2018 Major Trends in the Russian Retail Market

June 2019 Executive summary

GDP grew in line with consumer price inflation, which were both driven by higher consumer spending In 2018, Russian GDP grew at its highest rate in six years. The key driver of GDP growth was higher consumer spending rather than industrial advancements or investment. Consumer price inflation rose noticeably at the end of the year due to the cumulative effect of expectations for higher VAT rates, utility fees and gas prices, which led the Central Bank of Russia to increase its key rate.

While Russian consumers’ financial situation has yet to stabilize, they have been shopping more The overall financial situation of Russian consumers worsened in 2018, as real disposable income growth remains negative. Despite a gradual increase in nominal and real wages, real disposable household income continues to shrink. The accumulation of loans has been the main cause of the decline in real disposable incomes. Consumers began to notice price increases in late 2018. Pushed by the proximity of the VAT increase, Russians began to make large purchases, which is reflected in the average check as well as in retail turnover growth.

Retail turnover growth remains positive, most food retailers are growing their revenue by opening new stores Most food retailers reported an increase of revenue, mostly driven by new store openings and territorial expansion. The market became more consolidated among large retailers who chose the right strategic path and can resist external and internal negative factors effectively.

Convenience stores are attracting customers more than hypermarkets, which requires long trips to visit Lfl sales at most hypermarkets are under pressure as they continue to lose traffic, whereas supermarkets have reduced the size of their LfL baskets. There is a clear shift to supermarket and convenience store formats, as retailers search for more flexible business models to respond changing consumer behavior.

2 Content

Macroeconomic overview Consumer behaviour and Challenges and and forecast expectations opportunities for retailers

3 Strong GDP growth in 2018 was fueled by higher rates of consumer spending, but GDP is forecasted to drop as government spending levels may not provide a sufficient stimulus to the economy

In 2018, GDP growth was at its highest rate for the last six years, but is forecasted to fall in future years Russian real GDP, Y-o-Y, % change

-0.8 p.p.

2.3

1.6 1.6 1.7 1.5 1.3 1.2

0.6

2016 2017 2018 2019 2020 2021 2022 2023

Rosstat Average forecast (IMF, Oxford Economics, EIU)

According to Rosstat, Russian GDP grew Government expenditures continue to drop 2.3% in 2018, while international agencies estimated GDP growth at 1.7-1.9%. This represents the highest rate of economic Federal expenditures, % of GDP growth in Russia since 2012. The main CAGR: GDP growth driver in 2017 and 2018 was MinEc -2% consumer spending rather than industrial IHS -4% advances or investment. The Ministry of 19.1 Economic Development has announced 18.5 18.0 17.9 that the acceleration of GDP growth was 16.8 16.9 17.0 16.9 16.8 16.6 largely caused by one-off factors and not 16.2 16.1 16.0 15.6 sustainable. 14.6 14.5 In 2019, both Russian and international rating agencies expect Russian GDP growth to fall to 1.5%. These forecasts reflect the combined negative impact of increases in consumer taxes and utility fees, low levels of confidence and investment, lingering Western sanctions, lack of economic growth-stimulating measures (including meaningful reforms) and worsening external demand. According to Russian Ministry of Economic Development’s data, GPD growth will accelerate eventually after 2019. Ministry’s 2016 2017 2018 2019 2020 2021 2022 2023 GDP growth estimates are based on expected socio-economic and structural changes, including the implementation of Government expenditures are essential to GDP growth, especially to key national projects, infrastructure the government’s plans to support the Russian economy in 2019-2024. development plans, improvement of the However, Russian and international forecasters alike expect investment climate, enhanced expenditures to fall (by 2% and 4% CAGR, respectively). competitiveness of public-private enterprise and pension reform. Russian Ministry of Economic Development IHS Markit

Sources: PwC analysis, CBR, IHS Markit, DT Global Business Consulting 4 Consumer price inflation was driven by new taxes and utility charges, and real disposable incomes are not keeping pace

