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21.09.2011

BNE: Russia's top food retailers: X5 vs. Magnit. X5 Retail Group offers higher upside

We initiate coverage of X5 Retail Group and Magnit

We valued the two largest Russian food retailers and see higher potential upside for X5 Retail group GDRs. Our fair value estimate is USD 50.6 per GDR, corresponding to more than 70% upside to the current market value. At the same time, we estimate Magnit's fair value at USD 26.3 per GDR for 21% potential upside.

We expect similar EBITDA margins for both retailers in 2011

Both retailers are experiencing a decline in EBITDA margin this year due to increased social taxes and high fuel inflation. Moreover, the Kopeyka integration is adding pressure for X5, although it should be completed by year end. Magnit faces negative impact from aggressive store expansion, especially in the hypermarket segment.

X5 reported stronger 1H 11 IFRS results than Magnit

In our view, X5 is outperforming Magnit in terms of cost control and maintaining operating margin. X5 ended 1H 11 with a 7.2% EBITDA margin while Magnit saw the figure decline to 6% for the period. Taking into account that Magnit plans to open even more hypermarkets and discounter stores in the second half, we think the management guidance of 7.3-7.5% for the full year is unrealistic.

Stronger operating margin expected from X5 in 2012

Given that X5 plans to complete all integration processes by year end, we expect operating margin to increase to 7.3%-7.4% in 2012 as the new rebranded stores become fully operational and the synergy effect from the acquisition becomes tangible.

Magnit's aggressive expansion planned for 2012 will continue to exert pressure on profitability

Magnit plans to continue rapid store expansion in 2012, which exposes the company to the risk of continuing pressure on margins. Nevertheless, we still forecast improvement in the EBITDA margin as the newly opened hypermarkets reach the planned revenue targets.

X5 trades at more than 25% discount to Magnit, which is unjustified in our view

X5 looks more attractive relative to Magnit, trading at 2011E EV/EBITDA of 9.8x for a 25% discount to Magnit and 12% discount to EM peers. Given that recently reported Magnit's financial results were below market expectations and X5 posted solid operating efficiency figures, we consider X5 Retail Group is more attractive also in a short term.

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