Company: Magnit

Conference Title: Magnit 3Q and 9M 2019 Trading Update and Financial Highlights Conference Call

Date: Tuesday, 29th October 2019

Operator:

Good day, and welcome to the Magnit Third Quarter 2019 Trading Update and Financial Highlights Conference Call. Today’s conference is being recorded. And at this time, I’d like to turn the conference over to Jyrki Talvitie. Please go ahead.

Jyrki Talvitie:

Good afternoon. This is Jyrki Talvitie. Welcome to Magnit’s conference call dedicated to the operating and unaudited financial results for the third quarter of 2019. Our speakers today are our President and CEO, Jan Dunning, and our CFO, Elena Milinova.

The presentation and announcement published this morning are available on our website. We will start with some prepared remarks followed by a Q&A session. With this, I would like to hand over to Jan Dunning, President and CEO of Magnit. Jan, please.

Jan Dunning:

Thank you Jyrki. The first quarter total revenue grew by 10.5%. Our EBITDA margin came in at 5.8%, and net profit totaled RUB 3.3 billion. Like-for-like sales in the convenience and cosmetics formats continued to be positive. Our weaker results in the bigger formats caused the overall like-for-like sales decline to a minus 0.7%. Like-for-like in drogerie is recovering, but still negative with basket continuing its positive trend driven by assortment improvement and investment enterprising.

I’ll come back to this later on. The third quarter was difficult for the whole Russian food retail sector, with slowing food inflation and a high base for us for the third quarter 2018 affecting the results. We experienced further downward pressure on our results due to our decision to sell in July-August over half of the passive matrix we held after the second quarter. The sales of almost RUB 17 billion had a negative effect on EBITDA of 144 basis points, through a combination of price reduction and cannibalization.

And the like-for-like sales were actually affected by 117 basis points. So, adjusted pre-selloff EBITDA margin was 7.4%, which was 0.4% better than last year, and the like-for-like sales were plus 0.49. Despite this one-off effect, I felt strongly that this should be done, as not taking decisive actions will be delaying the implementation of the new assortment. The passive matrix SKUs at the end of the second quarter represented actually 40% of the overall SKUs, and were clogging up shelf space.

But we now have reduced the passive matrix to 13% which is much closer to our target of around 8%. The remaining passive matrix will be sold gradually as it consists of SKUs that are of seasonal nature, or such where deep discounting makes no sense as we will be able to sell it off over time with minimum discounting. We additionally modified the KPI structure of the category management. We streamlined it with the sales side operations, allowing us to control inventory more efficiently going forward.

After the sale in July-August, we have already seen the numbers improve in September with sales growth at 10.5%, year on year, and convenience like-for-like sales at 0.8%.

Now let me step back a bit from the previous quarter, and look at where we are in a broader scope. It’s obvious we lost some time this year with the leadership changes and the recalibration of the management focus from growth to fixing the existing business. My main focus is now on improving the existing business while slowing down expansion to a moderate level.

We see a couple of initiatives and the first group of initiatives is we’re doing this by better serving customers, which in turn will drive like-for-like sales improvement. Key areas in customer service we are focusing on and have already seen progress, are the assortment improvements. Our target assortment is established and the passive matrix sold down, allowing shelf space for full new assortment. In addition, the foundation work to ensure further improvement through regular efficient processes has been done.

New assortment management system was introduced with currently over 80% of the assortment migrated, which allows for a faster implementation of assortment changes down to four weeks, coming from ten weeks in the past. And we have significantly strengthened our team and category management with 50% new people, both in the head office but also primarily in the region, with 35 out of 45 management level positions filled this year. The KPI system for category managers was also updated to streamline it more efficient with sales.

Getting the assortment right is key as our research shows that it was the main deficiency in comparison to the CVP of our competitors. Although customer recognition of assortment changes usually takes time, two to three quarters, we see already the first positive signs as units per check are on the rise. And customer perception studies show us fast closing the gap with competition regarding assortments. The appreciation for our assortment is clearly growing.

Private label. During the next few months we will finalize the launch of our 26 new private label brands, representing all three category levels of good, better, and best. And our own production will play a significant role in that development with over 800 new SKUs with a strong emphasis on health, ecology and providence, which are growing trends among consumers. Brands like Made in Kuban will differentiate the Magnit assortment from the competition.

