© 2024 Alpha Spread Limited. All Rights Reserved.
www.alphaspread.com is not operated by a broker, a dealer, or a registered investment adviser. Under no circumstances does any information posted on www.alphaspread.com represent a recommendation to buy or sell a security. The information on this site, and in its related newsletters, is not intended to be, nor does it constitute, investment advice or recommendations. The information on this site is in no way guaranteed for completeness, accuracy or in any other way. In no event shall Alpha Spread Limited be liable to any member, guest or third party for any damages of any kind arising out of the use of any content or other material published or available on www.alphaspread.com, or relating to the use of, or inability to use, www.alphaspread.com or any content, including, without limitation, any investment losses, lost profits, lost opportunity, special, incidental, indirect, consequential or punitive damages. Past performance is a poor indicator of future performance.
You don't have any saved screeners yet
Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Good day, everyone, and welcome to the Lenta Q3 Sales and Operating Results Conference Call. Today's call is being recorded.At this time, I would like to turn the conference over to Albert. Please go ahead.
Thank you, Kim. Good evening, good afternoon and good morning, ladies and gentlemen. Thank you for joining us to discuss Lenta's third quarter 2018 sales and operating results. With me to review the results are our CEO, Jan Dunning; and CFO, Jago Lemmens. The announcement and respective presentation are available on our website. And after our remarks, we'll look forward to taking your questions.I will now turn the call over to Lenta's CEO, Jan Dunning. Jan, please.
Yes, thank you, Albert. Good day, everyone, and thank you for joining us.Yes, you will have seen from the announcement that the third quarter sales growth was below the previous quarter and our original expectations. We see this as mainly an economic effect but a significant one. We also announced a share back program. We think the company is fundamentally undervalued. And that buying back shares while slowing expansion growth will be value-creative for shareholders. We'll get back to that later on.I would like to take you through some highlights in a bit more detail. The environment has become tougher. The macro and consumer environment started worsening in the middle of the second quarter. Real disposable household income growth fell due to lower wage growth and rising expansion -- expenses. In September, consumer confidence plunged to the lowest level for the last 2.5 years. Expectations of higher inflation, pension reform, currency depreciation and hikes in tariffs led customers to a saving mode. High promo intensity brought additional pressure in customer spending ability.This more challenging environment has impacted our results in several ways. Lenta continues gaining many new customers, and the number of unique customers grew much faster than our sales, which, again, demonstrates the attractiveness of the Lenta's offer. Like-for-like traffic growth showed negative as growth of new customers was offset by a reduction in the frequency of visits to our store. This was seen across our hypermarkets in all regions, while the like-for-like supermarket traffic showed a big improvement from the previous 1.3% to 3.5%, that's largely thanks to improvements in the offer.Like-for-like ticket growth decelerated largely due to a lower number of articles in the basket and continuing shelf price deflation, which was only partly offset by trading up. Shelf price deflation eased a bit versus previous quarters of the year but still remains under pressure from the high promo level in the market. Trading up continued year-on-year but -- and again showed further improvements quarter-on-quarter. Average number of articles in the basket was weaker versus previous quarter, turning negative for the first time this year.Food sales growth turned negative, while non-food like-for-like sales remained positive. The non-food sales continued benefiting from assortment revisions, and in the third quarter, we had a total of 19% sales growth in non-food, with like-for-like higher than in fresh and dry food.Promotional activities intensified a bit quarter-on-quarter in the third quarter as several other retailers also had back-to-school promotions and anniversary campaigns. Year-on-year growth in promo share remains almost at the same level as growth quarter-on-quarter at around 2 to 3 percentage points.The weaker trends we saw in the third quarter have continued in October. Results in the first 3 weeks of October were below the third quarter, and based on this, we expect the fourth quarter will be even tougher than the third one. We made a decision to withdraw our activity in the low-margin cigarette wholesale market, which will have a negative impact on sales growth in the fourth quarter but limited EBITDA impact. The implications of this change will be negative for sales growth in the first 3 quarters of the next year as well. We continue improving our offer in terms of assortment as well as marketing activities and communication, but we don't expect these efforts to overcome the short-term headwinds.While there are short-term challenges, our confidence in the Lenta business model and in the longer term is unchanged, which are among the key reasons why we announced a RUB 11.6 billion share buyback program today. As you know, the Lenta board and management are focused on efficient capital deployment and shareholder value creation. We believe that the current market valuation does not reflect the