INDEPENDENT RESEARCH 15th November 2017 Standing at a cross-roads Food retailing Fair Value EUR20 vs. EUR22 (price EUR16.83) BUY

Bloomberg CA FP is the group’s Achilles heel and Alexandre Bompard is set to Reuters CARR.PA unveil his solutions on January 23th. At this stage, the combination of a 12-month High / Low (EUR) 23.6 / 16.5 positive timing (return to inflation?), a depressed valuation (the market Market capitalisation (EURm) 13,034 Enterprise Value (BG estimates EURm) 16,343 is valuing the French at a negative €3.4bn) and an event- Avg. 6m daily volume ('000 shares) 3 583 driven momentum underpin our maintained Buy opinion. Our Fair Free Float 83.4% Value (€20 vs €22) is the average of a DCF (€17.6) and a SOP (€22.5). 3y EPS CAGR -6.2% Gearing (12/16) 38% Dividend yields (12/17e) 3.43%  Although the group is crippled, Carrefour’s market capitalisation does not reflect the value of its assets in our view. Based on the SOP, which enables YE December 12/16 12/17e 12/18e 12/19e Revenue (EURm) 76,645 78,813 79,950 82,493 us to appreciate the asset liquidating market value, we derive an estimated Curr Op Inc. 2,351 2,010 2,070 2,197 share price of €22.5. At the current level of €17, we conclude that the EURm) market is valuing the French hypermarkets at a negative €3.4bn. Basic EPS (EUR) 1.01 0.93 1.05 1.15 Diluted EPS (EUR) 1.40 1.06 1.05 1.15 EV/Sales 0.22x 0.21x 0.22x 0.22x  Alexandre Bompard’s task is focused on the price positioning/future of EV/EBITDA 4.4x 4.5x 4.8x 4.6x EV/EBIT 8.5x 8.8x 8.5x 8.1x the hypermarkets in France (embroiled in the Leclerc trap), the re- P/E 12.0x 15.9x 16.1x 14.6x definition of the offer (too premium currently?) and the digitalisation of ROCE 8.7 7.6 7.5 7.7 the group (lost in the Amazonian forest). Lauded for his stock market

29.6 success at FNAC, he has a free rein in our view.

27.6

25.6  In France, beyond remodeling the promotional strategy, we see an 23.6 immediate need for some €400m of price investment together with a 6% 21.6 reduction in the fixed cost base (i.e. €330m) to stop the hemorrhaging of 19.6 market share. We believe that, over the medium term, an operating margin 17.6 of 2.4% is reachable (vs 1.9%e in 2017). 15.6 13/05/16 13/08/16 13/11/16 13/02/17 13/05/17 13/08/17 13/11/17 CARREFOUR SXX EUROPE 600  The timing of this fourth recovery attempt (!) could prove opportune in that inflation seems to be returning, and it could further be supported by a potential increase in the Below-Cost Selling threshold (SRP - Seuil de Revente à Perte). Judging by the knee-jerk reaction from its CEO, any such move would be detrimental to Leclerc and thus positive for Carrefour.

Analyst: Sector Analyst Team: Antoine Parison Nikolaas Faes 33(0) 1 70 36 57 03 Loïc Morvan [email protected] Virginie Roumage Cedric Rossi

r r

Carrefour

Simplified Profit & Loss Account (EURm) 2014 2015 2016 2017e 2018e 2019e Revenues 74,706 76,945 76,645 78,813 79,950 82,493 Change (%) -0.2% 3.0% -0.4% 2.8% 1.4% 3.2% EBITDA 3,768 3,914 3,838 3,608 3,669 3,847 Current operating income 2,387 2,444 2,351 2,010 2,070 2,197 Exceptionals 149 (257) (372) (150) 0.0 0.0 EBIT 2,536 2,187 1,979 1,860 2,070 2,197 Change (%) 6.5% -13.8% -9.5% -6.0% 11.2% 6.2% Financial results (563) (515) (515) (439) (450) (450) PBT 1,973 1,672 1,464 1,421 1,620 1,747 Tax (709) (597) (494) (508) (567) (612) Profits from associates 36.0 44.0 (36.0) 12.0 30.0 40.0 Income from discontinued activities 67.0 4.0 (40.0) (1.0) 0.0 0.0 Minority interests (118) (143) (148) (220) (291) (306) Net profit / group share 1,249 980 746 704 792 870 Restated net profit 1,040 1,113 1,032 802 792 870 Change (%) 11.1% 7.0% -7.2% -22.4% -1.2% 9.9% Cash Flow Statement (EURm) Operating cash flows 2,127 2,181 2,473 2,463 2,605 2,739 Capex, net (2,411) (2,378) (2,749) (2,450) (2,399) (2,475) Change in working capital 8.0 106 658 161 84.2 188 FCF (276) (91.0) 382 173 290 452 Financial investments (1,188) (85.0) (190) 0.0 0.0 0.0 Dividends (219) (488) (207) (236) (488) (483) Capital increase / buyback (18.0) 384 30.0 0.0 0.0 0.0 Assets disposal 702 205 178 1,113 0.0 0.0 Other 161 484 (178) 0.0 0.0 0.0 Decrease / (Increase) in net debt (838) 409 15.0 1,050 (197) (30.6) Net debt 4,955 4,546 4,531 3,481 3,678 3,709 Company description Balance Sheet (EURm) Carrefour is a multi-local (France, Tangible fixed assets 13,587 13,085 14,672 15,524 16,324 17,149 Europe, Latam and Asia) and multi- Intangibles assets 8,228 8,495 8,640 7,527 7,527 7,527 Cash & equivalents 3,162 2,790 3,335 4,385 4,188 4,157 format (mainly hypermarkets but also Other assets 20,812 20,725 22,198 22,485 22,659 23,022 , C&C and proximity) Total assets 45,789 45,095 48,845 49,922 50,698 51,855 operator. It was the pioneer in many Shareholders' funds 10,228 10,672 12,008 12,775 13,449 14,221 countries such as (1975) and L & ST Debt 8,572 7,628 8,075 8,075 8,075 8,075 Provisions 3,581 3,014 3,064 2,938 2,812 2,686 in (1995). It is the leading Others liabilities 23,408 23,768 25,659 26,134 26,362 26,873 retailer in Europe , employing nearly Total Liabilities 45,789 45,082 48,806 49,922 50,698 51,855 380,000 people. With more than WCR (4,911) (5,017) (5,675) (5,836) (5,920) (6,108) 11,900 stores under banner, it Capital employed 16,904 16,563 17,637 17,216 17,931 18,568 generated net revenues of €77 bn in Ratios 2016. Operating margin 3.20 3.18 3.07 2.55 2.59 2.66 Tax rate 35.94 35.71 33.74 35.75 35.00 35.00 Normative tax rate 35.00 35.00 35.00 35.00 35.00 35.00 Net margin 1.39 1.45 1.35 1.02 0.99 1.05 ROCE (after tax) 9.18 9.59 8.66 7.59 7.50 7.69 WACC 8.50 8.50 8.50 8.50 8.50 8.50 Gearing 48.45 42.60 37.73 27.24 27.35 26.08 Net debt / EBITDA 1.32 1.16 1.18 0.96 1.00 0.96 Pay out ratio 39.65 39.24 52.02 61.93 62.27 63.57 Number of shares, diluted 707 723 739 756 756 756 Data per Share (EUR) EPS 1.77 1.35 1.01 0.93 1.05 1.15 Restated EPS 1.47 1.54 1.40 1.06 1.05 1.15 % change 9.2% 4.7% -9.2% -24.1% -1.2% 9.9% Operating cash flows 3.01 3.02 3.35 3.26 3.45 3.62 FCF (0.39) (0.13) 0.52 0.23 0.38 0.60 Net dividend 0.70 0.53 0.53 0.58 0.65 0.73