Then loyalty program. After the very successful pilot launch of our multi-format loyalty program in the second quarter, we started a nationwide rollout in August with final regions coming online by the year end. Today, already, we have over six million activated cards, and percentage of sales with a loyalty card is, at the moment, 64%. And for number of checks it is 46%, allowing us to understand customer data and increasingly drive our decision-making and customized communication with our customers.

Availability, which is actually the fourth lever, on the supply chain side, we record improvements across all the KPIs, better availability, lower out-of-stock levels, and especially service level of deliveries from our distribution centers which increased by 6% in comparison to previous year.

The last point is big boxes. As I mentioned before, the big boxes have taken our like-for-like performance down. As we have discussed before, supermarkets below the 2,100 square meters, the supermarkets plus, and the Cash & Carry formats, or so-called big boxes, have dragged down the like-for-like, while the smaller formats have shown clear improvement. This has been a result of always being focused around the convenience format and the big box not actually receiving adequate attention and full focus. We feel, however, that as even our superstores are on average only around 2,500 to 3,000 square meters and they are located in urban areas rather than outside town, we think we will be able to avoid the negative trends related to hypermarkets as we transform the customer value proposition for the superstores.

We’ve now set a separate team to handle the transformation of these formats. And we’re building a separate category management team for the big box formats to build on the core SKUs of the convenience to add on especially fresh and ultrafresh, and few other traffic-driving categories. We’re reducing non-food category groups, but bringing in comprehensive selections in the chosen categories. We already have one pilot running in Moscow, and a second one will be opening in Krasnodar the next month with further rollout to be expected next year.

Then, concerning the organization, we are continuing to build up the 12 regions, but seven of them are fully launched, but with a stronger emphasis than before on separate format-based operations. The head office is also going through various changes. We feel we have been too vertical which makes the management too far away from the customer, and I’m also separating marketing from the commercial department as we get ready for a stronger push to attract customers back to experience our transformed customer value proposition.

Since July, I’ve spent a considerable amount of time concentrating on our most valuable asset, our people, to restart building a culture of collaboration, initiative and responsibility. We’ve had strategy meetings with the top 150 and 450 managers. And I’m regularly traveling into the regions to connect to them as well. The new approach has already shown turnover numbers declining. So, there’s rotation of staff coming down, but we still have lots to do on that front.

Costs, on the cost side, cost is another focus area for Magnit, and it has always been. Supply chain efficiency programs have been running for some time now. And we are actually improving logistics costs on a monthly basis, with September hitting a historic low. Staff costs should start showing improvements in the quarter to come as we finalize the organizational changes related to decentralization of front-office functions, and centralization of back-office functions.

As we focus on improving the existing business, new store openings are slowing down. Simultaneously, we have tightened the return criteria and selection process for new projects. In the third quarter, we opened just 276 new stores — new convenience stores actually, which is less than in the second quarter as well as in the third quarter of 2018. And in the quarter four, this declining trend will continue compared to the quarter three.

Now, I would like to shortly hand over to Elena to discuss the guidance.

Elena Milinova:

Good afternoon from my side as well. I would like to update you on our guidance for 2019. We guided EBITDA margin to be sustainable and in 2018 we showed 7.3%. We are now correcting it down to 6.5% for 2019. The change is due to effects of the one-off items of inventory sale, the fire at the Voronezh DC, and extra expenses related to management changes and consulting.

Adjusted to these one-off effects, the EBITDA margin will be 7.2%, so practically at last year levels. We guided for positive like-for-like sales this year, and there is no change to this. We promised to open convenience stores at a similar level to 2018; that is around 1,500 net openings. As we are concentrating more on the existing business and slowing down openings, our new guidance is around 1,200 net openings for the convenience formats.

We plan to redesign around 2,000 stores, but expect to outperform this, to hit around 2,300 redesigns. We maintain our CAPEX guidance for RUB 70-75 billion.

And now back to Jan.

Jan Dunning:

Yeah, let me finish with some last input. I think with the changes that we are implementing, we are seeing for the first time, in a long time, customer satisfaction numbers rising. And actually also the migration reports showing neutral results, vis-à-vis the main competitors. And although these developments are very positive, we have not yet been showing those in our like-for-like numbers.

But with green shots not only in our business, but in the overall environment with disposable income rising 3% in the third quarter and consumer confidence starting to improve and overall retail space growth slowing, I am actually looking to the coming quarters with more confidence. Our journey of transformation will continue for some time. The deeper changes like culture and IT systems lasting longer, but I feel that with our focus on the key CVP drivers, we’re making good progress and commercial results will see improvements already in first half year 2020. Thanks.