fundamental value of the business. The cost of equity capital is at elevated levels, both in absolute terms and relative to the cost of debt. The long-term fundamentals of the Russian food retail industry remain attractive for the most effective players and with less competition in the hypermarket format than in smaller formats. Though there are many opportunities to open new stores, the competing hypermarket players are not expanding, so these opportunities will not go away. We can therefore afford to slow down hypermarket expansion without sacrificing our strategic position. In these circumstances, we believe slowing organic expansion and returning cash to shareholders through a share buyback is an efficient and value creating use of capital.In a moment, Albert will take you through more details of the buyback program, but first, I will explain changes to our expansion growth. Our store opening guidance for this year remains unchanged, which is about 18 new hypers and about 14 -- 40 new supermarkets, but we will significantly reduce organic store openings next year. In this tougher consumer environment with elevated cost of capital, we think that adding a lot of new space risks suppressing the returns for our self and others. We will provide more precise guidance for 2019 in the first quarter of next year, but as of now, we expect to open around half as many hypermarkets as in 2018 and even perhaps less.We remain strongly return focused and prioritize projects with the best returns. Of course, we will also continue to evaluate bolt-on acquisitions if attractive value-accretive opportunities arise. We will probably also reduce the rate of supermarket openings but for different reasons. In contrast to the hypermarket format, competition for new space in the supermarket segment is strong. This can push our rental rates sometimes to absurd levels. We will be disciplined, so while we will continue to open stores, some slowdown from this year's guidance of about 40 stores seems very likely. The intention to slow expansion in 2019 should not be seen as a lack of confidence in the long-term attractiveness of the market, nor does it indicate the lack of opportunities. It is purely a sign of our confidence in Lenta's market position and our focus on value creation for shareholders.As you know, Lenta is the first hypermarket player in Russia and became third food retail chain in 2017. Our market positioning is improving in all key cities, in line with our goal to become the first hypermarket in all the areas of presence. We will continue strengthening our positioning in the sector by growing faster than the overall market and leveraging skill advantage for the other hypermarkets as well as local players. We don't compete head-on with the top 2 players in the convenience segment, who are adding a lot more space despite the weak consumer situation, and we will continue differentiating our offering through opportunity stores.Through all this, it should be clear that it makes sense to adopt -- adapt our plans to the changes in the environment, so we are no longer targeting to double selling space during the period 2017 to 2020.And now let me turn the call to Albert to give some more details on the buyback. Go ahead, Albert.
Thank you, Jan. I'm sure you have seen our announcement of the share buyback this morning with total purchases of up to RUB 11.6 billion. Jan has explained to you the rationale for the buyback, and now I will give you some details in terms of the program.The board has authorized the GDR buyback program to be conducted between 29th of October 2018 and 29th of October next year. Crédit Suisse has been engaged to carry out the buyback by means of open-market purchases on the London Stock Exchange. Crédit Suisse will, in turn, sell the GDRs it has purchased to Lenta LLC, the operating subsidiary of Lenta Ltd. The intention is to change the GDRs purchased back into shares of Lenta Ltd., which are not tradable. These shares will be held in treasury. The company has no plans to reissue the shares later. We can hold them as treasury shares indefinitely. It is not tax effective to repurchase GDRs via Lenta Ltd., so the stock will be owned by Lenta LLC and, therefore, cannot be canceled. It is also very important to notice that treasury shares cannot vote, whatever held by Lenta Ltd. or its subsidiaries. This is stipulated in the articles of association of the company.And now I will hand over to Jago to say a few words on cash flow and debt.
Yes, thank you very much, Albert. I will, indeed, say a few words on financing before I will hand back to Jan.As you know, Lenta has always taken a conservative approach to financing and is committed to a strong balance sheet. With the reduction in the planned organic openings, as Jan announced, the company is expected to become free cash flow positive in 2019. We expect to be able to fund the buyback and the organic expansions while reducing leverage in 2019. Lenta's lease-adjusted leverage remains the lowest among the major retailers due to our higher share of owned property. With the implementation of IFRS 16 in 2019, this will become even more relevant.Given the volatility that we have seen on the market, we decided to refinance all debt coming due in 2019. As a result, our average interest costs will remain around 8.5%, 8.4% throughout 2019 unless market rates change. Of course, the vast majority of debt is fixed rate. Our interest costs are not very sensitive to changes in the marketplace. And because of these refinancing activities, we will be able to do multi-expansion and the share buyback without having a need to borrow anything additional in 2019.And I would like to hand over back to Jan.