Inflation is expected to increase again after a 20-year low in 2017-2018

Consumer prices inflation rate, Y-o-Y, % change

+0.7 p.p. 5.4 5.0

4.3 4.4 4.2 4.3 4.2

2.5

2016 2017 2018 2019 2020 2021 2022 2023

Rosstat Average forecast (IMF, Oxford Economics, EIU)

From September 2017 to November 2018, Real disposable income growth was still negative in 2018 despite inflation in Russia was at a 20-year low. real wage growth The rise of the inflation rate to 4.3% in late 2018 was caused by utility fee increases Growth of real disposable income, Y-o-Y, % and the early impact of the VAT hike (from 18% to 20%) starting in January 2019. Furthermore, a weaker rouble (hit by US 2.2 2.3 2.4 2.1 sanctions) and yield increases in the 1.7 1.9 1.3 advanced economies forced the Russian 1.0 0.8 Central Bank to increase its key rate by 25 0.1 basis points to 7.5% in September, leading to another spike in the inflation rate in -0.2 December 2018. -1.2 However, weak consumer spending is expected to keep inflation in 2020 close to the Russian Central Bank’s 4% target. The Russian Ministry of Economic Development expects real disposable -5.8 income growth to be positive due to the sustainable growth of key income 2016 2017 2018 2019 2020 2021 2022 2023 components, including wages, pensions and social payments. Nevertheless, the Russian Ministry of Economic Development Rosstat recent year-on-year gains in nominal and Economic Intelligence Unit real wages have not closed the gap in real disposable household income for 2016- In Moscow, nominal and real wages grew faster than in other regions 2018. The accumulation of loans has been the main cause of the decline in real in 2018 disposable incomes. According to CBR data from December 2018, the volume of loans Nominal and real wage growth divided by Russian regions, 2018, % and other funds provided to individuals increased by 13% year-on-year. 14.3% Nominal wages +4 p.p. Moreover, the growth of wages varies 9.9% across Russia’s vast geography. In 2018, Moscow nominal and real wages grew significantly 7.8% Real wages +1 p.p. Other regions faster in Moscow (up to 4 p.p. and 1 p.p., 6.8% respectively) than in other regions.

Source: Russian Federal Statistics Service

Sources: PwC analysis, CBR, IHS Markit 5 Negative macroeconomic trends such as rising inflation and slow economic growth have negatively affected Russian consumer spending and expectations Consumer confidence has been undermined by expected VAT increases and consumer price inflation Consumer Confidence Index, divided by quarters, Russia

2016 2017 2018

-8 -8 -11 -11 -15 -14 -14 -17 -19 -18 CAGR: 29% -26 -30

Source: Russian Federal Statistics Service

More families believe that their financial situation got Due to expectations about rising inflation, consumer confidence started to fall in the worse in 2018 second half of 2018. In Q4 2018, consumer confidence fell to its lowest level since Q4 Changes in Russian consumers’ financial situation, divided 2016. These sentiments could slow the by quarters, % of all respondents growth of retail turnover. The Consumer Confidence Index dropped due to the negative changes in Russian consumers’ financial situation. For the first time since 2016, Russian consumers improved indicated that their financial situation had no change become worse. The number of respondents who believe that their material status has worsened become worse grew 4.1 p.p., while the number of consumers whose financial status improved decreased 1.2 p.p. Around 72% of Russian consumers claimed +4.1 p.p. to feel the impact of rapidly raising prices in 2018. Moreover, up to 8.9% of respondents felt that prices increased moderately, while up to 7.3% of consumers indicated that 2016 2017 2018 prices increased rapidly. Most respondents believe that the main cause of rising prices is the upcoming increase in the VAT rate. Russian consumers have felt the impact of price Russian consumers also believe that higher increases gasoline prices led to the growth of prices Changes in prices of food/non-food products and services, for other goods. divided by quarters, % of all respondents However, price increases are not in full swing, as large retail chains have sought to stretch price growth over time and make it +7.3 p.p. less visible to consumers when demand is low.

+1.6 p.p.

