LONG READ: Making Magnit Great again

LONG READ: Making Magnit Great again
Magnit is staging a comeback under its new management / Magnit
By Ben Aris in Berlin December 16, 2020

In its heyday, before the crisis of 2014 hit, Magnit was an investors’ darling. At one point international investors were 3% overweight in the benchmark MSCI Russia index and almost all of that overweight was in just one stock: Russian regional supermarket chain Magnit. The company could do no wrong.

But the chain fell from grace about five years ago and has been struggling to find its direction since. Retail in general has also been hit by the multiple economic shocks and also seven years of falling real incomes. New management was appointed two years ago and the new CEO, Jan Dunning, explains to bne IntelliNews in an exclusive interview how he is turning the business round.

The supermarket chain, founded by entrepreneur Sergey Galitsky in the regional city of Krasnodar, was one of Russia’s great retail success stories of the 90s.

Magnit's founder Sergey Galitsky doesn't like Moscow and establsihed and ran his nationwide retail empire from his home region of Krasnodar

Unusually the chain eschewed Moscow, which is by far the richest city in Russia and has a local population larger than most Central European countries, to focus on building out its business in Russia’s far flung regions.

Galitsky was also unusual, shunning the ritzy high life of Russia’s newly wealthy in Moscow and remained in his native Krasnodar to focus on building up a low-cost, but good quality retail business that catered to the everyday needs of the vast majority of the people.

The store’s revenues grew to top $10bn, making it the biggest retailer in Russia during the boom in the noughties and Galitsky became a billionaire on the back of his high volume, low margin concern. Investors fell over themselves to buy into the new Russia business story that tapped its greatest resource: not oil, gas, gold or diamonds, but its people.

But things started to go wrong in about 2017 when the management team was riven by disagreements on where to take the company next.

“The decline started in the last two years before Galitsky left. He was tired and was not paying attention. He was looking for a successor and wanted to sell,” Dunning told bne IntelliNews speaking from his office in Krasnodar by video link.

VTB Bank bought a 29% stake form the chain's founder in February 2019 for RUB138bn ($2.25bn). VTB then brought the stake down to 17.3% after selling 12.05mn shares, or 11.82%, to the Marathon Group of Alexander Vinokurov for a reported $1bn. Minority shareholders, led by Russia-veterans Prosperity Capital Management, were infuriated by the deal, saying it “spits in the face of investors.” The stake comes in just below the 30% threshold that would trigger a mandatory buy-out of minority investors, of which Prosperity was one of the biggest.

In that same year Magnit’s rival X5 Retail Group, which belongs to oligarch Mikhail Fridman and has a number of supermarket brands in its portfolio, overtook Magnit to become the biggest retailer by revenue and X5’s stock price soared, while that of Magnit’s remained flat, despite the green shoots of an economic recovery appearing. Magnit’s management regrouped and is now fighting back. This year it is the turn of Magnit’s shares to soar, while those of X5 remain more or less flat.

New broom

Dunning is a dyed-in-the-wool retail professional. He spent 10 years working for the German discount supermarket chain Aldi, was operations director of Metro Cash & Carry Russia and then general manager of Metro Cash & Carry Ukraine before taking over as CEO of Russia’s second tier chain Lenta and eventually was hired to be president, a non-executive position, which was introduced in 2019.

As president he spent time touring some of the company’s 22,000 stores that stretch down into the towns and villages across Russia’s 11 time zones.

“It was a good experience, as while president I toured the stores and got to know how the business was run on the ground,” says Dunning.

After Galitsky left the company Dunning was asked to take over as President and CEO of the company in June 2019 and began to reshape the juggernaut that Magnit had become.

“Since February 2019 I brought in my new management team to transform the business into a “proper” retail business,” says Dunning.

Dunning has had to face multiple challengers since he took the helm. The company had already been knocked by its internal disputes over direction and was rocked again by various crises even before the 2020 coronacrisis hit.

Magnit has always done well by offering value for money. While it is not a discounter per se, it has always focused on keeping prices down and has built up a loyal following as a result.

The organised retail business has had to cope with Russia’s economic stagnation that began in 2013, when growth stalled and real incomes began to stagnate. While firms like X5 have built up their businesses in the biggest cities – like Moscow and St Petersburg – the lower incomes hit the poor regions disproportionately, hurting Magnit’s business more than its rivals. Against that as bne IntelliNews has reported, the squeeze also killed off the small players and concentrated turnover in the biggest player, so ironically retail turnover in many of these companies has actually increased during the stagnation.