Jyrki Talvitie:

Now we are ready to go to Q&A.

Operator:

And just as a quick reminder, if you’d like to ask a question, please signal by pressing star one on your telephone keypad. And if you’re using a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. Again, that is star one to ask a question. And we’ll take our first question here from Ulyana Lenvalskaya with UBS. Please go ahead.

Ulyana Lenvalskaya:

Hi, everyone. Good afternoon. Thanks for the call. My first question will be more focused on this one-off. Just trying to understand how the one-off was calculated. Could you please quantify the old matrix, so passive matrix inventories which are left? And maybe describe what exactly is left, and shall we expect the impact in the fourth quarter in margin too?

Jan Dunning:

Thanks. Like I mentioned already on the call, we were able to sell down around RUB 17 billion of old stock, leaving us with around RUB 12 billion, RUB 13 billion of stock which is the stock that was recently selected into the passive matrix. Therefore, we feel quite confident that — and we see already that that’s selling down — that we do not need to discount that as much as we did with the old stock.

And there’s also stock which is much more seasonal related, like end of the year or spring, which we also do not see any need to sell down now. And we believe while we presented in the good period of the year, it will start selling as well. What is the best impact of the selling down is that we now have sufficient space on the shelf to present the new assortment, which was selected through a category management method. And I think that’s clearly visible for our consumers. And that’s why we believe that the first feedback from consumer satisfaction panels is that we’re actually starting to see correction on our assortment.

Ulyana Lenvalskaya:

Thank you, Jan. And maybe a bit of a traditional question, do you expect the positive like-for-like traffic anytime soon? Is it the priority or could you perhaps comment on traffic outlook?

Jan Dunning:

Like I mentioned on the previous call as well, of course we are looking at traffic, but we’re more looking at share of wallet. And now with the loyalty card and getting more insight into behavior of our customers, we are also able to follow this up. So, are we losing share from customers or actually are we gaining share from customers, but they just come less often.

And probably you’ve seen the Sberbank Ivanov reports; the general trend is that people start shopping less but spend more. And that’s exactly what we reflect. But it’s more important, do I see customers spend more with me? If they come, do they spend more? And the first results of the analysis of the loyalty card is yes, we see that customers still are coming less, although we see a big uplift in September and as well in October of visits. Still negative though, but we’re not losing on value. So, our customers continue spending with us as they did before.

Ulyana Lenvalskaya:

Okay, thanks.

Operator:

And we’ll take our next question from Yulia Gerasimova with Goldman Sachs. Please go ahead.

Yulia Gerasimova:

Yes, good afternoon. I have two questions please. So, first I just wanted to — for Jan maybe you can comment on the October trends, how October had been shaping up? And also there was some improvement in September growth which is actually the opposite trend that we have seen for some of your peers for whom September was actually a weaker month in the quarter. So, if you can also comment on what was driving, you think, an improvement in September. So, that’s the first question.

Jan Dunning:

So, what we’ve seen since the end of August is we see that the traffic is improving. We’re still in a negative area, but where we were posting into minus 3%, 3.5%, we see that coming down to minus 1.5%, around that area. And that clearly is a signal that people feel more comfortable to come.

What our biggest focus now is seeing the visits pick up, is how can we get the basket grow. We see the basket growing but, and most exciting, for me at least, is that I see as well the number of items in the basket grow. And that’s actually a confirmation that the activities that we are doing on the category management side are exactly the good alternatives that we offer to our customers.

Yulia Gerasimova:

And regarding October trends, any specific comment that you may share?

Jan Dunning:

Yes, I think what we’ve seen in September is what we see in October. What we do see, by the way, in September and October is a stronger deflation of shelf price, which is not helpful for the like-for-like. But okay, we have to deal with this. So, you see that the price pressure is strong. And that’s partly reflected by the competitive environment. We’ve seen as well with the reporting of the colleagues that promo pressure is high.

On our side, we think that we should take that pressure down as we have done a lot of initiatives in category management. And I think category management should help us to improve our sales instead of trying to boost more promo.

