X5 Retail Group - Buy on Weakness, Story Still Intact

X5 Retail Group remains the fastest growing listed food retailer in Russia. We expect its revenues to grow 11-12% in 2020 and its EBITDA margin to remain above 7.0%. The year looks set to be favorable for retailers, as sentiment is improving, price sensitivity is easing and upside remains from the boost in government social spending. X5 provides exposure to this story of improving sector fundamentals, though 4Q19 profitability could have been under pressure. As we wrote in our latest Ivanov Consumer Confidence Tracker, promos picked up in the period, though we assume this has already been priced in. In addition, we think that once Magnit scales down its promos, some of its traffic should be picked up by Pyaterochka. X5 stock is trading at a 2020E EV/EBITDA of 5.4 and offers a 5.3% yield on dividends to be paid in 2020. We open a short-term trade idea with the belief that the current share price weakness presents an opportunity to buy. > Performance and what's in the price. The share price has dropped 5.6% from a local high of $35.96 registered on January 10. As we mentioned above, this could have owed to expected pressure on 4Q19 margins amid more promos. > Where we are versus the consensus. Our 2020 EBITDA estimate is in line with the Bloomberg consensus, while our net income estimate is 3% higher. > Key drivers and catalysts. Profitability may have been under pressure in 4Q19 from intensified promo activity, as we wrote in our recent Ivanov survey report. Thus, despite a notable decrease in price sensitivity and ease in trading down, the share of respondents visiting stores solely for promos hit a record high of 51% in the quarter, up from 48% in 4Q18, while the share of those trying to save money by buying items on sale was 63%, up from 60% a year earlier. However, we assume this is already priced in. The story remains intact, as we treat the pickup in promotional activity as a one-off and still assume the EBITDA margin will remain above 7.0% in 2020. Moreover, once Magnit scales down its promotions, it could lose some traffic, and this traffic is most likely to be recaptured by Pyaterochka, which is still seen by survey respondents as having a better assortment and higher-quality products. Comments about the 1Q20 performance or details on dividends during the 4Q19 earnings call could also be supportive for the stock. > Risks to our view. The main short-term risk is that Magnit's efforts to improve its assortment will bear fruit and cause an outflow of traffic from Pyaterochka. That said, so far we have not seen this in our Ivanov survey data. Another key short-term risk is that Magnit will keep up its promos, undermining sector margins. However, we do not expect this to happen.