2016 2017 2018

increased rapidly increased insignificanly not sure increased moderately did not increase

6 Sources: FOM, PwC analysis Increased shopping activity in late 2018 was mostly driven by the upcoming VAT increase and should not be interpreted as a market trend Consumers reconsidered important purchases in Q4 2018 Key trends in consumers behavior, % of all respondents

37 35 34 33 33 32 30 29 29 32 30 35 27 Buy cheaper products 31 29 2016 2017 2018

29 30 27 26 26 26 25 28 2016 21 23 21 22 20 Buy less 24 2017 22 2018 2016 2017 2018

Source: FOM

In 2016-2017, a declining number of Saving money has become less of a priority for Russian Russian consumers bought cheaper products or fewer products. However, in consumers response to their worsening financial Saving behaviour of consumers, % of all respondents situation and rising prices, customers tended to buy cheaper products or shop 63 less through Q3 2018. The hype around the 58 upcoming VAT increase led to changes in 56 their behaviour in Q4 2018. 37 38 On average, around 29% of consumers 32 have sought to buy cheaper products, while more than 22% have cut back on shopping.

It is necessary There is no need to save We are witnessing a decline in to save consumer demand. Unfortunately, this is the trend of the year. 2016 2017 2018

Igor Shekhterman, CEO Source: FOM of X5 Retail Group

Triggered by growing inflation in consumer The share of large purchases is growing, driven by increased product and fuel prices, more Russians have come to believe that saving is not their shopping for non-food products before the VAT increase top priority. The share of respondents who Readiness to make large purchases, % of all respondents believe that it is necessary to save money decreased by 2 p.p. to 56% in 2018, while 38% of consumers find there is no need to save money. 38 40 42

Around 20% of Russian consumers were 17 prepared to make large purchases in 2018, 22 23 while 35% thought it was a bad year for 45 such purchases. The share of sceptics in 38 35 2018 was a bit lower than in previous year. More consumers are making large 2016 2017 2018 purchases to take advantage of lower prices before the VAT increase, although demand for non-food products fell in November and Bad time Good time Not sure limited the traditional pre-New Year increase in sales in December. Source: FOM

Sources: Rosstat, FOM, PwC analysis 7 Despite falling average receipts and negative macroeconomic factors, retail turnover growth remained positive in 2018, mostly driven by the opening of new stores

In the second half of 2018, the average check decreased in comparison with previous years Higher inflation leads to additional pressures on real disposable income. The Average receipt by quarter, RUB growth in the size of average receipts was disrupted in Q3-Q4 2018 by the worsening 560 financial situation of Russian consumers. 554552 Around 68% of Russian consumers believe their financial situation worsened in Q3-Q4 533 2018, and 72% felt the impact of the rapid 531 increase in prices. 522 518521 512515 In 2018, average receipts grew in 503 November and not in December, reflecting 498 on the New Year average basket. Meanwhile, in the fourth quarter, when 2016 receipts typically grow the most, the 2017 average receipt was smaller than in the same period of the previous two years. 2018 Q'1 Q'2 Q'3 Q'4 Source: ROMIR

Retail turnover continued to grow despite rising inflation and shrinking incomes

Overall retail turnover growth, Y-o-Y, %

Rosstat data show that retail turnover 10 8.3 continued to grow despite rising inflation 7.4 6.8 5.8 and unemployment and shrinking 4.6 4.2 3.9 incomes. The key factor of this 5 3.4 3.0 2.6 2.3 2.4 phenomenon is increased consumer spending. 0.9 2.0 3.3 2.4 2.9 2.6 2.7 0 In Q4 2018, the retail sector experienced -3.9 2.7% growth as consumers sought to take -5.0 -4.9 -4.6 -1.6 advantage of lower prices before the VAT -5 increase took effect on 1 January 2019. 2016 2017 2018 inflation rate, Y-o-Y, % Source: Russian Federal Service of Statistics

Revenue among top food retailers grew, mostly due to Most chain food retailers reported revenue the opening of new stores growth in 2018, mostly driven by new store openings. The X5 Retail Group’s retail Estimate of revenue growth by factors,* chains, Pyaterochka and Perekrestok, change in FY18 compared with FY17, % showed the highest growth rates (18.8% and 17.6%, respectively). In 2018, the X5 O’KEY -3.8 -2.7 -6.5 Retail Group operated 14,431 stores, including 13,522 Pyaterochka stores, 760 Karusel 0 1.7 1.7 Perekrestok stores and 94 Karusel stores. Although Pyaterochka indicated strong Magnit -2.5 10.7 8.2 revenue growth new store openings, Perekrestok was leading retailer in terms of revenue growth due to LfL sales growth in Lenta 1.3 11.9 13.2 existing stores.