Source: Company Data; Bryan, Garnier & Co ests.

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Carrefour

Table of contents

1. A valuation which is too low and event-driven momentum ...... 4 1.1. Carrefour’s balance sheet bears no comparison with 2012 ...... 4 1.2. At €17, the valuation is a negative €3.4bn ...... 4 2. The parameters of a fourth (!) recovery attempt ...... 7 2.1. Decline of the large hypermarkets and disruption from ...... 7 2.2. Price war and promotional activity ...... 9 2.3. Premiumisation or squaring the circle ...... 11 3. Surgical measures ...... 14 3.1. €400m of price investment in France, accompanied by cost savings ...... 14 3.2. Unprecedented measures and a revised decision-making paradigm ...... 15 3.3. Possible disposal of international assets...... 17 4. Potentially positive timing? ...... 18 4.1. Inflation is rearing its head ...... 18 4.2. An increase in the BCS threshold, the details of which remain hazy, could benefit Carrefour 19 Bryan Garnier stock rating system ...... 23

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Carrefour

1. A valuation which is too low and event-driven momentum 1.1. Carrefour’s balance sheet bears no comparison with 2012 It is perhaps possible to ‘compare’ the present operating situation with that of 2012. The hypermarket issue effectively remains unresolved while Carrefour looks to be lagging seriously behind on digitalisation. Against this backdrop, the group’s market share is down in France, for both the hypermarkets (-80bps over the Kantar P10 period vs. -30bp in the previous period) and the supermarkets (-10bp vs -20 bps).

On the other hand, the asset disposals made by Georges Plassat as of 2012 (i.e. ~€4.2bn/cf. Fig. 17) probably ensured the group’s longevity, such that the current balance sheet situation (BBB+, Investment Grade) bears little resemblance to that of 2012 (adjusted DFN/EBITDAR ratio of 2.1x in 2016e vs 2.9x in 2011e). In this respect, it seems inappropriate to value Carrefour at share price levels similar to the low point reached in 2012 (i.e. €13, amounting to the lowest share price target in the market), at a time when the group was on the brink of the abyss (with notable under-investment in the stores).

1.2. At €17, the hypermarket valuation is a negative €3.4bn We continue to consider it is inappropriate to value the French assets solely on the basis of the EBIT they generate and which, for circumstantial reasons, can be depressed (as was the case for Géant Casino when it suddenly lowered its prices in 2013). We are in a fixed-cost industry in which the priority is to dilute these invariable charges. The valuation is thus based on sales potential, which primarily increases depending on the quality of the location! Otherwise, Carrefour would never have paid ~0.35x sales for the loss-making banner. This is why we have, to date, mainly used sales multiples.

However, while our methodology seems to us relevant over the long term, for the mean time the market is functioning on the basis of earnings ratios. Hence, to avoid any ambiguity, we are modifying this and from now on will be mainly focusing on the EBIT ratio (i.e. the ‘least favourable’): 1/ we apply a 10x 2017 multiple to Carrefour’s European activities (vs a median of 12.5x for the panel of European retailers, according to IBES); 2/ we use share prices for the listed subsidiaries (i.e. Brazil and Carmila); and 3/ we apply a sales multiple of 50% for and a ratio of 30% for the two networks ( and China) which we estimate to be loss-making.

