The rush for additional selling space continued to be the main trend in the last year, and we will continue to see consolidation in the sector. Selling surface of modern retail increased by 50% in the last 3 years, despite the double digit drop in consumption. The most active players Kaufland, Lidl, Penny Market, Auchan or Mega Image have added more than 50% to their selling area in only one year, during 2011. And 2012 started more furious than ever, with 42 new stores in the first quarter. The same pattern was followed by the Do-It-Yourself sector, Romania recording the second largest expansion in the Central Europe in the last 3 years, despite the 20% decrease in the DIY market.
The most interesting trend is the rise of the local convenience stores: the ones that survived the first recession years have maintained the number of stores and even invested in new locations. Domestic players are mainly small, specialized networks developed by meat processors as an adjacent distribution channel of their products and for cashflow improvement.
Investments to continue, as the market records a slight recovery
As everyone is betting on the increase in the private consumption and on the shift of consumers from traditional to modern retail, it all comes down to fighting for the pole position in a race with a postponed start. An expensive pole position, but big players seem to be willing to spare no expense.
Somewhere in the corporate headquarters, Group CEOs and CFOs have drawn up their business plans, and have concluded that Romania is the place to be, once the recession will end. They have taken into account the real –estate opportunities created by the market downturn and by the availability of attractive locations, abandoned by local players going bankrupt. They have also considered the population size (and statistics show that Romanians spend half of their disposable income on food, drinks and tobacco), and the low degree of penetration of modern retail and private spending, compared to other European countries. Take all these factors into equation, and the conclusion is obvious.
But is it?
Everyone is predicting that consumer demand is likely to return in the long term. Retailers are arguing the potential of the market is great, so they continue to announce impressive capital expenditure budgets. But what does long term mean – (is it 3 years? Is it 5 years? ) and what are retailers’ growth expectations – are we thinking at the pre-crisis peak levels?
Why not happen now? For a start, let’s remember that the growth in the retail market in the boom years has been fueled by a rapidly increase in disposable income (not correlated with productivity) and most important, by credit availability.
With an un-restructured banking sector, and continued increase in the non performing loans, banks have their own issues to sort out first and some of them are reducing their retail operations. That means we will not see anytime soon bankers willing to lend in the same relaxed manner as before. On the other hand, consumers have learned to be more prudent, as consumer confidence is rather low: population cash savings have increased, but are sitting in bank deposits, instead of fueling consumption. According to the latest study performed by GfK, although the willingness to make major purchases has risen in the last months, it is still at a very low level.
The austerity measures from 2010 and especially the salary cuts in the public sector have had their direct hit in the households’ consumption. The average salary level increased in August 2012 by only 1.5% (in real terms) compared to the same month one year ago, hardly a sign of recovery. This year, the new Government had increased salaries in the public sector, and a new rise was recently announced for December this year, a predictable move, given the upcoming parliamentary elections. However, this would not be enough to boost consumption, as the private sector was also faced with salary corrections.
And yet, the key indicator in this sector - consumption of food, drinks and tobacco - has increased this year. In the first 8 months of the year, retail sales increased by 4.3%, compared to the same period in 2011. A higher growth (+9.3%) was reported on sales of fuel and consumption of food, drinks and tobacco (+4.5%), while non-food trade increased by 1.9%.
Could this be the revival sign that everyone was expecting? Modern retailers have already announced increased revenues last year compared to 2010 (driven by an expanding network). However, the August 2012 retail index represents only 55% of the August 2008 level. Assuming a constant 4.5% year-on-year growth, it will take 15 years to reach the August 2008 peak level (this is however, only arithmetics, the economy might surprise us).
In the meantime, the pricing wars and increased operating costs erode retailers’ profit margins
Main players have continued to experience a decrease in profitability, from a net profit margin of 3%-5% in the boom years, to 2-3% in 2009 and to a minimum net profit margin of 0-1% in 2010 and 2011.
Gross profit margins of the most important players decreased by 3-5% in 2011, except for Auchan and Mega Image, who improved their gross margins in 2011. But at the current sales level, a 15-20% gross margin (and lower for discount stores) barely covers the increased operating costs of a higher network.
With the common strategy of the smallest price in the market, the truth is it is difficult to distinguish between different formats, simply by comparing shelf prices. Making a simplistic calculation, using the sales and the selling areas at the end of 2011, there is no difference in the sales per square meter between Mega Image, Kaufland or Auchan. As the price is the one criteria consumers seem to care about, retailers are reluctant to differentiate, or implement value added services. Now is not the right time. Now is the time for price cuts, promotional sales and value for money. The larger the network, the higher the negotiating power and the ability to pass the price squeeze on the producers.
A good private labels offering has become more necessary than ever, and private labels sales continued to increase, as we have anticipated. There is still huge potential on the private labels line of business, especially on the non-food sector, which is under-developed. Private labels and the multi-format network are the two main weapons retailers use in the battle for the wallets of new consumers: a consumer which is price sensitive, with more frequent visits in the shops, more informed and less loyal to the store.
The problem with price cuts is that it puts pressure on the whole chain, from producers to retailers. Food prices are already considered too low, compared to the European average. The poor agricultural season has led to rising food prices, inflation and conflicts between farmers and processors. Meat processors are unwilling to pay more, as they are aware that an increased shelf price would drive away consumers, which puts extra pressure on the producers. The announced price increases on meat, bakery and dairy products expected to occur in the following months are not good news for anyone.
Consumption growth prospects continue to lure international players’ investments
So what should we expect in the near future? Modern retail will continue to gain market share from the traditional retail. There is still room for development, although the “white spots” period is over. According to a study by retail and property experts, international retailers regards Romania as the third most attractive CEE investment prospect over the next two years, after Russia and the Czech Republic. However, in August there were rumors about Carrefour making an exit, contrary to the market trends, as part of its 3 billion euro revival plan for its underperforming European hypermarkets. This raises new concerns, as we see the development of modern retail in Romania is exposed to the international groups’ results on their larger, strategic markets, affected by the Eurozone problems.
Should the consumption level increase at a slower pace than anticipated, it will be interesting to observe what will be the next move of the main players, once the expansion will slow-down. And with so many variables (volatility of the exchange rate, parliamentary elections, low consumer confidence, Eurozone context), having the financial means to tolerate and sustain the current low profit margins, while continuing to burn cash in capital expenditure in a market that has not shown a clear sign of recovery, will make the difference between success and an unplanned exit.
One thing is sure: modern retail is here to stay and demands a bigger slice of the market. And the word of the day in the rush for space is location, location, location. Who said real-estate is suffering?