OR Group - Market Recovery and New Business Model to Take Time

OR Group (formerly Obuv Rossii) remains under pressure due to the decline in disposable incomes and intensified competition from online marketplaces. The company's new business model was aimed at addressing these challenges, but price investments are still required. Given the low visibility over the recovery in the footwear market, we lower our EBITDA forecasts for 2021 and 2022 by 24% and 21% and downgrade our target price to R30 per share, reiterating our HOLD recommendation. Meanwhile, we note that the company has made progress in its marketplace Westfalica.ru and its pickup points, and that its high-margin financial services segment has also been quite successful.> Russian fashion market hit hard by pandemic. Spending on clothing, shoes and accessories in Russia decreased by 13.1% in 2020, according to SberIndex. We do not expect the market to recover to pre-Covid levels until 2023, though the company is more optimistic on its own prospects and anticipates a full recovery in revenues by 2022 (assuming revenues rise around 30% from R10.8 bln in 2020). With the decrease in demand amid the pressure on customers' incomes, the average ticket on footwear in Russia nearly halved in 2020, according to AKIT. Those aforementioned factors have most likely also made customers more price-sensitive, so we think companies will be forced to continue investing in prices. > The 2Q21 trading results were not too encouraging. OR Group released its 2Q21 operating results yesterday. Consolidated revenues soared 68% y-o-y to R2.1 bln in 2Q21 thanks to the low base, but this was well below the R2.8 bln in revenues generated in 2Q19. Marketplace revenues surged 132% y-o-y, suggesting some progress has been made on the project, while the revenues of the high-margin cash loan segment decreased 9% y-o-y to R566 mln. > Margins to narrow, unlikely to recover. In order to boost its sales density, OR Group has evolved into more of a universal store format, expanding its assortment in particular through its own marketplace and by partnering with online platforms for pickup points. With the 30% commission from OR Group's marketplace (versus a gross margin of more than 50% in the past), the intensified competition from online retailers and the decrease in the average price for a pair of shoes amid stable costs, we expect margins to be pressured this year and think they are unlikely to recover. We see the gross margin getting squeezed 3 pp to 54.8% in 2021 and then remaining close to this level over the long term.> Moderate working capital investments and lower capex. Selling third-party merchandise does not require WC investments (the main drag on cash flows in the past). Meanwhile, the company's capex program has been dramatically reduced. After this year, which will see no new store openings, we conservatively assume the company will open an average of 30 stores per year, which we estimate would require an average of R220 mln in capex per year (including maintenance and other capex), or 2% of revenues. We think OCF should move into positive territory this year for the first time since 2015, with free cash flow turning positive over 2022-25.> Target price decreased to R30 per share, HOLD reiterated. We cut our top-line forecasts by 17% and 18% and our EBITDA forecasts by 24% and 21% for 2021 and 2022, with our EBITDA margin projection remaining at 21.2% for 2021 and beyond. The stock currently trades at a 2021E EV/EBITDA of 5.5, which is above its historical average and does not compensate for the challenges the industry is faced with. While we do not anticipate any dividends for 2021-22, the stock offers a FCF yield of more than 50% on our 2022 numbers. Despite the decrease in cash loan revenues in 2Q21, OR Group's financial services segment has been performing well overall, and the changes in the company's strategy seem sensible to us. We reiterate our HOLD recommendation, noting that it will take time to prove the effectiveness of the new business model.