Time to Run up

There are no announcements of mergers amongst retailers yet, but sooner or later the impact of the crisis on the commercial real estate market will lead retailers to considerable changes. The volatile situation on the world markets has slowed down Russia’s economic growth. And we can see a slowdown in regional expansion. However, the successful consolidation processes of the last few years will remain a priority in the given sector.

Price and quality

“Consolidations will continue to happen in the form of mergers, and strong market players will gradually substitute for weaker ones,” considers Chris Skirrow, Partner, Consumer and Industrial Products Leader PricewaterhouseCoopers. In the last few months there’s been a certain segmentation of the market based on a consumer preference. Consumers remain loyal to the modern day retail formats, but are divided into those that shop at discounters and those that are still capable of shopping at super and hypermarkets. Both categories are seeking good quality at reasonable prices regardless of whether the product is from abroad or local. According to Chris Skirrow, there is no going back to the old ways of shopping at local markets and kiosks. However, according to analyst estimates, it is possible that organized commerce will have to deal with basic retailing which might stir up due to a search by the population for more affordable merchandise.

According to Irina Kanunnikova, Director at Union of Independent Retailers of Russia, retail is also subjected to intensive growth. At the present time the emphasis is undoubtedly on efficient business and not on regional expansion. Streamlining of inventory, fast reaction to consumer preferences, identification of key efficiency indicators, are the major issues facing retail. Both the manufacturer and retailer require a brand name, as it allows to reduce costs while preserving a relatively high quality of merchandise. Irina Kanunnikova insists on the fact that retailers must face the question of identifying the profile of the new consumer in order to better understand what products he looks for. “Companies must once again determine their target audiences and review their inventories in accordance with the consumer’s demand, concentrate on the sale of high quality products at affordable prices,” agrees Chris Skirrow.

“In crisis situations, the retail segment has two ways of surviving – mergers and acquisitions, – says Oleg Efremov, Consultant, Retail Real Estate, Cushman & Wakefield Stiles & Riabokobylko. Any kind of association is possible: the question is not who is ready and who’s not, but with whom and when.” According to Mr. Efremov, the nature of retail business is bank financing and the inventory used as a collateral. In order to purchase a company one needs private cash and who has such cash available is the question. Oleg Efremov considers that mergers will not occur between competing chains but rather between corporations and financial institutions. “At the present time mergers seem the most attractive for real market players, i.e. for retailers,” says Mr. Efremov.

Ivan Kotov, Manager, A.Т. Kearney, notes that today retailers are searching for strategic investors such as private investment funds, as banks will not be investing directly in such chains. Fund representatives, according to Mr. Kotov, understand that the crisis is a good time to acquire companies under the most favorable terms. The Russian retail segment is a rather attractive market, considering that after the crisis the entrance fee will be more affordable. At that, certain private investment funds are focusing on retail and are even getting directly involved at the management level.

Business first

Another important factor is that many retail companies, especially on the verge of bankruptcy, have no property. As an example, we can cite Nezabudka, Banana-Mama, and others. And the following question arises: which investor can be interested in such companies?

“Many Western retailers, including H&M, have no real estate ownership, and they don’t need it,” considers Oleg Efremov. “It’s purely a business that is being sold.” Ivan Kotov disagrees. He believes that Russian companies are badly managed. Once business was successful as there was low competition, so profits gained from a square meter in Russia was higher than in Europe. This is why location is extremely important. According to Mr. Kotov, we can look at the purchase of Ramstore by Auchan, the French retailer was mainly interested in Ramstore’s locations.

Mr. Kotov considers that Russian retail operators in 2 to 3 years will be fully capable of competing with Western ones. However, the Russian retail market has been developing under the most favorable conditions and is generally focused on sales volumes, not actual profit of a particular store. “If the crisis happened somewhat later, it is highly probable that Western generally well-managed companies might have already invaded the Russian market pushing most of the local retailers out of business,” says Ivan Kotov.

Russians have to fully review their management practices towards higher efficiency. Amongst the survivors will be small national niche retailers with good locations and highly efficient management practices. They will be first in their regions and will not be taken over against their will. If considering the expansion of any chain, major or mid-sized, the financial crisis has put a hamper to its development and companies are reviewing the geography and format of their expansions.

