X5 Retail Group - Valuing the Online Business

Last week, X5 Retail Group, which is the leading player in the Russian e-grocery segment, announced its intention to spin-off and IPO its online business. This should help to crystalize value that is currently overlooked by the market, in our view. We forecast GMV of R60 bln in 2021 and positive EBITDA starting in 2022. We lift our target price to $48.00 per GDR, with around $3 of this attributable to the online segment (implying a 2021E EV/GMV of 1.0, which may prove conservative). We now see hefty upside of 32% for the stock, which remains our top pick. We expect to hear more details on the spin-off of the digital segment from the company in the short run.> The Russian e-grocery market is expected to reach R605 bln in 2023, providing a 2021E-23E CAGR of 61%. X5's online revenues tripled to R12.7 bln in 9m20, making it the leader in the segment. Online hypermarket and express delivery represents 58% of the total e-grocery market (based on segmentation by shopping mission). The company also plans to enter other segments. > We expect the segment's GMV to climb to R60 bln in 2021 and R110 bln in 2022. The segment is enjoying rapid expansion of the target market, lower capital intensity, and cost advantages over key competitors. However, the market seems to be ignoring these factors, as it conventionally values retail using EV/EBITDA, and the segment's EBITDA contribution is likely to remain negative until 2021.> The IPO plans for the digital business and more active communication on the company's online prospects should help to crystalize the segment's value, in our view. In the long run, the market could switch to a SOTP valuation and price the online business based on GMV. That would lead to a valuation of $3 bln in the eyes of X5. In the meantime, we believe increased investor attention will contribute to a re-rate. > We raise our DCF-based target price from $40.00 to $48.00 per GDR, with $5.00 coming from upgraded forecasts in the core segment and $3.00 from the online segment (on higher revenues and an improved margin outlook). The SOTP valuation that we use for sensitivity purposes provides a 2021E EV/GMV of 1.0, which could prove conservative given the growth momentum and breakeven visibility. > Our target EV for the core offline business is R1,150 bln, which would be generated based on total investment of R510 bln over seven years. However, the R60 bln value for the online segment required just R5.6 bln in capex over four years. We think such a striking difference in value accretion could prompt the management to upgrade its expansion plans. The key constraint is demand for the service. X5 is focused on ROI, so it may not be keen to promote the service at the expense of its margin.