Russia

We traveled to Russia to build a more nuanced understanding of the economic and business landscape in the country and to assess the operations of several local and multinational businesses we follow, including a handful that we could potentially add to our watch list.  Russia currently has the lowest valuation metrics of any market in the world, making it an interesting place to search for good businesses at great prices.  We observed, however, hurdles that will challenge the operating performance of businesses in the country.  Russia’s economy has suffered over the past few years due to low oil prices and Western economic sanctions.  This economic stagnation, in combination with a shrinking and aging population, makes consumer-facing industries in Russia more like slow-growing Western Europe markets rather than emerging markets (as Russia is normally classified — clumsily so in our opinion).

In recent years, Russia has undergone a rapid shift from traditional to modern retail with many implications for the businesses we follow.

LENTA hypermarket — a large, big-box store that carries everything from clothing to groceries — is Dutch-founded and Saint Petersburg-based.  It is the largest hypermarket operator in Russia and has won considerable market share from smaller, regional players.  LENTA has the potential to leverage its merchant expertise and deep loyalty card network of over 12 million Russian consumers to enter the more fragmented supermarket segment, enabling the company to drive growth despite a mediocre economic environment.

Despite our conservative perspective on longer-term consumer spending in the country, the Russian consumer seems active today.  We observed a considerable amount of foot traffic and spending at Moscow’s Aviapark shopping mall, the largest mall in Europe.  At Aviapark we specifically wanted to observe and assess consumer behavior at multiple businesses domiciled inside and outside of the country, including Russia’s Detsky Mir and M.Video, Poland’s Reserved (Parent LPP), Spain’s Inditex, and China’s Xiaomi stores.

The “proximity” format is the most popular retail format in Russia, led by market leaders Magnit and Pyaterochka.   These stores are small enough to fit on the first floor of bare-bones, Communist-era residential buildings.  Although both have strong track records of growth, both companies’ results have been under pressure due to a recent regulatory change that sparked a huge spike in promotional activities from almost zero to 30-35% of SKUs.  The growth prospects for one of these retailers is constrained by a Russian anti-trust law limit on retail market share to 25% in a city, which it is close to meeting in both Moscow and Saint Petersburg.  Recently, the founder and largest shareholder of one of these retailers sold his stake to a state-owned bank, prompting concerns that food retail may be entering into the sphere of influence of the Russian government.

In Soviet times, there was only one beer brand in Russia called Zhigulevskoye, which survives today.  When the country opened its markets, almost every major brewer entered Russia and consumers greatly benefited from price competition.  They were also exposed to a wide variety of beers.  Today, Russia is the only market in the world where all three global brewers (AB InBev, Heineken, and Carlsberg) have large operations.  Consequently, beer has essentially become a commodity in Russia; customers have minimal brand loyalty and beer margins are low for all players.

Healthcare

Birth rates in Russia declined throughout the 1990s after the collapse of the Soviet Union.  Birth rates are again in decline and some predict the decline will get worse; in 2016, Russia saw 12.9 births per 1,000 people, the lowest rate since 2011.  To counter the long-term demographic decline (and also appeal to young Russians prior to an election), the Putin-led government began subsidizing the costs for the birth of a first born in January 2018, and it will extend an existing program that provides one-time payments and access to a special mortgage program to families having second and subsequent babies.  The images below were taken in the same building complex. One building is a private sector maternity ward called Мать и дитя (Russian for “Mother & Child”) and the other is a government-owned maternity ward.

As is in many countries, the public sector in Russia doesn’t have the resources to adequately meet consumer needs and standards in healthcare. Sixty-six per cent of Russian citizens are not satisfied with their healthcare system and an estimated 1/3 of public facilities need major refurbishment.  This discontent leaves room for private enterprise to coexist with the public sector and earn healthy profits.  Opened in 2006, Mother & Child was the first private maternity ward in Russia and was opened by the head OBGYN of a government maternity ward.

Mother & Child offers a premium, concierge-like product.  Above is an image of the “all-exclusive birth contract” from Mother & Child featuring a static, all-inclusive price based on the service and doctor.  A “regular birth,” including a 3-night stay runs about 189,000 Russian rubles or approximately $2,700 U.S. dollars.  The VIP experience — the preferred option for Russian oligarchs — is priced at 960,000 rubles.