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Carrefour

Fig. 1: SOP (22.5€)

2017 Sales EBITDA* Margin e EBIT* Margin e EV/SALES EV/EBITDA EV/EBIT EV

TOTAL GROUP 78 813 3 660 4,6% 2 061 2,6% 31% 6,7X 11,8X 24 375

FRANCE 35 893 1 568 4,4% 691 1,9% 19% 4,4X 10,0X 6 911 Hypers 18 865 541 2,9% 89 0,5% 5% 1,7X 10,0X 896 Supers 11 535 807 7,0% 519 4,5% 45% 6,4X 10,0X 5 191 Others 5 492 220 4,0% 82 1,5% 15% 3,8X 10,0X 824 OTHER EUROPE 20 864 1 106 5,3% 689 3,3% 33% 6,2X 10,0X 6 895 8 346 584 7,0% 417 5,0% 50% 7,1X 10,0X 4 173 5 007 150 3,0% 50 1,0% 10% 3,3X 10,0X 501 4 068 183 4,5% 102 2,5% 25% 5,6X 10,0X 1 017 European growth markets 3 443 189 5,5% 120 3,5% 35% 6,4X 10,0X 1 205 LATAM 16 210 919 5,7% 703 4,3% 52% 9,2X 12,0X 8 464 Brazil 13 292 942 7,1% 769 5,8% 57% 8,1X 9,9X 7 589 Argentina 2 918 -22 -0,8% -66 -2,3% 30% nm nm 875 ASIA 5 847 66 1,1% -21 -0,4% 36% nm nm 2 105 China 4 093 0 0,0% -61 -1,5% 30% nm nm 1 228 Others 1 754 66 3,8% 40 2,3% 50% 13,2X 21,9X 877

RESTATEMENT TO EV (7 364) Associates & other assets 3 252 Central Costs (520) Average net Debt (4 177) Minorities (2 981) Provisions (2 938) EQUITY VALUE PER SHARE 22.5

*Excl. central costs Source: Company Data; Bryan, Garnier & Co ests.

Via a reverse SOP and based on the current share price (€17), we conclude that the market is currently valuing the French hypermarkets at a negative €3.4bn. While it is objectively impossible to estimate the cost of the unprecedented measure that would consist of the closure of some fifteen hypermarkets1, we don’t see the cost of any such restructuring reaching this level. Naturally, nobody knows what will become of the group and whether consensus estimates have reached their lows. We are nonetheless convinced that, in the current state, the group is undervalued. Our Fair Value (€20), based on the average of a SOP at €22.5 and a DCF at €17.6, thus points to upside potential of 20%.

1 Garry Swindells, head of France, recently said that he could potentially look at any hypermarket acquisition opportunities offered to him.

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Carrefour

Fig. 2: DCF (€17.6)

€ m 2017 2018 2019 2020 2021 2022 2023 2024 Normative Sales 78 813 79 950 82 493 84 857 87 024 88 973 90 687 92 151 93 349 Variation (%) 2,8% 1,4% 3,2% 2,9% 2,6% 2,2% 1,9% 1,6% 1,3% EBIT 2 010 2 070 2 197 2 260 2 318 2 370 2 416 2 455 2 487 Margin 2,6% 2,6% 2,7% 2,7% 2,7% 2,7% 2,7% 2,7% 2,7% Tax (704) (724) (769) (791) (811) (830) (845) (859) (870) EBIT after tax 1 307 1 345 1 428 1 469 1 507 1 541 1 570 1 596 1 616 D&A 1 598 1 599 1 650 1 697 1 740 1 779 1 814 1 843 1 867 As a % of sales 2,0% 2,0% 2,0% 2,0% 2,0% 2,0% 2,0% 2,0% 2,0% WCR variation 161 84 188 175 160 144 127 108 0 Capex (2 450) (2 399) (2 475) (2 404) (2 321) (2 224) (2 116) (1 997) (1 867) As a % of sales 3,1% 3,0% 3,0% 2,8% 2,7% 2,5% 2,3% 2,2% 2,0% Operating cash-flow 615 630 792 937 1 087 1 240 1 395 1 550 1 616 Discounted Cash-flow 609 578 673 739 795 840 876 903 941

Sum of discounted cash flows 6 013 Terminal value 14 495 Total 20 508 Net debt (4 531) Provisions & Minorities & Associates (2 667) Value of groupe equity capital 13 310 Equity per share 17,6 €

Source: Company Data; Bryan, Garnier & Co ests.

The main assumptions retained in our DCF are as follows:  A WACC of 7.9% (risk-free rate of 1.6%, risk premium of 7% and beta of 1.2x);

 A growth rate to perpetuity of 1.3% and a normative margin of 2.7%;

 On a normative basis, capex and depreciation are equal and represent 2.0% of sales.

Our DCF remains sensitive to exchange rate fluctuations and margin assumptions in France:  A 10% depreciation in the BRL would thus have a €0.7 negative impact on our DCF;

 Should the margin ultimately reached 2.4% in France (vs 1.9% in 2017 and beyond now in our estimates), our DCF would work out at ~18.5€ (~19.5€ should the margin came back at 3.6%).

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Carrefour

2. The parameters of a fourth (!) recovery attempt 2.1. Decline of the large hypermarkets and disruption from Amazon Introduced in 2009, the French Law to Modernise the Economy (Loi de Modernisation de l’Economie – LME) created a beneficial backdrop for the hypermarket chains (cf. "Hypermarkets are dead, long live hypermarkets"). However, ever since its introduction, each banner has evolved differently, being for the worst or the best. Leclerc’s market share thus rose by +380bps between 2009 and 2016 (putting the current debate on increasing the Below-Cost Selling threshold in France into context) while those of Carrefour and Géant hypermarkets declined by ~230bps and ~60bps respectively. Although the strategies of listed retailers have sometimes been derailed, in favour of excessive shareholder governance (i.e. margin rate vs. cash margin), endemic factors have also penalised the large hypermarkets (hence the difficulties of the historic best-in-class, , whose market share fell by 80bps).

