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Good day, and welcome to the Lenta's 4Q and 2018 Sales and Operating Results Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Albert. Please go ahead, sir.
Thank you, Margaris. Good evening, good afternoon, and good morning, ladies and gentlemen. Thank you for joining us to discuss Lenta's fourth quarter and full year 2018 sales and operating results. With me to review the results are our CEO, Herman Tinga; and CFO, Jago Lemmens. You've seen the announcement and presentation, which are available on our website. And as usual, after our remarks, we look forward to taking your questions. I will now turn the call over to Lenta's CEO, Herman Tinga. Herman, please.
Good day, everyone, and thank you for joining us. Firstly, you will have seen from the announcement that our retail sales results remained strong in the fourth quarter despite slowing selling space growth, and that we delivered a significant acceleration of our like-for-like sales, with steadily improving trends during the quarter. However, though, the sales growth slowed in the fourth quarter due to a steep growth in wholesales. We have provided separate figures for our core retail business and wholesales to make and align trends more clear.I will start with some comments on the core retail business and then Jago will explain the rationale behind the separate wholesales disclosure and walk you through the nature of visibility and the recent changes. Before taking you through the retail operational highlights in a bit more detail, I would like to say a few words about Lenta's management team. As you know, there has been some changes. The board appointed me as CEO in December, replacing Jan Dunning. I'm excited with this opportunity and have great confidence in Lenta's future. Why? Because I know the business very well, I have a strong belief in our hypermarket business model and in Lenta's management team, who are the best in the hypermarket format.We have a clear hypermarket strategy and all the tools in place to implement this strategy and improve our business further.Jago continues as CFO until Rud Pedersen joins the company later in the first quarter of this year. This is a long-planned change. I know Rud since -- over 6 months and we are very comfortable together. He's a great guy, extremely capable and is looking forward to start working with Lenta. He will be a worthy successor of Jago. During the second half of last year, you were already informed, we had 2 other important additions to the senior team. Dmitry Bogod joined as Chief Strategy Officer; and [ Sergey Korobkov ] as Chief Digital Innovations Officer, both bringing valuable new knowledge and experience to our team. To be honest, I am less happy with supermarkets. Although this business has made significant progress over the last year and is showing increasing sales growth, we have more work to do on both strategy and execution. Since I took on the role of CEO, we have made -- we have taken action to strengthen the supermarket team and have selected a new head for this format, who will be announced in the next few days. We don't plan any other changes in the senior management team. As I said, it is a great team. We know what to do and have all the capabilities to continue growing the business profitably and adapting it to the changing economic and consumer environment. Now I will take you through the operating results in the fourth quarter, providing a bit more color. The environment continued to be challenging, but our efforts started paying off. The macro and consumer environment has been impacted by higher inflation, pension reform and currency depreciation, combined with higher tariffs and interest rates. All of this led to further drop of consumer confidence and real disposable household income growth. Strong competition in the industry combined with higher promo intensity, puts additional pressure on the customer spending deficit. Despite strong competition and weak economic environment, we delivered important improvements in retail sales year-on-year and compared with the third quarter of '18.The most visible improvement was the acceleration of like-for-like sales growth to 2.1% in the fourth quarter versus minus 0.6% in the previous quarter. Just as important, like-for-like sales improved each month of the quarter from October to December. In December, we finished the year with a very strong like-for-like sales growth, driven by significant traffic improvement.During the quarter, we continued gaining many new customers. The number of unique customers grew significantly faster than