Pyaterochka 0.9 18.8 19.7 O’KEY showed negative growth due to store closings. The retailer has changed its strategy and has decided to focus on the Perekrestok 5.9 17.6 23.5 DA! discount chain. LfL Sales growth Growth by openning / closing stores Total % revenue growth

*LfL effect was estimated based on reported revenue numbers and LfL revenue growth rates. LfL revenue growth rates have been applied to total revenue of the previous period, as share of LfL revenue is not available.

8 Sources: Retailers reports,PwC analysis The two leading food retailers, the X5 Retail Group and Magnit, increased their share of retail trade volumes

Share of retail chains in the retail trade of food products in Russia,%

72.8%

74.9% 73.8% 1.1%

1.2% 1.3%

1.3% 1.6% 2.0% 1.6% 2.0% 2.0% 2.3% 2.3% 2.6% 2.6% 2.4%

2.2%

8.1%

7.9%

7.8%

Other O’KEY 10.1% Metro 8.8% DIXY 7.3% Auchan Lenta Magnit X5 Retail Group

2016 2017 2018

By 2020, the market share of national food retail chains will expand to 40% and by 2030 to 60%. These numbers represent Western countries’ market by present days. Our market is not sufficiently consolidated yet, so there is space for national players to grow.

Martijn Peeters Partner, Retail & Consumer Leader, PwC Russia

Sources: Retailer reports, mass media, PwC analysis 9 Increasing frequency of microtrips to the nearby stores is driving the trend for smaller formats, while hypermarkets are steadily losing traffic Hypermarkets have become less popular; key retailers have noticed that drops in LfL traffic have put pressure on LfL sales Comparable sales LfL,% Comparable average LfL check in 2018,% 3.2

6 5.4 0.9 4.6 0.4

3.9 Karusel Lenta O'Key hypermarkets 2 1.1 1.3 0.7 0.8 0.0 Comparable LfL traffic in 2018,% 0.4 -3.2 -4.3

2016 2017 2018 -3.1 Karusel O'Key -4.8 Lenta hypermarkets Karusel Lenta O'Key Food inflation hypermarkets

Lfl sales growth is slowing in supermarkets and convenience stores. While most of them demonstrate positive LfL traffic growth, revenue is mostly being generated by new store openings

Comparable sales LfL,% Comparable average LfL check in 2018,% 1.2 0.5 65.5

0.4 0.4 52.0 -1 12.7 9.1 10.1 Da! 6.4 5.9

4.6 Magnit 6 4.6

5.5 Lenta

1.9 0.9

Perekrestok Pyaterochka

1.2 supermarkets 2.4 1.1

-3.1 Comparable LfL traffic in 2018,% -5.5 9.5 2016 2017 2018 6.2 0.4 1.6 Da! Pyaterochka

-2.1 Perekrestok Lenta

supermarket Da! Magnit

Magnit Food inflation Lenta

Perekrestok

Pyaterochka supermarkets

10 Sources: Retailers reports, PwC analysis Most hypermarkets are now experiencing negative LfL traffic. Retailers that traditionally relied on hypermarket format are now tending to shift their focus to smaller formats in response to changing consumer behaviour. O’KEY is developing a new compact urban hypermarket format (3,000- 7,000 m2 stores). They are find that such stores are up to 10% more effective than their traditional hypermarkets. With the loss of revenue due to the closing of hypermarkets in 2018, they are actively developing the DA! Discount chain and planning about 170 new openings of this format. The second important strategic priority is finding effective and innovative ways to create a better customer experience through loyalty programmes and omni-ecosystems. For example, Auchan is planning to launch a loyalty programme in 2019 and focus on developing an e- commerce channel. The X5 Retail Group is testing online channels through Perekrestok and plans to offer multi-channel sales through other chains. Magnit believes that its future is not as an e-commerce store, but as an online space that provides a portfolio of services.