Yulia Gerasimova:

Okay, thank you very much. And my second question was on dividends outlook. I think previously your soft guidance was that Magnit would like to maintain about the same absolute amount of dividends. Actually, last year set quite a high standard, about RUB 30 billion. With the net income basically being soft compared to last year, are you still sticking to that?

And what’s your outlook on the dividends? I mean, because I see that your Russian accounting standards is actually ahead of IFRS, providing you the opportunity to pay more than 100% if you wish to do so. But the question, I mean, are you willing to pay such a high dividend this year?

Jan Dunning:

Now, as the decision on the height of the dividend has not been made yet, so I can’t give you today any information. But there is from our side no inclination to change the policy like we did last year. So, I guess that you can expect a dividend payment for the second time, yeah.

Yulia Gerasimova:

Can you just — for me to clarify, what do you mean no change into the dividend strategy compared to last year? What does it mean?

Jan Dunning:

We have always been paying twice a year. We’ve paid here in June-July. And I think we expect to have a dividend payment as well in January. We won’t have any change in absolute terms as well.

Yulia Gerasimova:

Okay. Thanks.

Operator:

And as another reminder, please press star one to ask a question. And we’ll pause for just a moment to allow everyone the opportunity to signal. And we have another question here from Elena Jouronova with JP Morgan.

Elena Jouronova:

Yes, hi. So, I have a few questions. I guess, we can start with store openings guidance. It’s clear that for this year you’re slightly reducing that. But what are your initial thoughts about plans for next year? Do you think that we should expect convenience store openings to be around the level where they will be in 2019? Are you slowing, are you intending to pick up?

Jan Dunning:

Yes, like I mentioned in the call, Elena, I think for us it’s very important that we focus on our like-for-like business. There is a lot of stuff to do. And I see as well that the initial, the first efforts to improve the business are clearly recognized. So, that creates more courage, for me at least, to continue. I don’t think that I will increase the speed of openings. I think it’s more important for me to make sure that the existing business gets back to speed. Because, let’s be honest, we are the biggest retailer with regards to the number of stores in the country. It makes a lot of sense

for us to focus on like-for-like as that’s where our potential is. I’m not saying that there is no potential in groceries. But we can check that part anyway over time. And it’s better to be more convinced of our like-for-like in order to grow than distract the organization from where we can improve.

Having said that, I think we will continue the growth speed of the convenience — sorry, the cosmetics, because we see that that’s actually a business that is performing well, and also like-for- like is performing well. And by the way, that will help us as well on the margin side. So, I think that’s an initiative that I will support.

Elena Jouronova:

But just to quantify, because effectively this year, Jan, I don’t think that at the start of the year you were deciding on the number of openings. And you’re slowing down openings in the second half. Is it fair to assume that next year you might open even a lower number of convenience stores than in 2019? Or for the sake of modeling, we just assume flat openings next year compared to this year?

Jan Dunning:

I had already the suspicion mainly that it was because of your modeling that you want to know that. But let me be honest, we have raised the bar for accepting projects. And I mean, the IRR bar, the return bar, in the middle of the year. To the extent that if they would reach that number, it would really not be clever not to open them, and that’s what we do currently.

So, the stores that we are opening are — we are actually pretty convinced that the returns are good. I think that approach which still lead to a good number of store openings, we should continue in the next year as well. And by focusing the development teams on certain areas, we believe as well that we should be able to open a similar amount of stores next year as we do this year.

What I do tell you is that the composition of cosmetics and convenience might be a bit different, but just a bit. And I hope that this helps you to model because there is no intention to stop growing. I think we see opportunities. This market is certainly not mature. We also feel that we should look

at potential M&As, smaller ones, as in certain market areas, it makes more sense to replace than to add. But having lifted the return bar is I think the best guarantee for the investors and the shareholders that we’re at least using their money smart.

Elena Jouronova:

So, effectively, you are aiming to increase the quality of openings.

Jan Dunning:

Yes.

Elena Jouronova:

Then if I can ask another question on the assortment sales, has everything that — all this RUB 16.7 billion worth of inventory, this passive assortment, was it actually sold or something was written off, just to be clear? Because if my math is correct, then you’ve sold these products with virtually zero gross margins?

Elena Milinova:

I will answer that question. So, it was sold with discount. And the effect which we get split it by two. So, first we lost some commercial margin because we sold it with discount. It’s about RUB 1 billion. And also, we got cannibalization of regular sales which cost us RUB 4 billion. That’s the effect on EBITDA in total. But there were no write-offs, but we sold some things with deep discount.

