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. Last Updated: 07/27/2016

Foreign Giants Window Shop for Supermarkets

The long-awaited entry of a global retail giant into the Russian market appeared to inch closer as a senior executive for Wal-Mart hinted of an expansion into Russia and reports surfaced that the U.S. firm was planning talks with X5, Russia's biggest food retailer.

"So far, we are currently studying the market, but the decision on how to enter it has not yet been made," Wal-Mart vice president Mike Bratcher told a Moscow conference Thursday, Interfax reported.

Kommersant reported Jan. 29 that officials from X5 and Wal-Mart were due to hold talks in the United States last week. Wal-Mart could not be reached to confirm these reports.

The food retail market, though it accounts for less than 2 percent of GDP, has seen annual growth of more than 25 percent since 2001. At a time when Russian portfolio investors are getting tired of the instability in the country's core oil market, the consumer sector's steady growth has been a welcome source of relief.

"Right now, I'll do anything I can to buy something that is not tied down to the traditional industries of Russia," said James Beadle, head of research at Pilgrim Asset Management. "Anything which is not commodity or metals can fetch a very high price in an IPO."

There are only three listed food retailers in Russia, X5 (FIVE.LN), Sedmoi Kontinent (SCON) and Magnit (MGNT).

As a whole, the sector is one of the country's most unconsolidated and underdeveloped. Only 28 percent of food is purchased in large, Western-style stores, with the top five retailers controlling just 8 percent of the market, as opposed to an average of 60 percent in the West. The rest of the Russia's grocery shopping, 72 percent of the total, is done in "non-organized" venues, such as kiosks, corner stores and open-air markets, according to a study released Thursday by UBS.

"But habits are changing, because Russians demand more and more quality," said Svetlana Sukhanova, the author of the UBS study. "And once they move from non-organized to organized food retail, then it will be very difficult to move them back to these crazy open bazaars."

UBS expects 40 to 45 percent market penetration for organized retailers by 2010. The Economist Intelligence Unit predicts that the size of this market will reach $203 billion by that year, nearly double the 2005 figure of $113 billion.

Forecasts for 2007 are bullish at most local banks. "In two years' time, however, the concentration of organized trade in Moscow is likely to trigger more intense competition on prices," Aton Capital said in a note last week. This will in turn cause a drop in prices and profitability after 2008.

Both trends are likely to be driven by the entry of the three biggest global retailers, Wal-Mart, France's Carrefour and Britain's Tesco, all of which have so far been conspicuously absent from the Russian market.

Analysts agree that acquisition is a much more likely tactic for foreign entrants than greenfield constructions or franchising, mainly because of non-transparent land codes and the experience of firms like Sweden's IKEA, which after $2 billion of investment, 6 years of work and several costly run-ins with authorities has yet to turn a profit on the Russian market.

Acquiring an established firm would guarantee one of the big three firms a loyal customer base and a local partner to help navigate the infamous tangles of red tape.

The most likely acquisition target is X5, which was formed in May 2006 through the merger of major retailers Pyaterochka and Perekryostok. In 2008, X5 will have the option to buy another supermarket chain, Karusel, a move which analysts expect to take the company's market share to 5 percent, and to make its stock price soar by as much as 25 percent.

X5 has denied speculation that it will be sold this year.

Sukhanova said a buyout by one of the big three was unlikely for any firm with less than 4 percent of the market. As of now, X5's 3 percent is the biggest market share, and Sukhanova pointed out that Wal-Mart has been analyzing the Russian market for the last five years without making a move.

"Living here, we think Russia is top priority for foreign firms, and this is not always correct. They also have the priorities of India and China," she said.

"Frankly, I am becoming more and more resistant to comments from the heads of these companies."