Both small format retailers and hypermarkets are prioritising cost optimisation and a better customer experience. Both of these issues are key success factors in the current market environment. Smaller formats have become more popular among Russian consumers and most retailers report positive traffic growth in these formats, although their LfL sales are still under pressure. The main challenge for retailers is improving operational efficiency, including reducing losses and staff turnover, adopting innovative solutions and automating key business processes. This is not just about in-store technology. For example, Magnit and Headhunter launched automated system for staff recruitment, which helped to select 25% of potentially suitable candidates.

11 Key news for 2018 Management

Deputy Prime Minister Dmitry Kozak was assigned Kaufland); Pavel Remezov, real estate (Lenta, OBI, to oversee the retail sector among other areas Metro Cash & Carry); Niksha Nekich, domestic production (Kaufland); Tino Andjich, strategic Magnit marketing (Leo Burnett, WPP and J. Walter • Olga Naumova (former CEO of Pyaterochka) Thompson); and Dinko Gadzhev, fruit & vegetables became CEO at Magnit commercial directory (Kaufland) • Vladimir Sorokin (former CEO of Perekrestok) Azbuka Vkusa became deputy CEO at Magnit • Khachatur Pombuhchan (former CEO of Magnit) • Valeryia Solok became the leader of the joined the board of directors of Azbuka Vkusa Zdorovy’e project at Magnit (previously director of • Vadim Dolgov became president of Azbuka real estate management at Magnit and CEO of Vkusa (previously vice-president of AV Market the 36.6 pharmacy chain) format Lenta X5 Retail Group • Jan Dunning (former CEO of Lenta) was • Sergey Goncharov (former head of Magnit appointed president at Magnit and replaced by Cosmetic) became CEO of Pyaterochka German Tinga, former CFO of Lenta • Rinat Muhametvaleev (former CEO of Galamart) • Rud Pedersen (former CFO of Carlsberg Eastern was appointed CFO of Perekrestok Europe) became CFO of Lenta • Vladislav Kurbatov was appointed CEO of • Dmitry Bogod (former associate partner of Perekrestok (previously operational director) McKinsey & Co) was appointed Lenta strategy director Other retailers O’KEY • Oleg Paroev became the new CEO of McDonald’s, previously CFO of McDonald’s • O‘KEY Group Board of Directors appointed Armin Burger as the new CEO of the retail network • Oleg Minaev (former CEO of Karcher Russia) became new CEO of KupiVIP • O’KEY welcomed five new senior managers: Martin Piterak, operational director (Ahold and

Strategy

Metro returned to the cash & carry format and Auchan plans to build two hypermarkets in 2019 made the wholesale price available on the shelf for and intensify focus on ultra-proxy store formats. all. The Real supermarket chain is for sale. Pyaterochka is shifting to a new management The X5 Retail Group plans to slow the growth of model with five macro regions whose directors will new stores and concentrate on three key formats, report directly to the CEO. Each macro region while continuing to develop the online segment includes two-four territorial divisions. starting with Click&Collect in Pyaterochka. O’KEY plans to reduce the size of its hypermarkets Magnit sought to consolidate more than half of its and focus on optimisation rather than on the stores in renewed formats, expand the range of opening of new large format stores. The DA! products and services and move away from discount chain is expected to drive development. traditional food retail in collaboration with partners, while planning to double sales from private labels.

Deals & partnerships

Magnit and Russian Post have signed an M.Video made a deal to acquire Eldorado. agreement to cooperate on logistics and retail. Chains Bristol, Krasnoe & Beloe and Dixy agreed to Azbuka Vkusa began to cooperate with Apple by consolidate. selling Apple products in-store. VTB sold its 11.8% share in Magnit to Marafon Magnit’s board of directors agreed to buy the SIA Group (established by A1 former associates). Group, a pharmaceuticals distributor, for RUB DIXY is no longer a public joint stock company and 5.7bn. has changed its name from PAO Dixy Group.

