vk.com/id446425943

Goldman Sachs

Russia Retail

Lenta: Operational performance to remain challenged, Neutral

Despite Lenta’s underperformance, and its recently announced buyback plans and change in openings strategy (both of which make sense in the current environment, in our view), we remain Neutral on the stock (with a revised 12m price target of US$4.24, vs. US$4.70 previously, reflecting our estimate changes) for the following reasons:

(1)We see limited support to total shareholder returns from improved FCF generation, given Lenta could consider M&A, and the sustainability of cash distribution to shareholders is difficult to predict post 2019.

(2)Operational performance is likely to remain under pressure in the short term.

We expect LFL growth to decline given Lenta’s slower expansion (diminishing support from new stores) and ongoing pressure on sales densities from rising competition.

(3) Structural challenges are likely to weigh on hypermarkets in the midto

long-term. With an increasing focus on convenience, growing online penetration and a diminishing number of suitable locations for ‘big box’ stores, we believe hypermarkets are set to underperform other formats.

(1) Limited benefits to total shareholder returns from improved FCF generation

In October 2018, Lenta announced its intention to materially slow down new openings given a challenging consumer environment and fierce competition. Lenta also launched a buyback programme for the GDRs until October 2019, with total purchases of up to RUB11.6 bn, taking into account its expectation of becoming free cash flow positive in 2019. We believe the slowdown in openings and a more rational approach to capital allocation make strategic sense in the current challenging environment, but we note the following: (1) Unlike X5, Lenta intends to undertake share buybacks, the occurrence and timing of which are difficult to predict; (2) As per Lenta, the authorised amount for buybacks would not be applied in full given the low liquidity currently; (3) Lenta has indicated that it could still consider acquisitions if suitable opportunities arise, which implies uncertainty related to potential cash distribution to shareholders.

Exhibit 53: Lenta has announced plans to materially slow down hypermarket openings…

Number of hypermarket openings, total group selling space growth

	New hypermarkets		Total selling space growth
60				35%
30%
50				30%
40	21%			25%
30				20%
				15%
51		9%
20	40
				10%
			4%
10				4%
		18
				5%
			9	9
0				0%
2016	2017	2018E	2019E	2020E

Exhibit 54: …which should help reduce capex and materially improve FCF

FCF yield and capex as % of sales, 2016-20E

FCF yield Capex / sales

20%	18%		15%
15%		13%
10%	7%	7%
5%		3%	3%
0%

-5%

-2%

-5%

-10%

-15%

-14%

-20%

2016

2017

2018E

2019E

2020E

Source: Company data, Goldman Sachs Global Investment Research

Source: Company data, Goldman Sachs Global Investment Research

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Goldman Sachs

Russia Retail

(2) Operational performance likely to remain under pressure in the short term

We remain cautious on Lenta’s LFL growth over the next two years (Exhibit 55) as we believe that moderating cannibalisation effects (as a result of slower expansion) will not be sufficient to offset the fading LFL boost from new openings (Lenta’s hypers mature over three years and contribute to LFL growth after 12 months of operation). We are also mindful of increasing competition that may lead to a further decline in Lenta’s vintage store sales (we define vintage stores as those that operate over three years).

Exhibit 55: We expect Lenta’s LFL growth to deteriorate…	Exhibit 56: …as we expect a lower LFL boost from new openings
LFL growth	and the growing impact of increasing competition on vintage
	stores
	LFL boost from new openings and LFL in vintage stores

7.0%
6.0%					10%
5.0%	3.9%				8%
4.0%
					6%
3.0%		1.8%			4%
2.0%					2%
	0.9%		1%
1.0%					0%
				0%
0.0%
					-2%
-1.0%					-4%
-2.0%					-6%
-3.0%					-8%
					-10%

			LFL vintage stores				LFL boost from new openings		LFL hypers

3.9%
0.8%	1.8%	0.9%
		-0.1%

2016

2017

2018E

2019E

2020E

Source: Company data, Goldman Sachs Global Investment Research

Source: Company data, Goldman Sachs Global Investment Research

In terms of margins, we expect EBITDA margin to continue declining (Exhibit 57) primarily on the back of our more conservative LFL/sales density forecasts and increasing lease expenses (owing to supermarket expansion). Our expectations of a slower growth profile and a more conservative view on profitability put us 3%/4% below company-compiled consensus on EBITDA/net income over the next two years.