Jan Dunning:

And actually, to confirm what Elena is saying, we see also the shrinkage numbers. Because normally if you write-off, a part of it gets into your shrinkage numbers. We see the shrinkage numbers moving into the right direction as well. They’re improving quite a lot.

Elena Jouronova:

I’m sorry, but I’m just not familiar with how it works, how were you able to calculate this RUB 4 billion effect of cannibalization of regular sales. What does it actually mean?

Jan Dunning:

Yes, if you sell old stock, then the old stock could be a sales on top of the regular basket or it replaces a part of the regular basket. And what we’ve seen is that the replacement has been

pretty strong. And that’s what Elena was referring to. That’s called cannibalization and the impact of that cannibalization was RUB 4 billion. So, that’s actually what we lost in sales.

Elena Jouronova:

Lost sales, all right. Can I have just a few more questions, please? So, did I get your comment correct about margins for the rest of the year? So, you gave a guidance, an updated guidance for the full year margin of 6.5%. Again, if the math is correct, this implies that your margins should accelerate in the fourth quarter to something around 7%, which would be flat year-on-year.

Is that broadly in line with the management’s thinking of how fourth quarter will shape up? Obviously, we don’t know what competition is doing. But more or less, if there’s no intention on Magnit’s part to invest too much in price, and give away too much of the margin or — yeah, just maybe a comment if I got you correct on the margin point?

Jan Dunning:

Yes, I’m actually pretty outspoken here. I think our efforts have been done on improving the assortment. I think our assortment improvement should help us to first, play the bigger basket. Second, potentially have customers trade up on what we also see. I do understand that promo is an integrated part nowadays of retail in Russia. But I do not see a need to increase that pressure.

I think we should see like-for-like improvement coming out of category management initiatives. And I trust that that’s also what we see in the feedback because the feedback from customers, where we see better appreciation is on assortment. Our pricing is neutral. So, if I would lose on pricing, I could imagine that I would push pricing, but that’s currently not the case. And I think also in our price comparisons, we’ve seen that our pricing is actually pretty relevant. So, there’s no need to overdo.

Elena Jouronova:

Thank you. And then one other question where I was hoping you could help me is to try and understand the sales of Magnit’s new concept convenience stores that you’ve been opening I think in the past quarter or so — there’s a few of them in Moscow. What are they roughly versus sales in an ordinary Magnit store before the changes in assortment and the redesign? So, what is the uplift in sales per store?

Jan Dunning:

I understand the question. I can give you an average number. But what I mentioned on the call as well is one of the things that we see where we’re not strong yet is availability. We have improved with 6% the availability from DC to store. But we’ve run some projects — and I can give you some examples. We’ve run some projects in Moscow where we’ve said okay, we step out of the regular. We start focusing on availability. And what we have seen store uplifts from up to 26%, 30%. The regular one, the average one is around 9-12%.

And so, like I said, it’s average. It’s based on availability that we think can be better. And that’s what our focus will be on, which I mentioned by the way as well in the call. I think there’s a couple of initiatives that we need to develop still. And one of the initiatives that we’re currently working hard on is get better control on store orders and store availability, because that’s not sufficient. So, there’s an area to improve. If that’s done, we see that we get into pretty good numbers.

Elena Jouronova:

And when do you think you’ll be able to do it, to improve substantially on shelf availability across the entire network? What’s the timeframe?

Jan Dunning:

I want at least to see a considerably better availability number in December. So, we should review start of October already to analyze and to understand. And I think we will see also the first impact there in November. And we’ve done some tests which clearly show that that’s an area, if we pay attention, and we get that done, that that will really give us good results.

Elena Jouronova:

Thank you so much for answering my questions.

Jan Dunning:

Thank you.

Operator:

And again, I’d like to remind everyone that’s star one if you’d like to ask a question.

And we do not have any other phone questions at this time.

Jyrki Talvitie:

So, thank you everybody for participating. As always, if you have any further questions, do not hesitate to contact our IR. And I would just like to remind everybody that we have decided to have our Capital Markets Day on February 12th in London. So, obviously, I hope to see you there. But of course, we will be announcing our annual results before that as well.

So, thank you, everybody and have a good evening.

Operator:

And that concludes today’s call. Thank you for your participation. You may now disconnect.

Magnit 3Q and 9M 2019 trading update and financial highlights Ccall transcript