sales. This compensated for lower frequency of customer visits and resulted in a flat like-for-like traffic growth.Like-for-like ticket growth significantly improved to 2.1% in the fourth quarter from minus 0.3% in the third quarter, largely due to lower deflation and further trading up. Shelf deflation continued easing 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 and again showed further improvements quarter-on-quarter. Average number of the articles in the basket was weaker versus previous year, remaining negative. This development is partly explained by changes in customer mix and also consumer behavior. On the one hand, high promo activity in the industry, combined with [ fast ] selling space additions, pushes customers to [ visit ] more change. On the other hand, we are getting a lot of new customers with larger baskets from other hypermarket players.Food like-for-like sales growth continued improving and remained positive, while non-food like-for-like sales showed strong momentum as well. We are actively developing new categories in fresh food, for example, fruits and vegetables and fresh fish; and in dry food, for example, wines, to deliver even greater differentiation from other hypermarkets and convenience stores. In non-food, we made a lot of improvement in our assortment. Changes included many replacement of SKUs and private-label development.We also signed an agreement with Li & Fung, a leading global sourcing agency in Asia, which we expect to deliver further improvement for the non-food supplies. Promotional activity intensified year-on-year in quarter 4, although year-on-year growth rate was the lowest since the beginning of the year despite the usual seasonal trend. We made additional investments in marketing in the second half of last year to drive sales and traffic, which will be reflected in our SG&A expenses.Hypermarkets showed significant improvements in sales during the fourth quarter after a tough third quarter. Hypermarkets represent 89% of our total sales in the fourth quarter and showed retail sales growth of 8.4% on the back of selling space growth of 4.3%. We had a quite strong improvement of like-for-like sales growth to 1.8% versus minus 0.7% in the previous quarter. This was mainly driven by ticket increase as a result of further trading up and eased deflation, while like-for-like traffic growth remained under pressure during the quarter, although improving each month. Hypermarket sales were impacted by closure in November of one of our top 3 stores in St. Petersburg as a result of a fire. You must have seen that in the news. The store will be repaired and put back into operation late 2019. The interruption of operations in November, December had quite a visible impact on the fourth quarter sales. We had some delays in store openings due to the -- during the second half of the year. This included 4 hypermarkets openings which slipped into 2019, mostly due to bureaucratic delays.Supermarkets demonstrated strong like-for-likes, but are still in improvement mode. Supermarkets represent almost 8% of our total sales in the fourth quarter and showed sales growth around 60% on the selling space growth of 35%. Like-for-like sales growth accelerated to 7.6% versus 2.1% in the previous quarter. Growth was mainly driven by a combination of new stores and new customers in existing stores. The format faced a stronger competition compared to the hypermarkets and a higher SG&A pressure from rental rates in market weighing on the profitability. Although momentum is positive with sales density stabilizing and improving traffic, as I mentioned earlier, I'm not fully satisfied with the performance of this business.In addition to accelerating the initiatives already in progress, we will see the need to adjust customer proposition further and faster and to improve the execution to enable this business to realize its potential. We are appointing a new business leader to deliver this. I have confidence in the potential of this business and opportunities to improve it. We will slow down supermarket expansion this year until we are satisfied with the strategy, financial performance and returns. Then the momentum we saw in the quarter 4 has continued in January. If you look at the last 3 weeks of sales, retail sales growth in the first 3 weeks of January were above quarter 4 average and way above selling space growth. Like-for-like sales growth has continued improving in January, driven both by traffic and ticket increases. Now I will hand over to Jago to talk about wholesale activity and its impact on the business. Jago also provides some comments on that.