Fig. 3: Market shares of the groups (hypers+supers+Discount+e- commerce)

Market share (%) 2009-LME 2012-Plassat 2013 2014 2015 2016 2009-2016

Groupe Carrefour* 23,9% 19,8% 20,3% 21,8% 21,5% 21,0% -290 bp

Groupe Auchan* 11,1% 10,3% 11,3% 11,3% 11,1% 10,9% -20 bp

Groupe Casino* 10,3% 10,6% 11,7% 11,5% 11,5% 11,5% +120 bp

E. Leclerc 16,9% 18,4% 19,6% 19,9% 20,3% 20,7% +380 bp

Intermarché* 13,5% 15,4% 14,2% 14,4% 14,4% 14,4% +80 bp

Système U* 9,0% 10,8% 10,3% 10,3% 10,4% 10,4% +130 bp

* HM and SM Source: Kantar Worldpanel (FMCG+Fresh, Self-service); Linéaires; Bryan, Garnier & Co ests.

One platitude (more or less justified) is that young professionals no longer have time to shop in large out-of-town hypermarkets while the latter are inaccessible to elderly people, meaning that they are losing out to chains. Moreover, the weight of non-food is inversely proportional to the size of the store (i.e. c.15%e of the floor area of a 2,500m² hypermarket vs c.30%e in a unit of more than 10,000m²). Since the latter regroups the most ‘web-permeable’ categories (cf. Fig. 4), the large hypermarkets were Amazon’s designated victims.

Fig. 4: Breakdown of average hypermarket sales by product category

2010 2016 Var (%) Household and personal care 10.3% 10.4% 0.10 Beverages 11.0% 12.6% 1.60 Traditional chilled 16.2% 17.2% 1.00 Grocery 16.6% 18.2% 1.60 Self-service chilled 19.5% 21.6% 2.10 Non-food 26.4% 19.9% -6.50 - o/w Leisure 14.7% 10.5% -4.20 - o/w Textile 6.5% 5.3% -1.20 - o/w Household 5.3% 4.2% -1.10

Source: Nielsen; Bryan, Garnier & Co ests.

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Carrefour

NB: Contrary to popular belief, hypermarkets have not been the big losers in recent years. According to Nielesen’s figures (cf. Fig. 5), frequency of purchase has suffered more in supermarkets than in hypermarkets.

Fig. 5: Hypermarkets have not been the biggest losers in recent years

Penetration Frequency of purchase Basket (€) 2011 2015 2011 2015 2011 2015 Hypermarkets 94 95 40 44 44 41 Supermarkets 88 88 42 39 27 27 Discount 68 68 24 24 24 24 E-commerce* 16 34 7 9 64 60 Source: Nielsen; Bryan, Garnier & Co ests. * 2012 for E-commerce

However, we need to distinguish between small hypermarkets (<7,500m²) and the large formats (>7,500m²). Year- to-date (September 2017), the latter were thus down by 1.4% (vs +1.7% for small hypermarkets) and represented 40% of the market value losses (whereas the small hypermarkets contibutued 20% of the gains).

Fig. 6: Year-to-date trends for the different channels at end September

Change in value Proportion of value Contribution Evolution volume UC gains (+) / losses (-) HM/SM+HD+DRIVE+Conv +1.1% 100% +0.2% Hyper/ banners +0.7% 75.4% 0.0% (1) Hypermarkets +0.2% 41.1% -0.3% - HM<7,500m² +1.7% 21.0% +20% +0.7% - HM>7,500m² -1.4% 20.2% -40% -1.4% (2) Supermarkets +1.3% 34.3% +0.4% - SM<2,000m² -1.5% 15.0% -32% -2.3% - SM>2,000m² +3.6% 19.3% +37% +2.6% Local banners +4.8% 8.5% +4.3% - Urban +6.1% 6.1% +19% +5.6% - Rural +1.6% 2.4% +2% +0.8% DISCOUNT -1.8% 11.2% -28% -3.1% Drive-in +8.6% 4.9% +22% +7.6% Source: Nielsen; Bryan, Garnier & Co ests.

Fig. 7: More visits, but a fall in the average basket

25

20

15 Visits p.aVisits

10 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

Carrefour E. Leclerc Auchan Géant Casino

48 43 38 33 28 Average (EUR) basket Average 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

Carrefour E. Leclerc Auchan Géant Casino

Source: Kantar Worldpanel; Linéaires; Bryan, Garnier & Co ests.

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Carrefour

2.2. Price war and promotional activity The disruptive impact of e-commerce has been accompanied by a price war from which the sector is struggling to extricate itself. Within a stagnating FMCG market, a hypermarket player can only hope to win volumes at the expense of another. When its price positioning is inappropriate, there is a clear tendency for dissatisfied customers to desert a banner. The players are thus interchangeable and must diligently defend their piece of a pie, which is not getting any bigger (cf. our research: "Anorexic growth… the bigger the better!"). In addition, the brand loyalty indicator, a measure of a retailer’s market share with its customers (19% on average in France, 33% in the best cases) tends to show that customers are not loyal by nature (on average they shop at six different chains). This is the reason why, in 2013, Géant declared a price war to make up for a price ‘depositioning’ which had become prohibitive.

Fig. 8: Evolution de l’inflation par catégorie de produit en France (%)

7

5

3

1

-1

-3

-5 sept-03 sept-04 sept-05 sept-06 sept-07 sept-08 sept-09 sept-10 sept-11 sept-12 sept-13 sept-14 sept-15 sept-16 sept-17

Exhaustive Private labels Entry prices National brands

Source: Nielsen; Bryan, Garnier & Co ests.

This price war was reflected in total FMCG deflation of c.8%e between 2013 and 2017! Since absolute price elasticity is low (i.e. when the price of a product falls by 1%, the impact on its sales volume averages c.0.4%), it would be tempting to conclude that it has only destroyed value. However, Nielsen argues that the price war has mostly led to a material increase in relative elasticity linked to price comparison between a number of products and banners (cf. Fig. 9). Total elasticity (i.e. absolute and relative) thus moved from 0.8 (2010/12) to 1.2 (2015/16). From this perspective, we believe that the balances have clearly been disrupted to the detriment of Carrefour, the latter being left with no choice other than to invest heavily in prices to stabilise its market share.

