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One year on from invasion of Ukraine and Russian economy soldiers on while western brands stuggle with shortfall

One year on from the Invasion of the Ukraine and the Russian economy has shrunk less than expected as sanctions have a limited impact – so far – on the economy. Western retailers who pulled out of the country, however, are fairing more poorly.

Russia’s economy shrank by only 2.1% year on year, well below the 2.5%-3.5% contraction many professional economists were predicting. For example, the Central Bank of Russia (CBR) was expecting a 2.% contraction and the EBRD just improved its economic forecast for the year-end result for 2022 to a still painful -3.5% only a week ago, but left its outlook for this year at 3%. The EBRD’s previous prediction for 2022, given in September 2022, anticipated a 5% drop in Russian economic growth in 2022.

The Ministry of Economic Development has begun developing scenario conditions for the forecast of Russia’s socio-economic development until 2026. A number of indicators of the current forecast (prepared in September 2022) will be improved, according to sources inside the ministry. The revised document will be submitted to the government in April.

According to Macro Advisory, the current forecasts shows that the Russian economy will contract by 0.8% in 2023 and grow by 2.6% in 2024. Inflation at the end of this year is predicted at 5.5%, and the government expects it to return to the target of 4% in 2024.

“When preparing the document, we will take into account the positive results of 2022 achieved through the implementation of the Plan of Priority Actions in the Conditions of Sanctions,” the Ministry of Economic Development said in a statement earlier this month.

Retailer woes grow

However, Western retailers that pulled out of the country across 2022 have not done so well. Inditex, H&M and LPP’s withdrawals from Russia – one of their biggest growth markets by sales, and even bigger for profit – sees them struggling to close the gap, with the former having left the door ajar for a possible return.

Yet those retailers still in the country are facing boycotts from western neighbours, balancing profit and market-share losses.

According to Tatiana Lisitsina, retail analyst at Bloomberg Intelligence: “The withdrawal of European retailers from Russia – to which Inditex, H&M, Ikea, LPP and Asos had the highest sales exposure of peers – is exacerbating the slowdown in sales and triggering a search for substitute growth markets. In pursuit of new growth avenues, H&M is targeting Latin America, Inditex the US and LPP western and southern Europe, though these are all more-competitive and less profitable markets.”

Lisitsina adds: “The exit from Russia has left LPP, Inditex and H&M with a larger profit hole compared with sales, given the absence of that market’s historically higher margin is exerting a structural drag. The sale of LPP’s Russia stores — with an Ebit margin of 37.4% vs. 4.9% for the group (when excluding the country in fiscal 1H21) illustrates the extent of the gap. The comparable dent to H&M’s fiscal 2022 operating profit was 2 billion kronor. Lower operating costs (rent and wages) in Russia have lifted the margins of store-based retailers such as H&M and Inditex, though lower return rates and VAT have benefited Asos’ online sales. Inditex is the only one of peers expected to have increased fiscal 2022 profit.”

LPP has had to reorientate the business away from Russia (19.2% of sales and its key growth driver), toward more-competitive western Europe. The company’s aggressive expansion plan, adding 10-15% of floor space a year to regain close to 23% lost in Russia, could drive double-digit sales increases this and next year, though the retailer has yet to prove its stores can be profitable in the west. Inditex differs from peers, by keeping open its option to return to Russia — following the exit — via its franchise partner if circumstances change. 

The retailer has agreed to sell its business in Russia (making up about 5% of sales and 8.5% of Ebit) to UAE-based Daher Group, which runs the retail chain Azadea and with whom Zara has had a partnership since 1998 in the Middle East. By contrast, H&M and Ikea — which both had substantial Russia assets and supply links — seem to have completely closed the door. Asos and Next didn’t have any physical infrastructure in Russia, making it easy for them to turn supply chains back on, if desired. 

European retailers still operating in Russia since the war in Ukraine — including Auchan, Leroy Merlin and Metro — could suffer reputational damage in Eastern Europe that leaves room for rivals (e.g. Kingfisher in Poland) to take market share. The former two companies are subject to protests and calls for boycotts in Poland, with the negativity potentially responsible for driving Auchan’s under performance lower, with only 5% growth in 1H in Central and Eastern Europe vs. rivals Carrefour, Biedronka and Dino Polska.

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