Exhibit 57: We expect EBITDA margin to continue declining on the back of our more conservative LFL/sales density forecasts and increasing lease expenses

EBITDA margin, 2016-20E

GS Bloomberg cons

10.5%

10.2%

10.0%	9.7%
9.5%		9.2%
9.0%		9.0%	8.9%9.0%	8.8% 8.8%
8.5%
8.0%
2016	2017	2018E	2019E	2020E

Exhibit 58: We are below consensus on all key lines for the next two years

GS vs. Company-compiled consensus , FY19-20

0%	Sales	EBITDA	NI
-1%
-1%
-2%
-2%
-3%	-2%
-3%		-3%
-4%
-4%
-5%			-4%

Source: Company data, Goldman Sachs Global Investment Research

Source: Goldman Sachs Global Investment Research, Company-compiled consensus

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Goldman Sachs

Russia Retail

(3) Structural challenges to weigh on hypermarkets in the medium to long term

As we highlighted in our primer on Russian retail, we believe hypermarkets are set to underperform other formats over the next decade, given an increasing consumer focus on convenience, reduction in the price gap vs. small formats, and the diminishing number of suitable locations for big boxes. We note that hypermarkets are increasingly facing competitive pressure coupled with weak consumption, which has led to particularly weak performance across the key large format chains in 1H18 (Exhibit 59).

In our view, hypermarkets are also more exposed to the risk of disruption from online than any other retail format given higher exposure to non-food as well more distant location from a customer (a trip to a distant store is not worth the benefits). We also note that Lenta is the only leading hypermarket chain in Russia with no own online sales yet and no plans at present.

Exhibit 59: We note that hypermarkets are increasingly facing competitive pressure from small formats, which coupled with weak consumption, has led to weak performance across the key large format chains

Revenue growth of key large format chains in 1H18, % YoY

20% 18%

15%

10%

5%		5%	3%
0%
-5%			-4%
-10%			-8%	-8%	-9%
-15%	Lenta	Hyper	Karusel Magnit Auchan	Metro	OKEY
		Globus	hypers

Exhibit 60: Given that O’KEY is barely expanding its hypermarket business, its LFL growth largely reflects performance of mature stores, which is comparable with what we estimate for Lenta’s vintage stores (as shown in Exhibit 56)

O’KEY LFL growth in hypermarkets vs. selling space increase in hypermarkets

LFL	Selling space growth

6%
4%		4%
		3%
2%		2%
	1%	1%
0%
-2%		-2%
-4%		-3%
		-5%

-6%

2015

2016

2017

2018E

Source: Company data, Infoline

Source: Company data, Goldman Sachs Global Investment Research

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Goldman Sachs

Russia Retail

Valuation, price target and estimate changes

Valuation

In our September update we adjusted our EV/EBITDA target multiples across our Russian food retail coverage: we value the largest retailers (X5, Magnit and Lenta) at c.6x 2019E EV/EBITDA, which implies c.10% upside to current 2019 valuation multiples. Based on our analysis of historical retail valuations, we see a strong correlation between EV/EBITDA multiples and expected growth profiles, which we believe supports our target valuation for the food retailers (Exhibit 65). We also note that our earnings-based valuation does not yet incorporate an improving FCF profile (FCF yields appear to be more attractive now vs. SA food retail), and we would view this as potential upside to retail valuations together with improving macro momentum.

Exhibit 61: X5 has outperformed its peers over the last three	Exhibit 62: We value all the largest retailers at c.6x 2019 EV/EBITDA
months, but it is still below the Russian market average	2019E EV / EBITDA (market valuation, target multiple) vs. 5y average
Share price performance

	X5	MGNT	LNTA	MSCI RU
15%				14.0
10%				12.0
5%				10.0
0%				8.0
-5%
-10%				6.0
-15%				4.0
-20%				2.0
-25%				-
Sep-18	Sep-18		Oct-18	Nov-18

2019E current valuation

2019E Target multiple

5y average

X5

Magnit (GDR)