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Carrefour

Fig. 9: Trend in the structure of price elasticity in France

2010-2012 2015-2016

Average 44% 45% Average elasticity elasticity 56% 55% -0,8 -1,2

Relative elasticity Absolute elasticity Relative elasticity Absolute elasticity

Source: Nielsen; Bryan, Garnier & Co ests.

To add insult to injury, in 2015, Leclerc, which had historically been an EDLP (Every Day Low Price) player, launched a huge promotional offensive (cf. Fig. 10). Judging by the relationship between market share and share of voice, Leclerc has undeniably proved more effective at this than Carrefour (cf. Fig. 11). Supported by conclusive trials, it is now focusing on immediate discounts for most promotional products (c.2/3 of the September catalogue). This ‘cash’ offer is more ‘impactful’ than that of Carrefour, which is often based on virtual batches (2+1, percentage discount on a second product, points credited to loyalty cards, etc). A remodeling of the promotional strategy is thus clearly vital at Carrefour.

Fig. 10: Contribution of promotional activity to FMCG value gains (half-year moving average) in France

140 24 120 23 100 22 80 21 20 60 19 40 (%)

(EURm) 18 20 17 0 16 -20 15 -40 14 P10 13 P12 13 P01 14 P03 14 P05 14 P07 14 P09 14 P11 14 P13 14 P02 15 P04 15 P06 15 P08 15 P10 15 P12 15 P01 16 P03 16 P05 16 P07 16 P09 16 P11 16 P13 16 P02 17 P04 17 P06 17 P08 17

Promotion: value gains/losses (EURm) Excl. promotion: value gains/losses (EURm) Weight (%) of promotion (value)

Source: Nielsen; Bryan, Garnier & Co ests.

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Carrefour

Fig. 11: Prospectus share of voice and 2016 market share in France 20,9% 20,6% 17,8% 16,9% 15,6% 15,0% 10,7% 8,7% 8,0% 7,4% 5,7% 5,2% 4,3% 2,6% 2,3%

Carrefour E. Leclerc Auchan Géant Casino Hypermarché

Prospectus share of voice Media share of voice Market share

Source: a3distrib; Linéaires; Bryan, Garnier & Co ests. 2.3. Premiumisation or squaring the circle Casino did not only seek to reposition Géant at an acceptable level (price index of 94 in 2017 vs 106 in 2013 according to the Olivier Dauvers ‘drives’ price index), but also to make it Leclerc’s main outsider (cf. Fig. 12). The polarisation of the offer (initiated with the Law to Modernise the Economy or LME) was thus accentuated (cf. Fig. 15) with, on one side, the discount hypermarkets (i.e. Leclerc, Géant, etc.) and, on the other, the premium banners (, , etc.). And since (unlike and Carrefour), Casino has always maintained a clear distinction between formats, it is now able to position itself unambiguously in each of these areas. This is unfortunately not the case for Carrefour which, in the mid-2000s, embraced the questionable option of banner convergence.

Fig. 12: Olivier Dauvers price drives index (France)

120

116 Auchan

Carrefour 112

108 Casino

Géant Casino 104 Monoprix

100 Super U Hyper U 96 E.Leclerc

92 Oct-17 Jan-13 Jan-14 Jan-15 Jan-16 Jan-17 Sep-13 Sep-14 Sep-15 Sep-16 May-13 May-14 May-15 May-16 May-17

Source: Olivier Dauvers, Garnier & Co ests.

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Carrefour

Carrefour is now building its growth via the mix and innovation. It has consequently embraced the market trend of trading-up (cf. Fig. 13), which is being stoked by growing consumer sensitivity to quality (1/ organic, 2/ fresh 3/ locally-sourced products, etc.). We had thought (cf. our research "Tending towards premiumisation?") that offering compelling prices (i.e. low price guarantee) on loss-leaders would enable the company to attract customers before redirecting them towards higher-margin areas. However, the success of this strategy has been limited by the fact that customers with the most modest budgets (a significant proportion of a hypermarket’s customer base) just cannot afford organic products which are c.30/50% more expensive than their non-organic equivalents. On the other hand, we believe that price perception may have suffered from this up-selling with hard-up customers.

Fig. 13: Breakdown of FMCG growth in hypermarkets and supermarkets (France, half-year moving average)

5,0%

4,0%

3,0%

2,0%

1,0%

0,0%

-1,0%

-2,0% Jun-09 Jun-10 Jun-11 Jun-12 Jun-13 Jun-14 Jun-15 Jun-16 Jun-17 Sep-08 Sep-09 Sep-10 Sep-11 Sep-12 Sep-13 Sep-14 Sep-15 Sep-16 Sep-17 Dec-08 Dec-09 Dec-10 Dec-11 Dec-12 Dec-13 Dec-14 Dec-15 Dec-16 Mar-09 Mar-10 Mar-11 Mar-12 Mar-13 Mar-14 Mar-15 Mar-16 Mar-17

(1) Demand inflation (2) Mix + Innovation (3)Volumes (1)+(2)+(3) = Sales Average growth rate (semestrial moving average)

Source: IRI, Company Data; Bryan, Garnier & Co ests.

Carrefour’s ambivalent positioning is thus a priority for Alexandre Bompard. The difficulty being that its cost base is irredeemably higher than that of Leclerc (cf. section 2.2). The group thus cannot lay claim to the position of cheapest banner, just as it cannot allow itself to be solely premium vis-à-vis the hypermarket customer base. Consequently, a combination between quality and a decent price perception may imply revisiting the Private Label strategy, within an environment supported by a possible increase in the Below-Cost Selling threshold (SRP- Seuil de Revente à Perte).