Yes, thank you, Herman, and hello, everybody, and if I am still allowed to wish everybody Happy New Year. As Herman said early, I will focus on the wholesales and -- which is a relatively smart -- small part of our business, but which is currently impacting understanding of overall trends. We have seen this business starting to shrink significantly in the fourth quarter, and it will continue to put pressure on total sales in the next 3 quarters. As you have seen, we have decided to start disclosing retail sales separately from wholesales. Lenta has actually operated a relatively small wholesales business, with pretty volatile volumes in the range of 3% to 7% of total sales over the last 5 years. This business essentially involves bulk sales of a very small number of SKUs at very low margins with no particular service at all. It was kind of opportunistic sales for Lenta. It was predominantly driven by a supplier's desire to use retailers as an additional distribution smaller -- center of channel to, yes, larger and smaller customers.During 2018, we saw clear signals from a small number of our key wholesale suppliers that their distribution strategy was changing and that we might see a serious reduction in wholesales going forward. So in order to make underlying trends in the core retail business clearer, the company has decided to report wholesales separately going forward. We consider disclosing this part of the business separately is important as retail sales and wholesales have started showing complete opposite trends, and without separate disclosures, market participants might struggle to forecast properly the core business of the company.Quarterly data of wholesales has been shown separately for 2017 and '18 in the announcement, and understanding the changes that we see now in this volatile business, I think we have to admit that it would have been better to start reporting wholesales separately in an earlier stage.Please also note that Lenta Pro sales are not part of wholesales but they are included in the retail sales as this involves a high level of service with modest baskets containing multiple SKUs and actually delivering a similar profitability as the other retail business. Lenta Pro is a program for professional customers with a specialized loyalty program, which actually provides them progressive discounts based on retrospective purchases. So the decline of over 50% in sales to wholesales customers accounts for the difference between retail sales growth of 11.3% and the total sales growth of 6.6% in the fourth quarter. We expect this downward trend to continue in 2019, putting pressure on total sales growth, particularly in the first 3 quarters of the year. For example, based on our forecast, wholesales volumes in the first quarter 2019 are expected to be slightly above RUB 1 billion, which is RUB 4 billion lower than the same quarter last year.Speaking about the potential impact on EBITDA and margins, wholesales has always been a low-margin business, and based on the preliminary management accounts, we expect a negative impact in the second half of 2018 on EBITDA of a bit more than RUB 200 million due to the lower wholesales. And as you can expect, more details of the financial results will come to you on the 22nd of February, so I will not be able to speak any more about that.The only exception that we make today is to talk a bit about debt and interest, which usually we discuss with the financial result, but a couple of important points that I would like to tell you about our financing. We have taken actions actually in the second half year 2018 to ensure stable interest costs in 2019 and to have actually no refinancing needs in 2019 up till 2020 because after falling for more than 2 years' time, market interest rates started increasing in the third quarter of last year. In response, we decided to protect ourselves from any further rate increases by borrowing at fixed rates available in the second half of 2018 to refinance debt falling due in 2019, and I think this has proved to be a good decision. As a result, when we report our financials, you will see a relatively stable net debt figure, but you will see a significantly higher gross debt figure, which is offset by a -- also a very sizable cash position at year-end. This cash flow will be used to repay all debts which will fall due in 2019, so we will not need to borrow anything until 2020. Another implication is that 100% of our debt is long term with extended maturities. About 80% of the total debt is at fixed rates, with only 1 variable rate loan linked to MosPrime left in the portfolio. In case we see further substantial rate increases in the markets, we will have enough cash on hand to fully repay this variable loan on variable rates. And of course, when interest rates go up, then also deposit rates will go up. The net result of all of this is a predictable and controllable cost of debt, with a weighted average cost of debt of about 8.5% for 2019.So that was my part. In a moment, Albert will take you through the details of our buyback program, but first, I will give you back to Herman, who will give you some highlights of our expansion.
Thank you, Jago. Yes, summarizing our expansion. We opened 14 hypermarkets, while 1 was closed as a result of fire. All the stores were compact and super compact with an average size of 4,500 square meters. We added 4 new cities to our universe and are now present in 88 cities. We guided for 18 new hypermarkets in 2018, but 4 hypermarkets openings were delayed till the first part of 2019, mostly due to bureaucratic delays. We opened 41 new supermarkets, while 3 stores were closed. This was in line with the company's revised guidance. As usual, we will provide next year's store opening guidance when we report the full year financial results on the 22nd of February. As mentioned on the previous conference call, we expect to open less hypermarkets and supermarkets in 2019 compared to 2018. We remain strongly focused on returns and prioritize projects with the best returns. Of course, we will also continue to evaluate potential acquisitions if attractive value-accretive opportunities arise.And now let me turn the call to Albert to give some details on the execution of the buyback program.