Are they ready?

According to Galina Maliborskaya, Director of Agency Group of the Retail Property Department, Colliers International, the Russian market has become attractive for American operators (BEBE, GAP, Banana Republic, Disney Store, Burger King), Spanish (Desigual, Custo Barcelona, GrupoCortefiel, Pedro del Hierro) and English (Habibat, Mamas & Papas, New Look) operators.

Some of these brands are already negotiating leases with certain centers under construction, and some are finalizing their corporate decisions on territorial expansion. It should be noted that the world renowned British Harvey Nichols is actively considering entering the Russian market soon. Following the unsuccessful inauguration of Debenhaus some years ago, the company is once again evaluating the possibility to create its chain in Russia. It is also expected that the Irish River Island and German P&C will be inaugurating new outlets in Russia as well.

Analysts at Colliers International think that Italian, French and Turkish brands (Network, Fabrika, Ipekyol, Twist, Machka) are interested in Russia as well. Such brands as S’Oliver, Mango, Koton are present on the Russian markets via partnerships with local partners, and are ready to enter the market independently. There is also a growing number of companies that are entering the market directly by its major brand name, such as UNIQLO. “This indicates that the local retail real estate market has reached a certain maturity level and that business risks are now much lower, ” notes Galina Maliborskaya.

The weakest retail segment in Russia is the entertainment sector. As of today, the only foreign operator interested in the local market is the Kazakh Babylon. According to Andrei Bushin, Director General, MIEL – Commercial Real Estate, certain foreign companies are finalizing their entrance onto the Russian market. A good example is a $100 million deal between the French Carrefour and the Krasnodar Regional Administration. Furthermore, the German REWE Group of Cash & Carry stores announced its intention to open a chain of stores in Russia. Gap is also preparing to enter the Russian market with the Gap and Banana Republic brand names.

“Currently market players focus on cutting costs and business optimization. So it’s not yet the time to expand regionally, ” considers Mr. Bushin. On the other hand, according to Ilya Shuravin, Partner, S.A. Ricci / King Sturge, Metro Group and Auchan will be actively expanding throughout the whole country. Real is about to open a bunch of new hypermarkets, Carrefour is also aggressively expanding and Globus is breaking into the Central Federal district.

Based on forecasts by Oleg Efremov, Wal-Mart is planning to enter the Russian market, Carrefour is already here, H&M is expected to come in 2009. In 2009-2010 New Look and Appeal, amongst other major players, should be hitting the market as well. “Life in the retail sector is going on despite the crisis,” concludes Mr. Efremov. Ivan Kotov considers that the Russian market in 2009 will remain attractive for most Western players. “Foreign retailers, as we saw during the last MAPIC, are pessimistic,” says Alexei Lazutin, Commercial Real Estate Director at Becar Realty Group in St. Petersburg. Europeans and Americans have tightened their belts and are unlikely to enter the Russian market any time soon, unless those plans were budgeted in the past. “Multinational corporations are generally following their proven strategies and are making decisions focusing on consumer’s buying power, general financial situation and value of assets,” considers Irina Kanunnikova. It can be assumed that major players will hold back before hitting the Russian market as they have plenty of time before undertaking a running start.

What is good for a Russian…

According to Galina Maliborskaya, there are many factors to be considered when planning any regional expansion: population, average income, number of cars in use, retail sales volumes, and obviously, the availability of modern day retail areas. For instance, in Kazan, there is an oversupply of retail stores while in Nizhny Novgorod there is plenty of room regardless of the limited purchasing power of the population. However, even in such cities well located new facilities will be in demand. The Central Federal District will always be attractive, the same about the Siberian (Irkutsk, Krasnoyarsk, Tomsk, Omsk, Novosibirsk) and the Far Eastern regions (Khabarovsk, Vladivostok), the Urals region, especially Tyumen. In a crisis liquidity situation, retailers are only willing to consider facilities being built with identified funding and a fixed inauguration date.