Lenta

Source: FactSet		Source: FactSet, Goldman Sachs Global Investment Research
Exhibit 63: We now see limited correlation between EBITDA		Exhibit 64: Based on our analysis, we see earning growth as the
margin and the valuation multiple		key driver of retailers’ valuations over the last three years...
EBITDA margin vs EV /EBITDA, 2016 and 2019E		12m fwd EV/EBITDA (X5, Magnit, Lenta) and Y2 (next year) EBITDA
		growth

EV / EBITDA

14.0x
12.0x			2016			MGNTq.L
10.0x								LNTAq.L
8.0x			OKEYq.L		PJPq.L
6.0x				MGNTq.L
4.0x			OKEYq.L	PJPq.L	LNTAq.L
2.0x						2019E
0.0x
3.0%	4.0%	5.0%	6.0%	7.0%	8.0%	9.0%	10.0%	11.0%

EBITDA margin

12m fwd EV / EBITDA (lhs)		Y2 EBITDA growth (rhs)

12.0

30%

10.0

25%

8.0

20%

6.0

4.0

15%

2.0

10%

0.0

Jul-15

Jul-16

Jul-17

Jul-18

5%

Jan-15

Mar-15

May-15

Sep-15

Nov-15

Jan-16

Mar-16

May-16

Sep-16

Nov-16

Jan-17

Mar-17

May-17

Sep-17

Nov-17

Jan-18

Mar-18

May-18

Sep-18

Nov-18

Source: Goldman Sachs Global Investment Research, FactSet

Source: Bloomberg, Goldman Sachs Global Investment Research

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Goldman Sachs

Russia Retail

Exhibit 65: ...and c.6x EV/EBITDA is supported by historical analysis

12m fwd EV/EBITDA (X5, Magnit, Lenta) and Y2 (next year) EBITDA growth

	12.0
	11.0	2019-20E EBITDA				R† = 0.8514
	10.0
EV/EBITDA	7.0	growth for Russian retail
	9.0
	8.0
fwd	6.0
12m	5.0
	4.0
	3.0
	2.0
	5%	10%	15%	20%	25%	30%

Expected Y2 EBITDA growth

Source: Bloomberg, Goldman Sachs Global Investment Research

Exhibit 66: Our target multiples are largely growth driven and do not yet reflect improving FCF generation

12m fwd FCF yield, Russia and SA food retail

			Russian retail 12M fwd free cash flow yield, %
	5.0%		SA retail 12M fwd free cash flow yield, %				4.3%
%	4.0%
	3.0%
yield,							2.7%
	2.0%
flow	1.0%
cash	0.0%
free	-1.0%
fwd
	-2.0%
12M
	-3.0%
	-4.0%
	-5.0%
	Jan-12	Jan-13	Jan-14	Jan-15	Jan-16	Jan-17	Jan-18

Source: FactSet, Goldman Sachs Global Investment Research

Price target and estimate changes

We revise our estimates for the food retailers in our coverage, incorporating latest results, updated management guidance and other changes (Exhibit 67). For X5, our EPS estimates decline by 12% for 2018-20, largely as a result of higher leverage assumptions, as we now expect more capital to be allocated towards dividends (we expect 100% payout in 2019-20) rather than deleveraging (we marginally increase our target multiple to reflect this - owing to rounding, our target multiple stays at 6x). For Lenta, we incorporate a weaker margin outlook (as a result of negative operating leverage), slower expansion plans from 2019 and its recently announced buyback programme. For Magnit, we incorporate lower growth/EBITDA margin assumptions in 2019, as we now expect a recovery in 2020 vs. 2019 previously as new refurbishments need time to achieve scale. For O’Key, we incorporate recent results, which drives a 14% cut in our EPS estimates for 2018-20.