Yes, thank you, Jago. Also, some closing remarks from my side. The Lenta board and management remain committed to high standards of corporate governance with a strong focus on efficient capital allocation and returns. We have adapted our plans in order to maximize shareholder value creation in a more challenging environment. The macro and consumer environment remains tough and competition in the sector is increasing, with some players adding what we consider to be excessive amounts of new space and being forced by suppliers into excessive amounts of promotion. The challenging market conditions have impacted our performance. We have the tools and capabilities to offset these effects over time. However, we expect the quarter 4 change will be even tougher than the third quarter.While the short-term outlook remains quite negative, long-term fundamentals in the fragmented Russian market are still attractive, offering lots of opportunities for the most effective players. Our confidence in the business remains high and believe that current valuation does not reflect the fundamental value. In the short term, we will restrain growth to only the most attractive opportunities. Our strong cash generation and slower expansion will enable us to return cash to shareholders through a buyback while maintaining a strong balance sheet.Thanks for listening, and now we look forward to your questions.
Kim, we're ready for the Q&A session.
[Operator Instructions] Our first question is from Elena Jouronova from JPMorgan.
Thank you, first of all, for being quite honest about the card consumption environment and very sensible about your expansion plans going into next year. I'd like to focus my questions on the differentiation of offering vis-à-vis your core competitors, Magnit and X5, and vis-à-vis specialized retailers and maybe even other hypermarket players. Do you think that you are doing enough in terms of differentiating? And do you think that you're investing enough in price? I will explain where my question comes from. Jan, I think you were the one who -- probably the only manager out there in Russian retail who always said that, "I'm happy to sacrifice margins in order to drive like-for-likes." And today's print of these, in my opinion, very weak like-for-like sales numbers leaves me [ tracked ]. Is that still the case? Are you still willing to invest in price to drive like-for-likes? Or you think something has really changed in the way that retail works in Russia, in particular, at this moment that now this is not what Lenta should be doing?
Yes, thanks, Elena, for your question and thanks for the compliments for the script. The -- although I'm not happy, of course, with the things that we had to be open about. There's a couple of questions that you raised, so let me try to sort them. Let me first react on the pricing, which is the last part of your question. Within Lenta, that is still the approach that -- yes, we will sacrifice pricing, potentially margin, if that is beneficial for sales. So top line is #1. What we see in the market, Elena, is that I cannot jump on all the promos that are around. So it means that we develop our own promo activities and pricing policy. But with all the competition currently due to the trade law moving in the instrument of promo, it is very difficult to follow on all those activities just physically already because we need to be aware of all the promo prices in the market and then also change them and change them back. The main addition in the market currently is that, actually, if you do a promo, you go out to the supplier and negotiate the promo and the discount on your pricing. If I react on the promo of one of my competitors, I will not be able to get the discount on my invoice. So besides not having the total -- our view at the moment of the time to react is also -- is almost impossible. If I know in advance, I will try to match the pricing. Having said that, and then I get to the first part of your question, all the time, we also have to acknowledge that mission with the growth of the #1 and #2 who are primarily operating in the convenience segment. I need to think as well of what is the reason to come to Lenta, where pricing is important. But pricing also is getting less important as the aggressiveness of competitors are growing as well, and that's called differentiation. So what kind of other reasons can I develop that make people come? Now we have, last year and this year, we're investing quite a lot of energy into private label development, and I think that pays off quite well because despite the fact that the private label development is primarily in the dry food, we see that the private label has a like-for-like loss. That's one. The second one is define the departments where you know that you can't be beaten by convenience, which -- whether our categories which are actually daily on the Russian consumer table, which is fruit and veg, meats, gastronomy, fish and all those we are currently developing. Your question is whether the speed is correct. Of course, I would always like to be quicker. And in certain areas, I think we should have been quicker. But it's also a method of awareness because I think the biggest issue that we have is the differentiation is there, but is it explicit enough for the consumer as well. And I think that's where we need to work on to get that better across to our customers because -- I mean, I have some evidence, Elena, here that if that would not be evident, how to explain that customers -- that more customers come to Lenta. Yes, their frequency goes down, but it's not that they say farewell to Lenta, and there's more and more customers coming. So I think our aim on the short term should be how to increase the basket of those customers that come. And I think that's where our current activities are focused on. I hope this answers a bit your question.
Yes, Jan. And I appreciate that -- the working environment is quite tough right now, so I'm sure you're trying to do the best under the circumstances. Apologies if I offended you with my question.
No, no, no, you didn't. That's a challenging one.
Moving on, we have a question from Maria Kolbina from VTB Capital.
I have 2 questions. First of all, can you comment on the openings that you did within the last 12 months, how the paybacks and the stores catch up compared to the stores that you opened like 2, 3 years ago as definitely where a tough consumer environment is not something new? So that's the first question. And the second, as you cut down the growth quite materially, where do you see -- do you think you will be able to keep the same level of profitability going forward? Or what are your key thoughts on profitability development in the next 12 months?
