in RUB, % 3.0% 7.0% 6.0% 5.0% 5.0% 4.5% 4.0% 4.0% 4.0% Avarage electricity tariffs, RUB/MWH 940 1,084 1,268 1,444 1,631 1,743 1,841 1,940 2,040 Electricity inflation, % 17.5% 15.4% 16.9% 13.9% 12.9% 6.9% 5.6% 5.4% 5.2% $/Rub exchange rate average at the year end years OFZ yield, % 6.0% 5.5% 4.5% 3.9% 3.6% 3.3% 3.3% 3.3% 3.3% CBR refinancing rate, % 10.0% 8.0% 8.0% 7.0% 6.0% 5.5% 5.5% 5.5% 5.5% Source: Rosstat, Gazprombank estimates Expansion In 2010, Magnit plans to open convenience stores (discounters) and small and middle format hypermarkets financing its challenging CAPEX program with $1 bln. We see only difficulty in finding a good developer and bureaucracy as possible obstacles to executing the capital expenditure program in hypermarkets expansion. Moreover, we think that it is quite achievable, taking into account the company s experienced management team which has been developing the segment since Number of stores by format E 2011F 2012F 2013F 2014F 2015F 2016F 2017F Convenience stores 3,204 3,754 4,204 4,554 4,854 5,154 5,404 5,654 5,764 Hypermarkets Total 3,228 3,803 4,283 4,668 4,998 5,328 5,608 5,888 6,008 Source: company, Gazprombank estimates 16

17 Selling space by format, thsd sqm E 2011F 2012F 2013F 2014F 2015F 2016F 2017F Convenience stores 977 1,145 1,282 1,389 1,480 1,572 1,648 1,724 1,758 Hypermarkets Total 1,060 1,306 1,539 1,753 1,934 2,111 2,270 2,438 2,502 Source: company, Gazprombank estimates Like-for-like growth rates and revenue Last year Magnit was pressured on its performance in like-for-like sales, which were up only 4% comparing with almost 20% in pre-crisis times. This year will be challenging for Magnit in terms of LFL sales growth because the retailer is already pressured by traffic outflow due to very conservative pricing policy. The basis for our forecast is LFL sales of existing stores and store openings, composed of average ticket and traffic. We expect Magnit s revenue to increase at a 26.4% CAGR in F to $17 bln. In our view, this is mainly driven by: Magnit s cost performance 7,000 6,000 5,000 4,000 3,000 2,000 1, E 2011F 2012F 2013F 2014F 2015F A 15% annual increase in selling space, which should reach 2.1 mln sqm by This implies an ambitious target of convenience store openings per annum (having on average 15 stores in each Russian city with population exceeding 50,000 people) and hypermarket openings per annum. Like-for-like sales growth should catch up later this year. While ruble denominated LFL sales growth declined to 4% y-o-y in 2009, we expect a pick-up to 8% in In later years, we anticipate a slowdown in LFL sales growth as we see pressure from growing competition. SG&A performance Magnit spent the lowest proportion of revenue equivalent on SG&A in 2008 among the listed Russian retailers just under 16%. This is the result of strict discipline and cost control, as well as the focus on the Russian regions where expansion and operating costs are lower than in the main economic hubs. We expect salaries and rental rates to grow at CAGRs of 21.9% and 11.4%, respectively in ruble terms over being the main drivers of cost growth. However, we view cost growth as primarily a function of Magnit s continuing expansion and believe that the SG&A/sales ratio should remain broadly in the range of 15-16%. Labor costs - additional room for improvement Labor costs remain the second largest line in company s cost structure and account for 9% of total costs. The company s headcount reaches over 90K employees at the end of F 2017F Salaries Rent Other SG&A as % of sales (Rhs) 17.0% 16.5% 16.0% 15.5% 15.0% 14.5% 14.0% 13.5% Magnit s margin forecast 10% 8% 6% 4% 2% 0% E 2011F 2012F 2013F 2014F 2015F 2016F 2017F Net income margin EBITDA margin Gross margin (Rhs) 24% 23% 22% 21% 20% 19% 17