Retail revolution

Already arguably one of the most modern parts of the Russian economy, organised retail is currently going through a revolution and e-commerce is booming, catalysed by the coronacrisis. Turning Magnit’s fortunes around is not just a question of fixing its problems but actively developing its business to take these new realities into account. The task is two-fold: digitise the business, but as Dunning points out, the backbone of the business remains running the thousands of physical stores spread across the country.

“It’s an asset you can’t ignore,” he says. “The future is digital, but we have reached a critical mass offline and the network is so big it has its own challenges. The stores are very important and how they are run, how shoppers make on the spot decisions, is key part of the business.”

Dunning admits that Magnit has been a bit slow in setting up its IT and getting into e-groceries, but its site was updated earlier this year and it is now getting its act together. Like everyone it has seen explosive online sales growth during the coronacrisis and over the last six months Dunning has introduced a slew of new services and innovations.

Online sales tripled from their January-February levels during the lockdown that started in May and the base went from a 100 orders a day to 3,000.

While at Lenta Dunning revamped the IT sector and claims that he had some of the best information on customers of any of the big retailers thanks to one of the most advanced systems. (Magnit attempted to buy Lenta in 2019, offering $1.8bn for the chain, but was pipped at the post by Severgroup of steel tycoon Alexei Mordashov, who also has retail ambitions.)

“The e-commerce has started but in the short term we are looking for customer insights. It’s what we need: to better understand our consumers,” says Dunning. “Magnit has no choice. We have to be digital and we need an e-commerce platform and by next year we will be an active e-commerce player.”

Amongst the first changes Dunning made was to introduce a customer loyalty card in September 2019 to begin collecting information on customers' shopping habits.

Dunning says that Magnit has always concentrated on the procurement to present the best customer value proposition. Now he wants to turn the relationship around and listen and learn from the customers for more insights on appealing prices, product ranges and private labels.

“It’s customer-centric thinking. We are not there yet but we are making progress,” says Dunning. “We have to re-orientate from procurement and fancy stores. We need to know what the customer wants, how to present it, and how they want to pick it up. That last part is new: there are more aspects to retail now as it is changing very fast. What used to take 20 years to change now changes in five years.”

Delivery options

One of the biggest changes in Russian retail in recent years is the possibility of having your groceries delivered to your home rather than trekking down to the store with an avoska, the string shopping bag everyone used to carry in Soviet times in case there was something to buy in the shops.

The company started with food deliveries in August and in September followed up with the launch of e-pharmacy and an e-grocers delivery service in partnership with e-commerce firms Delivery Club and Yandex.Eda the marketplace owned by Russia’s internet powerhouse Yandex. The tie-up with the e-commerce is natural, as all the serious players have already invested heavily in distribution and logistics to support their own businesses.

The tie-up with Delivery Club is also being used for express delivery of cosmetics from the company’s cosmetics subsidiary. A pilot was launched in Yekaterinburg and Krasnodar in December and will be expanded to major cities where Magnit operates in 2021.

Like everyone else, Magnit is also investing in its own delivery and logistic system. In November the company launched the Magnit Dostavka (Delivery) app, which will support the e-commerce effort. Initially available in Moscow inside the major MKAD ring road it carries 5,000 products that can be delivered in under 60 minutes. The pilot has been set up in partnership with Yandex.Eda, the food delivery service of Russia’s internet giant. In the same month deliveries from hypermarkets in the company’s home region of Krasnodar were added and more will follow.

Cosmetics is a first step to expanding deliveries from the company’s drogerie format. The e-pharmacy draws on over 100 pharmacies in Moscow and offers a 30-minute pick-up period at the nearest store to the customer. A courier service for over-the-counter items is also in the works.

The company is also in the process of setting up “dark stores” that have no walk-in customers, as they are there to fulfil online orders quickly. But Dunning says that currently the main appeal of the online platforms is the insight they give into customers’ behaviour.

Magnit super App

The most recent addition to the family was the launch Magnit Pay on December 15, a payment system within the Magnit app developed in partnership with VTB that will be a key digital platform in the future.

Registered users can obtain a virtual card that can be used to pay for purchases both in-store and online. The card can be topped up via bank transfer and can also be used to send money to any Russian card.