You want to, let me guess, specifically to the 12 months, Maria? Or can we just say 2017, '18?
Only '17.
For the openings.
Yes. Because in the last 12 months, it's actually the NASH stores plus 2 hypers that we organically opened. Now the NASH stores have -- if we look at the returns, and I think they show a similar pattern to what we've seen in the years before. I think the biggest issue that we face, Maria, is our general return matrix of the business due to the like-for-like pressure is, of course, not improving. And I think that's what we need to work on. In the stores that we have opened over the recent couple of years, I would say they have shown similar patterns as what we've done before. There are some that performed less, there are some that performed better. But overall, due to the macro, the environment has become tough. Having said that, it's not that we have announced that we will not open stores next year. So it's not that we've lost courage. What we -- what happens is, actually, looking at the competitive market, we see that there's very little hypermarket business that opens up, and it's chasing the products that we have identified. So there is no hurry. Second, we believe at the current share price that it actually is much more accretive to buy back shares than to open up stores, certainly, on the short term. And that's actually how we got to this point. I don't know, Jago, whether you could -- whether there's something to add on the return?
No. I think that you explained it perfectly well, yes.
And my second question was on profitability. Where do you see it going forward? Do you think you will be able to see the same level of profitability? Or what are your key thoughts here?
Maria, let me give you a bit of color on that. You understand we don't provide guidance on the profitability, so I'm not in a position to give any precise number. If you remember, in the first half of 2018, we had some improvement in the gross margin, thanks to better supply conditions and better coverage of our promo activity by suppliers. We reported some pressure on shrinkage, and this is the area we're working on, putting a lot of efforts and hope to get this thing off. We will continue working on the efficiency of our supply chain and into production. In the SG&A part, as you remember, there was some pressure from rent as we opened a lot of rented space in 2017, new rented space. This year, most of our openings will be owned. And there was some pressure on utilities linked to increase in electricity tariffs and wages due to indexation of wages in October '17. There is no discussion at the moment about new wage increase this year. And there was some pressure, of course, from the road tax as well. So we are working to improve all these lines I mentioned, including shrinkage on the gross profit level and SG&A expenses. That's all I can comment at the moment. Thank you.
And then one thing I can add to this, Albert, is that if you look at the revised CapEx forecast, then you will see that the growth of depreciation will, of course, also significantly go down.
Yes.
Okay. And maybe like one follow-up question, my third question. So like, is it possible to do like maybe, like a very simple mathematics to understand how the current economics of hypermarkets work in Russia? So like previously, you had like an average payback of 5 years, now it doesn't go to 10 years, 8 years, 15 years. So can you give some, like can you make a color to understand how bad the situation is in the hypermarket segment, if we can put it in the words of payback?
Now actually, Maria, that hasn't changed. We still are aiming at 20% IRR, and the payback periods are not changing. In our approvals or in our criteria, we don't change those and has also not changed over time. So it's not, "Okay, let us stop hypermarket because the hypermarket segment is very difficult," that's not the case. It's simply pragmatic. We feel and we have a strong belief that buying back shares at the current price is a better option than putting it into breaks, which we can always do.
[Operator Instructions] Our next question comes from Maryia Berasneva from Morgan Stanley.
My first question is with regard to your debt portfolio. Jago, did I understand correctly that you have refinanced the entire portfolio? And does that mean that in the next 12 to 24 months, you will not -- you are not looking to pay down debt? Or is that a wrong interpretation?
Yes, that is not a fully correct interpretation. What I said is that we have refinanced parts of our debt to make sure that next year, we are secured against big changes in interest rates. And secondly, we have made sure that with the current amount of debt plus cash that we have on the balance sheet, we will be able to finance, in combination, of course, with the operating cash flows coming in, next year's expansions and the full RUB 11.6 billion of buyback without having to take on new debt. So I don't need to go to the banks next year.
Okay. And if you do not -- because this is -- you're not committed to this share buyback. So if you -- could there be a scenario under which you choose to prioritize deleveraging over a buyback if you see that this is a better opportunity?
I think we will always do, Maryia, what we feel is best for shareholder value. So if that is a better option, then therefore, we will choose for. For the time being, we believe that buying back shares, in the way we have always had shares announced, is the most value-accretive of the capital employment, I would say.
Yes. And I think you -- I hope you understood also very clearly that with the cash flows of next year, we will be able to finance share buyback, our CapEx, and still remain on a very conservative level of leverage and even potentially deleverage.
And then taking into account that next year, under the IFRS 16, I think you generally still have to look at lease adjusted. I think you will see that looking at the first half year this year, that we are by far the lowest leveraged business in the Russian retail.
