Description

Company Overview & Thesis

Magint is a market share leader in Russian food retail and a former Russian equity high-flyer. The company is currently valued at $6bn, with over $20bn in sales and over 17,000 stores in the convenience, supermarket, and drogerie segments. ROEs have declined from ~30% to 13% over the past two years as LFL sales have faltered due to a combination of declining traffic and cyclically low food price inflation. However, food inflation appears to be returning and traffic has bottomed, while Magnit has a new CEO who has a track record of successful food retail turnarounds. I expect ROE to increase as turnaround efforts begin to take hold.

Oil price and currency will drive an improvement in the Russian economy. In the medium-term, oil supply deficits are signalling higher oil prices, which should be supportive of Russian GDP and consumer spending growth. Meanwhile, the Dollar cycle appears to have peaked, which will encourage a rotation from DM equities to EM equities.

Valuation

Magnit currently trades at 4x 2021F EV/EBITDA. This equates to trough valuation on cycle-low ROEs. Using a fair value multiple of 10x EV/EBITDA, which is in line with the historical average, I believe that the business will be worth $18.3bn in three years’ time, a 200% potential return. This opportunity is based on consensus numbers and assumes no ROE increase above the consensus estimate of 15%. If ROE reverts toward the historical mean of 30%, then further upside is possible.

New Management

Olga Naumova was appointed CEO in June 2018. She is the former head of X5’s core convenience format Pyaterochka. She successfully led the turnaround of Pyaterochka during 2013-2017, increasing traffic and taking share from Magnit. During her tenure, X5 significantly outperformed both the Russian index and Magnit. Prior to her appointment, Magnit lacked a strong operational manager with experience in food retail and implementing efficient business processes. Similar to most “outsider” CEOs, Ms. Naumova’s management style relies on decentralized teams and a preference for hiring and developing strong regional team heads.

Corporate Governance

Russia suffers from weak corporate governance, and Magnit is not immune. Magnit recently purchased SIA, a pharmaceutical distributor, from its second-largest shareholder, Marathon Group. The market reacted poorly to this self-dealing and because this business has much worse economics than the core food retailing. However, I believe the impact of the acquisition is overblown, as pharmacy distribution will account for only 5% of Magnit’s revenue. Further self-dealing cannot be ruled out, however I believe that Magnit’s largest shareholder, VTB, which has strong ties to the Russian government, is incentivized to turn the company around in order to show improved equity earnings on its own income statement.

Catalyst

1. Positive traffic gains

2. Higher oil prices

3. Lower dollar

4. Rotation from DM to EM