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Retailers Warm Up to Russia

Daniel M. Harrison

Big retailers are gearing up for another battle on the potentially lucrative emerging-market shop floor: Russia.

Recent weeks have brought a trail of hints that U.S. retail titan Wal-Mart (WMT Quote), France's Carrefour and U.K. retailer Tesco are making preparations to set up shop in this relatively undeveloped but rapidly growing consumer economy.

Last week the Russian newspaper Vedemosti reported that Carrefour, the world's second-largest retailer by sales after Wal-Mart, was setting up shop in Rostov-on-Don and Krasnodar in the south of the country. The newspaper claimed that it had received a tip from a local real estate broker that Carrefour has recently made two large purchases of land in the districts. Carrefour does not deny the claims, though it says it is company policy not to discuss deals before they are officially announced.

Meanwhile, Karusel, a Russian hypermarket, said last month it was in talks with Wal-Mart about a possible sale of its chain.

"Russia is a growing retail market, and we're definitely looking at it," says Amy Wyatt, Wal-Mart's international corporate communications director, who declined to comment more specifically about Wal-Mart's intentions in the country. "There's no one set approach that we have to entering a market; sometimes we choose to grow organically, sometimes we partner up and sometimes we look to grow by acquisition -- but I would say that in our experience it does work very well when we have a strong local partner on the ground."

Wal-Mart, which has been in China since 1999, announced last month the acquisition of 35% of Taiwan-based Trust Mart for a reported $1 billion. The Bentonville, Ark., retailer -- which has 73 stores in China already -- is expected to take control of the 101 Trust Mart stores by 2010. The deal follows the December 2006 acquisition by Tesco of the same Taiwanese company's Chinese superstore venture. And Carrefour has a large presence in China already, where most of its stores are concentrated in Shanghai and Beijing.

As for Tesco, on Wednesday the British retailer announced that it was selling the real estate assets of 50% of 21 stores to British Land for 650 million pounds, or about $1.3 billion. The sale-and-leaseback agreement would net the British retailer 570 million pounds, about $1.1 billion, after taxes.

The money would fund the supermarket and discount store chain's expansion overseas, the company says. Tesco didn't provided further details, but it already has operations in China and is reportedly planning to expand into Russia, according to The Guardian U.K.

While the exact strategy the retailers will take if they decide to launch in Russia is still uncertain, it appears that with the companies' hefty cash positions now, acquisitions (like those in Asia) are certainly possible. Both Wal-Mart and Tesco have raised $1 billion in the last three months in the cheap long-term corporate debt market.

"There's a sense in which these companies are issuing the debt to get free money right now, but as well all know, they can easily use the cash" for international expansion, says Arun Daniel, senior consumer analyst at ING Investment Management in New York. "In Russia, there is no one major player, so they will need to cobble together some smaller players."

While Wal-Mart's main focus is on Japan and China, Russia is part of its long-term international strategy, he says.

As a result of the ongoing interest in the local market, shares in the few of Russia's publicly traded retail chains have soared on speculation that some of them may soon become acquisition targets by foreign firms. For example, shares in X5, a Russian retail grocer listed on the London Stock Exchange, have doubled since June.

With petrodollars fueling a rising middle class, the Russian retail market grew by 22% in 2006 to 8.6 trillion rubbles, or $316 billion. This growth is expected to increase to 21.14 trillion rubbles ($777 billion) by 2010.

The potential for big brands is good because the country's retail market is still comparatively undeveloped, with most shopping still done in open-air markets. Such buying habits are seen as an opportunity for brands to penetrate the market as an increasingly fickle middle-class population demands quality and convenience.

"Fortunately for retail chains, the emerging middle-class market is looking for more comfort, quality and safety when shopping," says a research note issued by PMR Consulting in Russia. "Consequently, companies operating supermarkets, hypermarkets and discount stores are developing faster than the whole grocery market and increasing their market share. In 2007, we predict organized retail chain share growth to grow by 3.6% to 15.6%."

Longer term, some observes believe Russia could be fertile ground for Home Depot (HD Quote) and/or Lowe's (LOW Quote). In Russia, unbranded open-market retailers still make up three-quarters of "do it yourself" retailers, while the other quarter of the market is divided between six branded stores. Home Depot already has stores in Mexico and China; Lowe's operates in Mexico.