Yes. And the other question I had was with regards to promotional activity. Did I -- did you mention that it's up year-over-year again in the third quarter based on your estimates?
Maryia, yes. We've mentioned that promo intensity is higher year-on-year. And the difference is in the range of 2, 3 percentage points.
And the last question is, I know you haven't given specific CapEx guidance for next year yet, but is it reasonable to assume that it will be sub-20 given you're substantially slowing down store openings for next year? And I assume that you will not need to invest as much in the logistics infrastructure, therefore, as previously planned. Would it be reasonable to assume that the CapEx goes below RUB 20 billion for the year?
No, I -- Maryia, I don't want to mention any number on CapEx at the moment. What I've given here is a direction where it will go with expansion. But we, as a management team, are currently also preparing for the -- our view on CapEx for next year, where other aspects like improvements in the existing -- what will help to differentiate stores from others will also have to be looked at and, potentially, will also require some CapEx. So I think in the 2019 session, we will update you on the CapEx. I'm only giving you a direction in this script of where is our thinking.
Maryia, definitely, in early 2019, we will provide the full breakdown of a link to store opening program as we usually do.
[Operator Instructions] I do have another question that comes from Marat Ibragimov from Gazprombank.
Buyback program, one question. You will be in -- you switch or transfer these shares to Lenta LLC, which is a subsidiary, so this will be a quasi-treasury share, so you will not be canceling them. So does that mean that in the future, you may potentially use this share for some other programs, for example, M&A or management option program?
Thank you for the question, Marat? What I can tell you at the moment is that our plan after we get the shares, GDRs, we'll able to get the receipts from Crédit Suisse, these shares will be held at treasury by Lenta LLC, and we will transfer those GDRs into shares of Lenta Ltd., which are not tradable. We cannot cancel the shares, as you mentioned, this is fully correct. And they'll be shares -- in the form of shares held by Lenta LLC who will not be able to vote these treasury shares. That's what we can tell you at the moment.
Okay, okay. Then next question on store opening. In the end of August, your updated guidance was to open at least 18 hypermarkets. So to meet this guidance, you need to open 16 hypermarkets until the end of this year, essentially in the next 2 months. Are you on track to meet this target or not?
Yes. At the moment -- otherwise, I would have mentioned this number here. We believe that those will happen, yes. As you can remember, that is the normal course of business for us. Every year, most of the store openings we have in 4Q, and predominantly, openings come in November, December. Last year, that was absolutely the same. And we can do it with our target this year.
Okay. You've been giving us some feeling that you are very open to -- for new acquisitions, but they are not coming through. So that just mean that the potential sellers are not ready to take new price, full price. Can you explain and give some more color what's the situation with the potential new assets? I mean, what's the price behavior of sellers? As far as I understand, they are not ready to reduce prices in order to meet your IRR criteria.
Marat, we continue looking toward the bolt-on acquisition opportunities. On a very selective basis, we are looking for those assets which fit our criteria, our requirement. And we're looking at the acquisitions which are value-accretive for our shareholders in our case. At the most, the nothing to report on that front. We're absolutely fine. If we still need some time to look, we're absolutely fine if nothing happens. But what is the most important for us in this activity is to get attractive opportunities which fit our concept, our requirements and come with value accretion.
But we can presume that next year, if something arises, if there will be some M&A opportunity, potentially will -- you will find it quite easier to find money, to raise money to finance these acquisitions -- potential acquisitions, right?
Yes. The -- like I've mentioned before, I think we will be looking at what is the best way to create value if the acquisition -- because I think your question is more, okay, now it's not the buyback, so there's no money for an acquisition. I think that's not the right conclusion. I think there is a value-accretive acquisition in the market that we can get our hands on, we will certainly do this because I think that's, in general, the approach that we take currently to the business. If it's there, we will take it. We currently slow down on organic because we know that there is little competition and we can pick up anytime that we like and see that the macro is more supportive.
I would say that your treasury shares, which you will get in the next 12 months, probably will be -- could be used as M&A currency if you see some M&A opportunities. What do you think about that?
I don't think that, that has been the intention of it.
And I think you have not seen us using our shares in any occasion over the last 5, 6 years, using shares as currency in M&A deals.
And there are no further questions at this time. Speakers, I'll turn the conference back to you for additional closing remarks.
Kim, thank you very much. Everyone, thanks for listening and hear you when we report our fourth quarter trading update. Thanks a lot.
Thank you all.
Thank you.
Bye-bye.
And that does conclude our conference today. Thank you for your participation. You may now disconnect.