Thank you, Herman. Hi, everyone. I'm sure you all have seen our regular reports on the buyback program, so I will not go into a lot of details but will provide you with some highlights. As you remember, Lenta's board has authorized a GDR buyback program of up to RUB 11.6 billion to be conducted between 29th of October 2018 and 29th of October 2019. We have purchased around 1.5 million GDRs since the beginning of the program, which represents 0.3% of the company's share capital or 0.6% of the free float. The current free float is around 57.5% based on the company's estimate. The company spent around RUB 350 million for the buyback as of now, which is only about 3% of the authorized amount. The relatively low purchased volumes are linked to trading volumes in the stock and regulatory requirements, which I believe you are aware of. So we will continue the program in 2019, but of course, Lenta's board may consider other routes to distribute cash to shareholders in the future. That's it from my side, and I will turn the call back to Herman for closing remarks. Thanks.
Thank you, Albert. And now some closing remarks from my side. The Lenta team remains strongly focused on improving the underlying business. The macro and consumer environment remained tough and competition in the sector is strong with excessive selling space growth in combination with high promo activity. Our headline sales growth was impacted by structural changes in the small wholesale business. Against this challenging backdrop, we saw a significant improvement in retail sales in both hyper and supers during the fourth quarter last year. In hypermarkets, we have a very strong market position, the right strategy and a very strong team to execute it. We have a strong business operating in a tough environment. A key focus is to enhance our differentiation with competitors of all formats. We have the tools and the team to realize this. The impact of our initiatives became already visible in fourth quarter and will grow in 2019. The long-term fundamentals of Lenta hypermarket business remains very attractive. In supermarkets, growth accelerated significantly in the fourth quarter, showing that initiatives taken by the team in 2018 are beginning to pay off. This business has great potential, but we still have work to do to realize this. I'm confident that we will succeed. While the short-term outlook remains cautious with expected further impact from the reduction in wholesales and the high promo intensity, we are confident in the long term in both our retail formats. We remain strongly focused on shareholder value and returns. A key goal for 2019 and beyond is to raise returns on capital invested. We will continue to grow and improve our market position in both hypers and supers, but we will invest carefully at a slower pace than in prior years.
Thank you, everyone. Margaris, we are now ready for the questions.
[Operator Instructions] And we can now take our first question from Nikolay Kovalev.
I have 2 questions. So the first question is to Herman. Can you mention to us, for the next upcoming year, what would be your prime strategic focus and what will be initiatives you plan to take? And second question is on your profitability. We saw some 70 basis points correction in EBITDA margin in the first half. So I was wondering, like, given we saw the incremental pressure from the wholesale operations, would be the magnitude of the correction similar or greater than we saw in the first half?
Thank you, Nikolay, for the question. Yes, let's say my focus as the new CEO is -- I can split in 2 directions, first, for hypermarkets; and second, for supermarkets. In the hypermarkets, there is no basic change in our strategy. It represents 90% of our business. And we, last year, defined that -- our strategy and action plan. This is coordinated and approved by our Board of Directors. And my focus is, mostly, the speed of the acceleration of these plans. As the management team of retail have been part of the last 5 years, we have together agreed on this strategy and to follow the current market circumstances. I was very engaged in the process to develop our hypermarket strategy, and now we have to execute it and accelerate it. Supermarket is a little different. The business is improving but, in my view, positioning requires additional attention. I decided very quickly after taking the CEO role that we needed to strengthen the supermarket leadership team and have chosen a new leader that we will announce in a few days. I will work together with the new head of supermarkets and accelerate implementation, and I'm confident we will succeed in this. Jago, maybe you can comment on the profitability?
Yes, I think this is a perfect question for me, Herman. Thank you very much. With the -- sorry, Nikolay, an answer which you can expect, as I already said during my part of the speech, we are reporting operating results. And I understand that you are very curious about our financial results, but unfortunately, I cannot give an answer on your question.
Nikolay, the audited -- audit process is going on at the moment, is in progress, so we will wait until we get the final results and provide you all the details on 22nd of February.