Fig. 14: Polarisation of the offer

From mainstream offer … … to a polarised one

Monoprix (Casino) Monoprix (Casino)

Amazon Carrefour Carrefour Géant (Casino) Tesco Tesco

Géant (Casino) Dia / LP (Casino) Dia / LP (Casino) Jeronimo Martins Jeronimo Martins

Source: Company Data; Bryan, Garnier & Co ests.

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Carrefour

Fig. 15: The Linéaires price index shows growing polarisation in France

120

115

110

105

100

95

90 H1 H2 H1 H2 H1 H2 H1 H2 H1 H2 H1 H2 H1 H2 H1 H2 H1 H2 H1 H2 H1 H2 H1 H2 H1 H2 H1 H2 H1 H2 H1 H2 H1 H2 H1 00 00 01 01 02 02 03 03 04 04 05 05 06 06 07 07 08 08 09 09 10 10 11 11 12 12 13 13 14 14 15 15 16 16 17

Leclerc Auchan Carrefour Super U Géant Intermarché Carrefour Market Casino Monoprix

Source: Linéaires; Company Data; Bryan, Garnier & Co ests.

At the end of the day, the decline of the large hypermarkets, the polarisation of the offer and the irruption of the internet are now putting the retailers’ strategies into perspective. Disregarding Casino’s controversial history (the group’s complexity, debt, Muddy Waters, etc.), one has to admit that the Saint- Etienne-based company has often been an early adopter of strategic options giving it today’s advantageous positioning. It “opted” for judiciously-targeted international diversification (Latam and Thailand in the late 1990s, etc.), proximity (acquisition of FP/LP at the end of the 1990s), the internet (acquisition of Cdiscount from Frères Charles in the early 2000s) and banner ‘divergence’. From this perspective, our preference would rather be for Casino than Carrefour.

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Carrefour

3. Surgical measures 3.1. €400m of price investment in France, accompanied by cost savings The reasons behind the profit warning (30th August), i.e. kitchen sinking and/or a degradation in the fundamentals (along with a strong price deflation on fruits and vegetables), remain murky. In fact, if footfall experienced a very significant deterioration and further price investment were to be made, ceteris paribus, the margin would not reach its low in 2017 (1.9%e). This painful price initiative would be accompanied (?) by other plans leaked by the unions (i.e. closure of some fifteen unprofitable hypermarkets, the franchising of stores and Sunday opening?2), which seem credible in our view.

The hypermarkets (53% of sales in France) are suffering from an average 400bp price gap in favour of Leclerc in FMCG. For the time being, we see Carrefour being forced to invest a minimum of c.€400m (i.e. c.1.1% of revenues in France) in prices to remedy this situation (i.e. a reduction of the price gap with Leclerc to 100bp). All other factors remaining equal (i.e. excluding natural cost inflation), the margin in France excluding Dia would therefore decline from 2.5%e to 1.4%e, while an unlikely 8% volume increase would be needed to maintain it (i.e. a market share gain of c.90bp). Alexandre Bompard will thus need to focus on slashing costs, something at which he mastered at Fnac-Darty.

In concrete terms, on our estimates, a c.€330m reduction (i.e. c.6%e of the fixed cost base in France/0.9% of sales), along with a 1.3%3 increase in volumes in France (i.e. a c.15bp market share gain) would enable the margin to be maintained at 2.5% excluding Dia. Were the latter’s losses to be eradicated (i.e. an estimated €150m in 2017), total profitability of France could reach 2.4%. This looks to be eminently achievable given the current extravagant level of head office costs. To give a rough idea, note that cost-cutting averaged 1.2% of sales for the UK retailers over a three-year period (Fig. 16).

2 According to Linéaires, Carrefour is likely to transfer some hypermarkets (floor area of between 3,000 and 7,000m², average headcount of 120 and sales starting at €125m) to lease management as of March 2018 (link to the article).

3 Assumption based on the total elasticity estimated by Nielsen (cf. Fig. 9)

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Carrefour

Fig. 16: Cost saving programmes by the UK retailers

1 200 2,5%

1 000 2,0% 800 1,5% 600 1,0% 400

years (GBPm) years 200 0,5%

0 0,0% Cost savings over thepast 3 Sainsbury Tesco Morrisons Cost savings as of 3Y a % sales Cost savings over the last 3 years Cost savings as % of sales

Source: Company Data; Bryan, Garnier & Co ests.

3.2. Unprecedented measures and a revised decision- making paradigm In our view, Alexandre Bompard may be planning radical measures, which have never been put open- mindedly on the table. We remain dubious about a large-scale reduction in floor area to the benefit of third-party chains and see closures (15 according to the hypotheses reported in Le Figaro4), together with partnerships (shop in shop, pooled procurement?) with Fnac-Darty (cf. Philippe Houzé’s comments on BFM5) and/or Galeries Lafayette/La Redoute (cf. our research "Tending towards premiumisation?"6) as an option. Similarly the roll-out of new activities (market and , wholesale, etc. ?). This is because 1/ slashing the floor area of a large 15,000m² Carrefour hypermarket by a third is far more difficult than downsizing a 6,000m² Géant unit by the same proportion (i.e. Alcudia project); 2/ reallocating floor space to certain category killers (?) would obviously negatively impact other profitable categories at Carrefour (textiles for example).