Sources: Retailers reports, mass media, PwC analysis 12 Key news for 2018 year New formats Perekrestok announced the launch of a kitchen Auchan presented a new store concept with factory project worth RUB 3.5bn that has no updated designs, brand new colour schemes, analogues in Russia yet and opened its first dark equipment and product assortments and switched store supermarket. from vertical to semi-vertical and spot goods outlay. Magnit started to test cafeterias inside its stores. Lamoda announced its first offline store, Lamoda Market, located in Moscow (Atrium Mall). Perekrestok has launched a marketplace for perishable goods in Moscow and Saint Petersburg. Detskiy Mir launched a new format store that sells Suppliers have to deliver products within 5-10 large goods (such as prams) in Moscow. hours to the store of the customer’s choice Leroy Merlin announced the opening of a dark- Vkusvill launched a pilot project, Tilsy, to deliver store format hypermarket in Saint Petersburg in highly perishable goods to retail chains. 2019 and opened the Leroy Merlin Market initially Perekrestok is the first client. for four categories of home appliances. Vkusvill is testing the micro format, installing IKEA is experimenting with new small formats vending machines in office centres and presented as design studios with popular underground stations. The chain is planning to categories of goods such as kitchens and closets. cover every station in the Moscow Central Circle The new store is available in Saint Petersburg and with vending machines placed right next to Coffee expected to expand to other areas. House small-format coffee machines. M.Video opened its first compact stores (M_Mobile) Magnit has decided against developing the that sell smartphones, SIM-cards, gadgets and hypermarket format and controversially plans to related products. open ultra-small format shops. Magnit started a pilot project to open stores in Russia Post offices in Moscow, Krasnodar Region and Ryazan Region. New on the market

Odnoklassniki launched an online store for Chinese Alibaba Group, the Russian Direct Investment Fund, goods with more than 3m products in 20 categories. Mail.ru Group and Megafon have collaborated Aliexpress Russia, an e-commerce project with Vkontakte launched an Internet store with private plans to lead the Russian online market. labeled clothing and souvenirs with different delivery types. Xiaomi has launched Mi.com, a trading platform, as it seeks to strengthen its position on the Russian The Chinese marketplace Tmall started selling DIY, market. home improvement and repair goods in Russia, starting with 250 labels and planning to expand to Alexander Kolobov, owner of Shokoladnitsa, has 4,000 labels in the second half of the year. partnered with Igor Sosin (Starik Khottabych, OBI) to launch a chain of grocery stores with cafe zones. Instamart is expanding delivery services for purchases from stores in Ekaterinburg, Kazan, Perekrestok has launched Uhtushky, its first private Nizhniy Novgorod and Novosibirsk. label brand of products for children aged 4 to 7. Sberbank is planning to open pickup points for online purchases at its bank branches. Yandex and Sberbank launched a beta-version of Bringly, a new cross-border marketplace with Zilyan Group (Turkey). The project has more than 200 shoe brands in its portfolio. Sberbank and Yandex launched Beru marketplace; Yandex Market opened its first regional logistics complex in Rostov Region to process Beru orders. Technology

Perekrestok has released a mobile application for X5 Retail Group launched a laboratory at a purchases with self-scan technology which could Pyaterochka store to test digital technology, help increase the average receipt up to 77%. including e-price tags, video analytics, smart LED shelves and self-scan technology. The most Magnit completed testing machine learning effective technologies are implemented in chain technology that helps to forecast demand for stores. consumer goods up to 3-5% more accurately and expects to increase revenue up to RUB 4bn. MVideo-Eldorado Group opened a competency center specialised in data science and expects to increase revenue up to RUB 5bn.

Sources: Retailers reports, mass media, PwC analysis 13 Key contact

Martijn Peeters Partner Retail & Consumer Leader [email protected] +7 (495) 967 61 44

14 www.pwc.ru

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