“There are still available niches in Moscow and the competition is helping companies further develop,” considers Ivan Kotov. He also notes that the market will require discounters such as Liddle, but because of the lack of surfaces in major cities, the question arises as to the availability of space for such operators. He also brings to our attention the huge potential of affordable clothing brands, such as Kiabi.

Alexei Lazutin notes that oil and gas regions with high living standards such as part of Siberia, Yamal and the Tyumen region still have plenty of room for good retail operators and quality shopping centers. “A major market share will be taken by major national operators capable of providing a fast cash turnover,” considers Alexei Lazutin. Lenta in particular has significantly reduced prices in order to obtain its next loan. According to Alexei Vanchugov, Director General, Mall Marketing, the leading companies will remain MediaMarkt, Carrefour, Real, Inditex, Esprit, Benetton, and other major solid retailers already present on the Russian market. According to Mrs. Kanunnikova, the liquidity crisis will provoke consolidation of the grocery retail market. Badly managed stores will close down and some will be bought out for the optimization of businesses, and such changes may occur amongst both national chains as well as regional retailers.

“A great change amongst landlords and retail management is expected not only amid the national level but also in the regions,” notes Irina Kanunnikova. For instance, the retail chain from Kemerovo called Chibis has joined two other chains: Bonus and Poliana, while the Yekaterinburg Kirovsky chain is joining some regional chains like Korzinka. However, the crisis is also a time of opportunities, so we will see some bankruptcies and new names as well. “In the current situation some unknown Russian players will have a chance to enter the market: they are generally less dependent on debt financing and have extensive experience working in a highly competitive environment,” says Andrei Bushin. As a result, there is hope that good management and stability will become more important than the marketing of the brand.

“The national market will require Western operators of affordable quality clothing such as H&M,” considers Mr. Lazutin. This operator’s stores in Finland has line ups of Russian tourists. We come to the conclusion that good clothing in Russia is still too expensive. It appears that a Western chain that can satisfy such a demand will certainly be a winner. Ilya Shuravin notes that some Russian operators like Seventh Continent will not go beyond the Central District, Paterson will keep losing its position on the market place and Grossmart as an operator is practically out of the game. A number of Russian operators will remain afloat and will concentrate on streamlining their existing facilities.

No time for expansion

According to Alexei Lazutin, the first to go belly up will be the home appliance operators. This segment is close to saturation and the turnover is very low. Mr. Shuravin notes that the expansion rate amid home appliance stores will drop considerably especially because some development projects have been suspended. Clothing and shoeware operators will be actively developing in two subsegments: middle-lower and chains of group brands (such as Inditex). Some Western brand chains will be exploring independent department stores in major Russian cities. With regard to major anchor tenants, DIY and grocery operators, landlords will undoubtedly give preference to stable Western operators over more profitable rental rates. “We can speculate that major Russian food hypermarkets such as Carrousel, OK and Mosmart will reduce their earlier announced regional expansion plans in order to improve their management practices,” says Ilya Shuravin. “Lenta will most probably find its buyer, everything seems to point that way. The Russian DIY will considerably lower its ambitions with regard to its national programs, many projects will be suspended for at least a year. This situation is ideal for major Western operators that instead of undertaking some mergers and acquisitions with Russian operators will simply develop their own hypermarkets in a less competitive environment. “It should be noted that should the crisis go on for more than a year or year and half, no Russian company will able to compete with large DIY and will only compete with local stores of 4-8 sq m,” says Ilya Shuravin. “With regard to Russian companies, the only durable proposition is Maxidom which is actively working on its expansion.”

The latest trends are such that the issue of takeovers by the strongest of the weakest is not as much a problem as the actual disappearance of many retail operators. Many developers are facing a major lack of tenants. The diversity of the pool of operators is no longer an issue: shopping centers inaugurated prior to the end of 2008 and in early 2009 are about half vacant. According to estimates by S.A. Ricci / King Sturge, the lack of operators in 2009 will be a serious risk factor in cities with populations of less than half a million.

According to Alexei Vanchugov, the lack of operators will become manifest in absolutely all sectors and any newcomer will be most welcome. Because of the major redistribution within the market, the rules of the game and players will change substantially. We can only talk about general trends as the situation remains somewhat obscure.