Grocers Look to Gobble Up Smaller Rivals

MTA customer browsing bare shelves at a Samokhval chain store in Moscow. Distributors have had trouble filling orders.
Financial institutions and over-leveraged oligarchs may have been the first casualties of the global credit crunch, but a torrent of bad news for the country's grocers suggests that another wave of consolidation is on the way.

Russian food retailers, large and small, say they're feeling the weight of the economic crisis. Some regional and independent grocers are seeing emptier shelves amid supply disruptions, while the largest chains are cutting staff and spending in preparation for the battle ahead.

And while the ubiquitous, unbranded produkty shops may seem like the easiest targets for acquisition, the big supermarkets are sizing up their smaller, indebted rivals as the best chance to boost market share.

"The financial crisis is going to weed out a lot of weaker players," said Alexander Kliment, an analyst at the Eurasia Group in New York. "The state is stepping in to help out the largest and politically most well-connected companies as smaller, weaker and less-favored players are more or less hung out to dry," he said.

Sberbank and VTB will extend government-financed loans to nine major retailers that have a collective $2 billion worth of loans to refinance, including X5 Retail Group, Magnit and Sedmoi Kontinent, Kommersant reported.

Kremlin economic aide Arkady Dvorkovich said Tuesday that banks would boost lending to grocery chains.

"Government support will ensure that these stores stay in the market but perhaps at the expense of smaller competitors," said Maria Sulima, a consumer analyst at investment bank Metropol.

Alexander Rusnyak, chief financial officer at Sedmoi Kontinent, told a recent meeting of retailers that the crisis would lead to a major consolidation.

"The situation is so bad that even relatively big businesses are finding it increasingly tough to raise funds for development," he said.

X5 Retail Group, the country's largest food retailer, said Monday that it would lay off as many as 1,000 of its 3,000 managerial workers to reduce costs. Earlier this month, it announced a capital expenditures cut of 30 percent.

Russia's second-largest supermarket company, Krasnodar-based Magnit, has also run up against difficulties.

The retailer is in the middle of a $1.5 billion, two-year expansion program, but on Oct. 9 the company said it was shelving a sale of shares held by a "long-term Magnit private investor" after its London-listed stock plummeted.

Stefan Dertnig, managing director of the Boston Consulting Group, said any consolidation of the sector would be a positive step for Russia, catalyzing a shift toward a more-efficient "modern format" retail model.

Many small grocery stores have all of the goods behind shelves, meaning that customers must ask a cashier to gather them item by item. In a rapidly disappearing variation on the theme, many shops once required customers to pay first — individually reciting each item's price — in order to then request the goods from behind the counter.

The distribution side of the equation hasn't been any better.

"The growth of the consumer business in Russia has been based on a very inefficient retail process," Dertnig said. "There are usually three or four middlemen in the chain from producer to retail. This adds a lot of costs, and the liquidity crisis is going to change this."

Small, single-owner stores and market vendors comprise 70 percent of the country's food sales, Dertnig said. The "modern format" stores — which include grocery chains, bulk discount stores and hypermarkets — make up the remainder.

And while a consolidation of the sector has long been expected, the crisis has hastened the process.

Irina Yarotskaya, a consumer goods analyst at brokerage Otkritie, said large retail companies were waiting for just the right time to pounce on stores and chains with attractive assets: direct contracts with suppliers, low debt burdens and a significant local market share.

"Very soon, even in one month, the [small chains] will be much cheaper than they are now," she said. "Companies are waiting until they become cheaper. And they will be cheap — very cheap."

Regional chains, in particular, are going through a rough patch, Yarotskaya said.

"Some banks have closed credit lines to them, and short-term loans are given only at very high rates. They can't borrow to refinance their debts and pay producers. As a result, these chains may soon be desperate for buyers."

But even with so much low-hanging fruit, it remains to be seen how the bigger retailers will fund their acquisitions amid the tight credit-market conditions.

"It is quite obvious that the access to new credit facilities [has become] very limited, and the price of new debt will be higher," Fyodor Rybasov, vice president of major food retailer Dixy Group, said in a written statement Thursday.

Dixy, which is listed in Russia, last week received permission from the Federal Service for Financial Markets to sell shares abroad to fund expansion.

Sulima, of Metropol, said X5 has decided to delay long-term construction plans to set aside capital for potential acquisitions. The company's Karusel, Pyatyorochka and Perekryostok chains occupy a combined 15 percent of Russia's grocery market.

Competition from rapidly expanding chains, fueled by a long period of rising incomes, has made life difficult for the sector's smaller players.

"Our business is being suffocated," said Olga Artemyeva, the co-owner of a small produkty shop in northwest Moscow.

"People aren't coming, our sales are down and we aren't turning any profit."

Drawing attention to the store's partially empty refrigerator shelves, she said, "Look, no beer."

In the past two months, Artemyeva's distributors, who supply the store with its staples — beer, cigarettes, soft drinks, snacks and dairy products — have not been able to fulfill the store's demands.

"Every day, we give the list of what we want, and every day they only deliver half. Now, we even have to go ourselves to open markets to buy items," she said.

But the independent shops might actually survive in the market longer than small and midsize modern-format retailers because they do not have leveraged assets, said Alexander Gorsky, a partner in Deloitte's retail industry group.

"The small produkty are family-run businesses, and so far, during this first wave of the credit crunch this segment won't be as heavily hit. But when the second wave comes and the population reduces its spending in the stores, it may be a problem," he said.

Lower income buyers — households with a monthly salary of less than 600 euros ($790) — will be the hardest hit, as inflation and debt payments eat into their purchasing power, according to a report released last week by Boston Consulting Group.

The study found that spending on more expensive meat, such as beef and pork, is already declining in favor of less expensive poultry.

If consumers continue to look for ways to cut costs, individually owned groceries — which benefit from good location but tend to charge higher prices — may be in for further trouble.

"When layoffs begin, and maybe salary cutbacks, then people feel poorer and spend less money," said Gorsky, of Deloitte. "This will affect convenience stores heavily because people will turn to hypermarkets with more attractive prices."