Russian Retail - Ticket and Margins to Be Hit by Promos in 4Q19

Our latest Ivanov survey indicates that sentiment has been improving and trading down started easing. It also suggests that food spending over the New Year holidays increased 10% y-o-y. But promo risks have materialized: Magnit turned aggressive on prices in 4Q19, but this had the effect of merely attracting promo hunters rather than building a loyal customer base (this pattern has also spilled over to X5 Retail Group). We think both chains are set to report what will appear to be robust traffic, though the ticket is likely to be diluted by fewer items, while the increased share of promotions will affect margins. We expect X5 to offset this with strong December sales and post neutral results, while Magnit risks missing on margin guidance. We believe that both chains are now likely to scale down promotions.> The Ivanov tracker has yet to be published, but the preliminary numbers are positive. It was estimated that food budgets for the New Year holidays would be up 10% y-o-y (after adjustments). This, coupled with 3% food inflation in December, indicates an increase in volumes and trading up. Consumer confidence has been improving: in 4Q19, the share of Ivanovs trading down fell 3 pp Q-o-Q to 69% (the same level as before the economic downturn).> Price and assortment perception are improving for both Magnit and X5. The latter is enjoying stably high customer loyalty (it is the primary store for 24% of respondents in our Ivanov survey), whereas the share of people describing Magnit as their primary store dropped to a record low of 19% last quarter. Only 14% planned to do their New Year spending at Magnit, versus 21% at Pyaterochka.> To recapture traffic and introduce a new CVP, Magnit intensified promo activities. But this has not increased customer loyalty; instead, traffic has been driven solely by promotions. The share of promo hunters at Magnit traffic grew to a record high of 29%, surpassing Pyaterochka for the first time.> Thus, we expect to see good traffic for both chains. But as incremental customers are coming solely for a small number of promoted items, the tickets are set to decline and the higher share of promos is likely to pressure margins.> We expect Magnit's revenue growth to accelerate to 10% in 4Q19, but we see the EBITDA margin coming in at 6.0-6.5%. For X5, we anticipate revenues up 11% y-o-y, while the EBITDA margin should come in at 6.7-7.0% (post LTI). So we expect neutral results for X5 but negative ones for Magnit, as it is likely to miss the guidance provided in late October. > We don't expect the wave of promos to continue in 1Q20, as they damage margins but haven't done much to boost loyalty. Magnit faces the risk of losing part of the traffic that it had attracted via the promos. We think Magnit is likely to turn to more selective discounts and fine-tune its CVP. Any traffic outflow would likely be picked up by X5, thus supporting its top line. X5 remains our top pick.