[Operator Instructions] We can now take our next question from Alexey Krivoshapko.
I just have a few questions. Number one, do you currently have a plan to share with us on 2019 expansion of hypermarket and supermarket business?
Sorry, can you repeat that question because I didn't understand it?
Yes, I understood it.
You understood it?
Yes, let me rephrase it.
Okay. How many stores...
Alexey, yes, as I said earlier, we will choose our projects carefully, but we cannot give the guidance at the moment of our store openings in 2019. This will all be disclosed this 22nd of February.
Alexey, in general -- let me add a bit to Herman's answer. In general, we are in line with what we provided to the market in October. And I can confirm this now, we will definitely open less hypermarkets and supermarkets in 2019 compared to 2018, but management team and the board still needs to do some work to define the best projects with the best returns, and we will come to you with the precise guidance on 22nd of February. And please, also remember that we had 4 slippages last year, so 4 hypermarkets which were scheduled to be opened last year will be opened in 1Q this year.
Okay, that's clear. Just to clarify, I mean, you said that sales growth in the first 3 weeks of January was in line with retail sales growth in Q4 or total sales growth in Q4? I didn't quite get it.
Alexey, I can clarify. What we said is that during first 3 weeks of January, we see the momentum continuing. By that we mean that within the fourth quarter, we had sales growth improving each month of the quarter from October to December. And during 3 weeks of January, we see sales growth above 4Q average, like-for-like sales growth improving as well. And another remark was that sales growth is above, way above selling space growth.
And the sales growth that Albert means is the retail sales growth.
Yes, that was the question. Above Q4 average retail sales growth. Okay, that's clear.
And on wholesales in 1Q, Jago guided that we will have significantly lower volume.
Okay, clear, yes. That is -- again, would be clear. May I ask you, just to clarify, what is this wholesale business about, and why is it shrinking?
What is the wholesale about and why is it shrinking?
What is this wholesale business about? Which categories do you sell? And which is...
Alexey, so basically, you are talking a lot about cigarettes, alcohol, but also some confectionery in big bulks. As I said, this has been very much driven in the past by suppliers which approached us with a question, if we could be intermediary between them and other players to whom, seemingly, they didn't want to deliver directly, for whatever reasons, complexity of administration, I don't know. But we always have been happy to take over that kind of business. We have seen it going up and down, as can be expected, throughout the last 5 years within every quarter, although a few of them stayed relatively stable throughout the years. But what we have seen now is that, suddenly, those suppliers don't call us anymore and don't offer the volume for wholesales, for whatever reasons. Now we understood from what we have seen in quarter 4 that this is a trend that is going to last in 2019, and that is why we have decided that it is wise to start reporting separately the wholesales from the retail sales.
And you said these categories are tobacco, alcohol and confectionery. And roughly speaking, like, what is the breakdown? What is the primary -- is there a primary, secondary, kind of evenly split?
Maybe the bulk is tobacco.
Okay, the bulk is tobacco. And the -- was it some sort of common practice for the industry? Or did you take some lion market share in this business?
Alexey, we understand that it was quite common practice for the industry for many years. And Lenta has never been the largest player in this market.
So in other words, these suppliers don't want to go to you anymore, yes? Like in [indiscernible] precisely, these tobacco guys don't want to resell to intermediaries through you anymore?
Yes, in the past they used retailers as an additional channel for distributing their volumes. But as we understand, there is a dramatic change in their distribution strategy.
And may I ask you if these are tobacco wholesalers or tobacco producers? What are we talking about? Is it GTI or is it Mediapolis?
These are distributors, these are producers, so all participants who have been seen in these markets. And to clarify, when we speak about wholesales, once again, we are not speaking about Lenta Pro programs, we are not speaking about professional customers or so-called HoReCa customers.
And we can now take our next question from Dmitry Skryabin from BCS.
I have a technical question on the Page #8 of the presentation.
We can hear you very badly, Dmitry.
Sorry, can you hear me now?
Yes, now loud and clearly.