Magnit Pay's functionality will be expanded in the first half of 2021, with users able to pay for third-party services (utilities, telecommunications and fines) and transfer funds to other Magnit Pay users. Magnit customers will be able to withdraw cash from VTB ATMs using only a QR code.

“We consider the development of a payment system as a promising niche considering Magnit's unmatched customer base. Similar systems have made a material contribution to EM and DM retailers. [Russian regional shoe retailer] Obuv Rossii has already had success with a similar scheme in the Russian retail space. That said, the take-up for the service could take some time, so we see no impact over the medium term,” Sova Capital said in a research note.

Discounter and Private label

Another new feature of Russia’s retail has been the rise of the hard discounters – another bricks and mortar business that is geared towards the impulse buy rather than the convenience of online sales.

Stagnant incomes have made punters a lot more price conscious and Russia’s new discount chains are flourishing, as bne IntelliNews featured in its profile of Fix Price. Indeed, they have been doing so well the discounters are starting to cut into the sales of the major chains and now the big boys are fighting back.

Magnit opened its first three Moya Tsena (My Price) discount stores in July 20 in the Samara, Ulyanovsk and the Volgograd regions. Moya Tsena is a hard discount store, earlier than its rivals; X5 announced it was launching its Chizhik discounter at a strategy day in October, partly to counter the rise of firms like Fix Price that has been enjoying double-digit growth for several years now.

“It has been very successful. The store has 1,500 stock keeping units (SKUs) and one item per need,” says Dunning, who adds that more stores will be rolled out in the New Year.

Keeping the costs under control is doubly important to discounts and like the other firms, Magnit is investing into production to produce its own private label goods for consumer commodities.

With the ruble’s devaluation in 2014 and the growing demand from domestic retailers Russia’s light manufacturing and food processing sectors have enjoyed a renaissance, as local firms strive to meet the demands of the domestic consumer using domestic producers who are now cheaper than China, the traditional supplier to the Russian market.

Magnit currently has 11 factories producing goods for its own in-store products, including things like pelmeni, pasta, chocolate, sweets and buns as well as a variety of common fruit and vegetables such as mushrooms and carrots, potatoes and onions.

“Russia’s doesn't grow bananas and coconuts but it is much more able to provide for its own needs,” says Dunning. “We still need international sources, but we can find things like plastics, textiles, seasonal goods on the Russian market. There are lots of quality suppliers. And the devaluation of the ruble and the sanctions have pushed industry to develop fast.”

Magnit stock rallies

Investors seem to approve of all the changes being made at the store, as the company’s stock price performance has come back to life.

After Galitsky sold his shares to VTB in 2019 the stock became a dud. As the Russian stock market began to recover again that year, Magnit shares remained flat, ending the year slightly down 6.8%, while rival X5 Retail Group gained 37.6% over the same period and became the new hot name in retail.

This year the story has reversed again. Both companies saw their shares crash in March, falling by over 40% in the worst of the panic selling, but since then Magnit’s shares have easily outperformed those of X5; they have returned 41.4% and 13.8% respectively since the start of year as of December 16. Magnit’s stock is back in fashion and analyst have been writing glowing research notes on the company.

This new enthusiasm is partly a result of the strong results that Magnit has put in. The pick-up in sales and lower costs in the last two quarters is due to the new executive team finding its stride, according to VTB Capital (VTBC), which expects more good things to come.

Next year, VTBC says it expects the store rollout to resume, with 7% year-on-year higher selling space and a 6% top-line compound average growth rate (CAGR) for the next five years.

The Ebitda margin of 7% is at a comfortable level and the gross margin cushion is sufficient to offset cost expansion, the bank said in a note. 

"The story now switches to careful capex allocation and working capital optimisation, which in our model returns a blended free cash flow (FCF) yield of 6% in 2021-2025," VTBC wrote.

Dunning is says that he is keen to restore investors’ confidence in the company’s stock and after income and EBITDA improved in the third quarter of this year he was happy to return cash to investors with a surprisingly generous dividend payment. Magnit offers a sector-leading dividend yield of 10%, with the higher-than-expected dividends for 9M20 and a total payment of RUB25bn ($330mn), making a 67% y/y increase at RUB245.3 per share.

“The EBITDA has been good and the like-for-like (LFL) sales robust. We spent less on capex than we anticipated and so as there was free cash flow we decided we could return some money to the shareholders. It’s one of Magnit’s traditions that we will keep,” says Dunning. “But what we will really reward shareholders with is the results. We want to grow the value of the business.”