4 ‘The 18 labours of Hercules to get Carrefour out of its rut’ dated 2 October 2017

5 4 September 2017 interview during the BFM business programme on the acquisition of La Redoute by Galeries Lafayette

6 In this report, we outlined a theoretical merger between Carrefour and Galeries Lafayette. Note that they share the same reference shareholder (Moulin family)

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Carrefour

Cost cutting is a categorical imperative when it comes to reducing Leclerc’s unfair competitive advantage, enabling the latter to be structurally the cheapest on the market. In fact, the members occupy all the management positions and work for free, several days a week, to ensure the proactive functioning of the (they are also responsible for negotiating directly with manufacturers, etc.). According to Michel-Edouard Leclerc, head office employees number half those of Carrefour (‘our 529 members and their spouses amount to nearly one thousand senior financial executive salaries’7). And all that saving can be reinvested in prices. The inverse applies at Carrefour where there are rafts of consultants on top of the management layers, meaning that the decision-making and execution process drags on and on. Alexandre Bompard will need to tackle this multi-layered decision-making structure.

At Leclerc, the floor managers are also responsible for monitoring prices in competitors’ stores for more than 10,000 products (!) on a weekly basis, thereby ensuring that their banner is the cheapest on a -time basis. At Carrefour, we understand that the conclusions of the pricing algorithms, based on margin equalization principles, are imposed inefficiently on the store managers. Within their own catchment area, the latter thus have only limited room for manœuvre. Giving them back some real autonomy is one way to ensure greater responsiveness and thus improved commercial effectiveness.

Similarly, management autonomy seems to be a breeding ground for digitalisation. This is what Jean- Agon (CEO of L’Oréal) meant at the inauguration of his company’s incubator at the Station F campus. ‘This organisation (note from the editor: ‘highly decentralised’, ‘relatively informal’, with ‘fairly autonomous subsidiaries’) which used to be a bit strange […] is in osmosis with today’s digital world, which is totally decentralised and where there are very few top down decisions’8. And therein lies the rub (?) for Carrefour where, in our view, digital initially did not seem to be embedded in the mindset. In concrete terms, at the time when was acquiring jet.com ($3bn!), Carrefour settled for a bit of unconvincing cherry picking (rueducommerce.com, grennweez.com and croquetteland.com, etc.). The announcement of a partnership with Google, as Walmart has already done it, might perhaps lend credibility to the group’s current digital project.

7 Quote from an interview with Michel-Edouard Leclerc in Capital (no.313, October 2017)

8 Remarks by Jean-Paul Agon (CEO of L’Oréal) picked up in a Linkedin article

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Carrefour

3.3. Possible disposal of international assets In parallel with the recovery initiatives in France, in accordance with the philosophy which consists of exiting countries where the group has no hope of becoming a major player and/or profitable, we believe that asset disposals could be on the cards. In this regard, China (5% of group sales, estimated 2016 losses of c.€61m) must not remain a taboo subject. Until now, the only Western retailers to have successfully established themselves in this country have done so via partnerships with local retailers, like Auchan with Sun Art Retail. A combination of online and offline is also an option, as seen with the recent agreements between Walmart and JD.com, and Alibaba and Bailian (now 18% owned by the e- retailer). Failing the rapid conclusion of such a partnership, we believe that the decision could be taken to sell the Carrefour assets (valued at €1.2bn in our SOP).

Fig. 17: Past asset disposals and price positioning in France

2500 98,5 Disposal of Colombia (EUR2bn EV / 1,3x sales) 2000 97,5

96,5 1500 95,5

EURm Diposal of Thaïland Price Index 1000 (EUR870m EV / 0,9 x sales) 94,5

Disposal of the 25% in the JV with MAF (EUR530m EV 93,5 / 0,7x sales) 500 Disposal of Indonesia (EUR525m EV / 0,9x sales) Disposal of 12% of IE in 92,5 Disposal of (EUR60m EV / (EUR250m EV/ 0,6x sales) 0,45x sales) 0 91,5 H2 08 H1 09 H2 09 H1 10 H2 10 H1 11 H2 11 H1 12 H2 12 H1 13 H2 13 H1 14 H2 14 H1 15 H2 15 H1 16 H2 16

(1) Deterioration of the price positionning under the direction of L. Olofsson (2) In France, N. Prioux starts investing in prices (3) G. Plassat takes the helm at the right timing / optimization of the asset portfolio Leclerc price index Carrefour price index

Source: Linéaires; Company Data; Bryan, Garnier & Co ests.

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Carrefour

4. Potentially positive timing? 4.1. Inflation is rearing its head Independently of the irruption of Amazon which is, in any case, a salient fact for the coming decade, in our view the timing of this fourth recovery attempt could prove opportune. Nearly four years after the launch of the price war, deflation seems to be drawing to a close, something which should create a positive market context. According to the Nielsen figures, the decline in prices slowed to just 0.4% in September (vs -0.7% YtD and -0.8% in 12m moving average).

Furthermore, we understand from a number of industry contacts that one of the more aggressive players had recently applied the brakes, something which could perhaps be reflected in the forthcoming Linéaires price indices. This doesn’t change the fact that Carrefour clearly needs to invest in prices over the next few quarters, to reduce the differential separating it from the market leader. However, the exercise would be less painful within a market context marked by a possible return to inflation, supported by an increase in the Below-Cost Selling threshold (?).

Fig. 18: Breakdown of FMCG growth in France in August and year-to-date

Units Units sold: sold: 0,0% +0,2% Volume Volume Volume: Volume: per unit: per unit: -0,4% +0,1% -0,4% -0,1%

P09: YtD: +0,7% +1,1%

Inflation / Inflation / Price: Price: deflation: deflation: +1,1% +1,0% -0,4% -0,7% Mix Mix effect: effect: +1,5% +1,7%

Source: Nielsen; Bryan, Garnier & Co ests.