Exhibit 67: Summary of estimate changes

					Sales			EBITDA			EBITDA margin			EPS, Rub
				2018E	2019E	2020E	2018E	2019E	2020E	2018E	2019E	2020E	2018E	2019E	2020E
		Magnit GDR	New	1,235,507	1,379,908	1,573,945	89,576	98,361	115,532	7.3%	7.1%	7.3%	68.0	73.1	90.3
		Rub mn	old	1,235,146	1,404,451	1,587,648	90,674	103,696	116,776	7.3%	7.4%	7.4%	68.9	80.6	93.1
			% chng	0.0%	-1.7%	-0.9%	-1.2%	-5.1%	-1.1%	-0.1p.p.	-0.3p.p.	0.0p.p.	-1.3%	-9.3%	-3.0%
			% vs cons	-1.8%	-0.1%	2.6%	-2.3%	-3.8%	1.4%	1.8p.p.	1.6p.p.	1.9p.p.	-3.8%	-8.2%	-1.3%
		X5 Retail Group	New	1,529,474	1,767,428	1,995,710	105,761	119,315	132,159	6.9%	6.8%	6.6%	110.5	132.9	147.9
		Rub mn	old	1,535,117	1,809,412	2,060,004	105,737	124,729	141,280	6.9%	6.9%	6.9%	116.4	153.2	178.8
			% chng	-0.4%	-2.3%	-3.1%	0.0%	-4.3%	-6.5%	0.0p.p.	-0.1p.p.	-0.2p.p.	-5.0%	-13.2%	-17.3%
	Russia		% vs cons	-0.3%	-0.1%	0.1%	-1.1%	-2.5%	-2.9%	-0.1p.p.	-0.2p.p.	-0.2p.p.	-8.7%	-9.1%	-12.7%
		O’KEY Group	New	160,467	166,619	177,098	8,821	9,947	11,096	5.5%	6.0%	6.3%	5.0	9.4	12.7
		Rub mn	old	162,414	172,008	187,825	9,091	10,623	11,818	5.6%	6.2%	6.3%	5.8	11.3	14.5
			% chng	-1.2%	-3.1%	-5.7%	-3.0%	-6.4%	-6.1%	-0.1p.p.	-0.2p.p.	0.0p.p.	-14.3%	-16.1%	-12.8%
			% vs cons	-8.0%	-10.5%	-11.3%	-8.6%	-5.6%	-5.9%	0.0p.p.	0.3p.p.	0.4p.p.	-4.7%	na	na
		Lenta	New	418,214	459,292	485,192	37,749	40,941	42,877	9.0%	8.9%	8.8%	27.8	32.6	37.2
		Rub mn	old	426,358	485,265	546,890	39,162	43,812	48,756	9.2%	9.0%	8.9%	29.6	36.9	42.9
			% chng	-1.9%	-5.4%	-11.3%	-3.6%	-6.6%	-12.1%	-0.2p.p.	-0.1p.p.	-0.1p.p.	-6.0%	-11.7%	-13.2%
			% vs cons	-0.8%	-1.0%	-3.4%	-2.5%	-2.1%	-3.4%	-0.2p.p.	-0.1p.p.	0.0p.p.	-4.1%	-4.6%	-3.8%

Source: Goldman Sachs Global Investment Research, Bloomberg

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Goldman Sachs

Russia Retail

Exhibit 68: Summary of changes to our 12-month price targets

Last close is as of November 26, 2018

	Company	12m TP		Share	Upside, %	Rating		Methodology		Key Risks
		New	Old	price
	X5 Retail Group	$29.6	$28.7	$24.1	23%	Buy	6x	@ 2019E	EV/EBITDA	(1) Intensifying competition, (2) Further changes in the management team, (3) Macro risks, (4) Capex
										overruns caused by increased store openings, (5) worse-than-expected cost control, and (6) value-eroding
										acquisitions
	Lenta	$4.24	$4.70	$3.5	21%	Neutral	6x	@ 2019E	EV/EBITDA	(1) increasing/softening competition, (2) higher/lower-than-expected LFL sales, (3) better/worse cost
										control, (4) improvement/deterioration in macro.
	Magnit (GDR)	$15.0	$16.0	$13.0	16%	Neutral	6x	@ 2019E	EV/EBITDA
										(1) a deteriorating/improving macro backdrop and consumer situation in Russia, (2) higher/lower
										competition, (3) better/worse execution on its operational turnaround, cost optimisation and capital
										investments
	Magnit (Locals)	RUB 4,100	RUB 4,470	RUB 3,490	17%	Neutral	5x	@ 2019E EV/EBITDA
	O’KEY Group	$1.9	$2.1	$1.7	14%	Neutral	5x	@ 2019E	EV/EBITDA	(1) Higher/lower discounter openings, (2) lower/higher-than-expected LFL sales, (3) increasing/lower
										competition, (4) worse/better cost control

Source: Goldman Sachs Global Investment Research, FactSet

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