Okay. I have a technical question on the Page #8 of the presentation. You have 2% retail sales growth like-for-likes, so for 2017, for the full year, plus 2%. Is it a kind of typo here? Because as I can see all lines are pretty much negative for full year 2017. Can you [ see ] this?
Yes, that is a very good question that we should recheck.
I understand your point. We will come back on this, Dmitry, thanks.
There are no further questions on the line at this time. I would now like to -- I beg your pardon, we have just -- somebody queued, and that is Yulia Gerasimova from Goldman Sachs.
Just a couple of questions, just on the wholesale. Thank you very much for providing us with the guidance for the Q1, but is it possible to disclose what were the wholesale revenue in 2Q and Q3 last year, so we can kind of try to estimate what would be the full year impact, which as you said, will continue for the 3 quarters in 2019? That's the first question.
Yulia, thanks for the question. If you take a look at the Slide 8 of the presentation or the last page of the 4Q and full year results announcement, then you will find the disclosure of wholesale volumes on retrospective basis for each quarter of 2018 and '17.
Yes, I found it. And also given that in the Q4 '18, decline was 50% year-on-year, and what you just guided for the Q1 '19 is implied 80% decline, so how we should look at that second and the third quarter decline -- expected decline, somewhere in between or like...
I told you that the Q1 volume that we expect is around RUB 1 billion.
Yes, I got that.
Just over...
RUB 1 billion exactly versus RUB 5 billion that you had previously in first quarter '18. So that implies 80% decline on a year-on-year basis, and in Q4 '18, you have 50% decline. So I'm trying to understand what kind of percentage decline we should expect in Q2 and Q3.
Well, I would say that...
This is [ obviously ] a big difference.
Yulia, I think we're not ready yet to provide you the data for Q2, Q3 or Q4 this year. And the reason is that wholesale volumes, as we said, are extremely volatile. So you can't really plan these volumes 3 quarters in advance. Q1, we already know what we can get.
And structurally, given that there is a change in the -- in how distributors approach these retailers as intermediary for the reselling, do you think this business can actually, eventually, come to be 0 or it's just going to continue to decline until it will just disappear or that some volume will be retained? What's your outlook for the most prolonged period?
We expect that some volume will be retained.
Okay. And my second question, I think, Albert, you mentioned that given the low amount of the buyback -- was spent on the buyback for now, the board may consider alternative ways to return cash to the shareholders. To me, the alternative ways is just dividends basically, but you were always against the dividends as a policy, so can you just clarify what kind of other ways we have?
Yulia, of course. Definitely, you are absolutely right. There are 2 ways to distribute cash to shareholders, and these are dividends and share buybacks. Speaking about the dividends, I would say that we're not against dividends. But given Lenta's corporate structure, I mean, domiciliation in BVI of the issuer, Lenta Ltd., due to tax reasons, basically withholding tax, dividends are not considered by the board. Speaking about the buybacks in general, there are 2 forms of the buybacks, which are repurchase from the market and tender offers. All these options are -- may be considered by the board, but at the moment there are no discussions, no decisions made.
And the dividend is the most unlikely one due to the tax inefficiency.
[Operator Instructions] And we now have Nikolay Kovalev from VTB Capital.
I have one clarification question. You had the guidance of RUB 25 billion, RUB 30 billion for CapEx. Can you state like how much you spent last year?
Nikolay, we will disclose that on the 22nd of February. As our financials are not audited, I cannot say anything out of that.
Nikolay, we are waiting for the cash flow statement ourselves. So when we get the final audited figures, we will definitely disclose as well as provide CapEx guidance for 2019.
[Operator Instructions] We have no further questions on the line. I would now like to turn the call back to the hosts for any additional or closing remarks.
Thank you, Margaris. Thank you, everyone, for joining us. Just to remind you that we will disclose full year results on 22nd of February, and will be happy to speak to you again. Thank you.
Thank you very much, all of you. Bye-bye.
Thank you. That concludes today's conference. Thank you for your participation. Ladies and gentlemen, you may now disconnect.