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Having suffered several years of headwinds arising from weak oil prices, interest rate increases and the impact of international sanctions in 2017 Russian economy demonstrated the signs of recovery. Supported by slowing inflation and growing real wages throughout 2016-2017 Russian food retail sales moved to positive territory, posting 4.4% YoY growth in 2017

Despite the gradual recovery on the macro front, the operating environment remained challenging in 2017. While consumer demand demonstrated modest signs of recovery, and consumer confidence remained healthy overall, the supply-side recorded disproportionate growth owing to the aggressive pursuit of selling space expansion on the part of retailers. According to Infoline, the top 10 retailers added 2.2 mln m2 in additional space in 2017, 15.2% growth YoY, with the three largest retailers accounting for 84% of this growth. The continuous aggressive roll-out of the selling space across top-10 retailers on the one hand remained the key pillar of the double digit net retail revenue growth in 2017, on the other hand continued to dilute the sales density and cannibalise not only competitors stores, but their own store base as well. As a result of aggressive selling space roll-out, modern trade penetration reached 71% (according Goldman Sachs research) as of the end of the year and is estimated to increase up to 81% in the next several years in line with developed market levels.

However, the nature of the penetration is rather uneven with one third of Russian territory accounting for 85% of the retail market and quite fragmented with top-5 retailers accounting for around quarter of the market. While the former is the function of the low population density in Russia (one of the lowest in the world) suggesting the potential growth to come from already well-penetrated regions, the latter sets the solid ground for market consolidation around the largest players. This suggest the room for larger players, such as O’KEY, to deliver sustainable growth, using differentiated formats to reach target consumer segments.

Building our strategy around two main formats – compact hypermarkets and discounters – we aim to cover the needs and preferences of all consumer segments. Striving for efficiency and productivity across all business processes in our compact hypermarkets, we aim to create a distinctive competitive advantage in the food retail market, attracting new customers and increasing customer loyalty by greatly expanding the range of consumer needs that can be met in a single location. We remain committed to developing a unique for Russia value-for-money discounter concept with an aim to become a destination point. The results demonstrated by the segment in 2017 are very encouraging and we aspire to continue the active store roll-out in 2018.

Outlook

Given official estimates place real GDP growth in Russia in 2018-2019 within the range of 2 to 2.2%, we remain cautiously optimistic on the outlook for the Russian economy. We expect that the marginal recovery of consumer sentiment witnessed in 2017 will continue in 2018, though competitive pressures will continue to weight on the market. Taking into account that the level of modern trade penetration in Russia increased to 71% by the end of the year, we contend that going forward sales densities will tend to decline driven by increasing competition.

While we do see some upside from a recovery in consumer spending through improvement in real wages and slowing inflation, our strategy is based on a more cautious scenario. We believe by investing in our business today to enhance efficiency and ensure price competitiveness alongside our established reputation for quality and service, we will be one of the best-positioned retailers in the Russian marketplace to benefit from market growth opportunities.