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Carrefour

4.2. An increase in the BCS threshold, the details of which remain hazy, could benefit Carrefour Following the Galland Law (1996) and until 2009 (LME), retailers were not authorised to negotiate supplier prices. 1/ This opportunity cost was offset via the invoicing, to manufacturers, of back-margins which could not be deducted from the Below-Cost Selling threshold (Seuil de Revente à Perte -SVP, i.e. gross margin below which a retailer cannot sell its merchandise). 2/ To compensate for ever-mounting back-margins (40% of the net purchase price in 2007 vs. 12% in 1995), manufacturers increased their prices (BCS calculation base). 3/ The increase in back-margins was thus reflected in high inflation and the ballooning of the margin rate (cf. our initiation of coverage: "Hypermarkets are dead, long live hypermarkets").

NB: the distorted back-margin mechanism enabled Carrefour to finance its international deployment meanwhile, in France, National Brands’ price competitiveness disintegrated to the benefit of Private Labels (not concerned by the Galland Law).

Fig. 19: Number of countries in the portfolio and margin rate

35 Galland law Dutreil law LME 7% 30 IFRS 6% 25 5% 20 4% 15 3%

10 2% rate Margin

Countries (own (own stores) Countries 5 1% 0 0% 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017e

Margin rate

Source: Company Data; Bryan, Garnier & Co ests.

Since then, by authorising retailers to negotiate supplier prices and deduct all back-margins from the BCS threshold (a measure partly introduced by the Dutreil directive) using the ‘triple net’ principle (i.e. the price calculated net of 1/ rebates, 2/ discounts and 3/ allowances), the LME (January 2009) made it possible for hypermarket retailers to again invest in National Brand prices (it is now easy to see why Michel-Edouard Leclerc was such a fervent backer of the LME…). This has had two main consequences 1/ a marked decrease in NB prices (i.e. an improvement in value for money versus Private Labels) and 2/ the collapse of the hard discounters (c.100% Private Label) who had been the major beneficiaries of the Galland and Raffarin Laws.

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Carrefour

Fig. 20: Simulated theoretical and simplified impact of the Galland law and the LME on retailers’ margins

Before Galland law During Galland law During Dutreil law LME

Purchase price billed by supplier 100 100 100 100

Back margin (assumption) 33 33 33 33

Cost price for retailer 67 67 67 67

Below-cost selling threshold 67 100 82 67

Minimum retail price 67 100 82 67

Retailer’s gross margin 0 33 15 0

Source: ILEC, Company Data; Bryan, Garnier & Co ests.

At present the must-have brands (i.e. Nutella, Coca , etc.) are sold at the BCS price, thereby encouraging retailers to bolster their margins elsewhere to the detriment of small producers. Given this fact, many are now lobbying for an amendment to the LME. This would potentially consist of increasing the BCS to a c.15% gross margin on FMCGs, resulting in an upswing in inflation. (+c.1% according to those advocating the reform), something which has of course been condemned by Michel-Edouard Leclerc (who is forecasting price rises of between c.5% and 15% as the case may be). On this scenario, ceteris paribus, just +0.5% inflation in FMCG selling prices would have an estimated +c.45bp impact on Carrefour’s operating margin. The consequences of such reform would thus be major.

In his speech concluding the round table discussions on retailing, President Macron finally came out in favour of an increase of the BCS on ‘food products’ alone (versus all FMCGs in the original proposals) and depending on the segment. An overall increase would have been a very positive decision for Carrefour in that it would have scuppered Leclerc’s strategy of systematically reinvesting productivity gains in prices to which, objectively, Carrefour is unable to respond. As such, its repositioning relative to the price leader would have been massively facilitated.

However, this scenario seems to have been decisively ruled out, in favour of a ceiling on promotions and an increase in the BCS on food alone. Measures whose scope (no-one knows precisely what the President includes under food products) and timing (the coming rounds of trade discussions should take place within the current legal framework) are as yet unclear. The fact remains that an increase of the BCS has a good chance of benefiting Carrefour’s price repositioning relative to Leclerc, particularly if it concerns loss leaders.

20

Carrefour

Price Chart and Rating History

Carrefour

30.0

28.0

26.0

24.0

22.0

20.0

18.0

16.0

14.0

12.0

10.0 13/05/16 13/08/16 13/11/16 13/02/17 13/05/17 13/08/17 13/11/17

CARREFOUR Fair Value Achat Neutre Vente

Ratings

Date Ratings Price 20/11/14 BUY EUR24.55

Target Price Date Target price 15/11/17 EUR20

31/08/17 EUR22 12/07/17 EUR28

10/03/17 EUR29

04/04/16 EUR30 25/09/15 EUR31

13/04/15 EUR34

24/03/15 EUR33

06/03/15 EUR32

20/11/14 EUR30

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Carrefour

Intentionally left blank

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Carrefour

Bryan Garnier stock rating system For the purposes of this Report, the Bryan Garnier stock rating system is defined as follows: Stock rating Positive opinion for a stock where we expect a favourable performance in absolute terms over a period of 6 months from the publication of a BUY recommendation. This opinion is based not only on the FV (the potential upside based on valuation), but also takes into account a number of elements that could include a SWOT analysis, momentum, technical aspects or the sector backdrop. Every subsequent published update on the stock will feature an introduction outlining the key reasons behind the opinion. Opinion recommending not to trade in a stock short-term, neither as a BUYER or a SELLER, due to a specific set of factors. This view is intended to NEUTRAL be temporary. It may reflect different situations, but in particular those where a fair value shows no significant potential or where an upcoming binary event constitutes a high-risk that is difficult to quantify. Every subsequent published update on the stock will feature an introduction outlining the key reasons behind the opinion. Negative opinion for a stock where we expect an unfavourable performance in absolute terms over a period of 6 months from the publication of a SELL recommendation. This opinion is based not only on the FV (the potential downside based on valuation), but also takes into account a number of elements that could include a SWOT analysis, momentum, technical aspects or the sector backdrop. Every subsequent published update on the stock will feature an introduction outlining the key reasons behind the opinion. Distribution of stock ratings

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