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Edited Transcript of MGNT.MZ earnings conference call or presentation 25-Jul-19 1:00pm GMT

Q2 & H1 2019 Magnit PAO Earnings Call

Krasnodar Jul 31, 2019 (Thomson StreetEvents) -- Edited Transcript of Magnit PAO earnings conference call or presentation Thursday, July 25, 2019 at 1:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Elena Milinova

Public Joint Stock Company Magnit - CFO & Deputy Chairman of the Management Board

* Jan Gezinius Dunning

Public Joint Stock Company Magnit - CEO, President, Chairman of Management Board & Director

* Jyrki Talvitie

Public Joint Stock Company Magnit - Member of the Management Board & Director of Strategic Communications

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Conference Call Participants

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* Elena Jouronova

JP Morgan Chase & Co, Research Division - Research Analyst

* Marat Ibragimov

Gazprombank (Joint Stock Company), Research Division - Research Analyst

* Ulyana Lenvalskaya

UBS Investment Bank, Research Division - Director and Analyst of Media & Technology

* Victoria Petrova

Crédit Suisse AG, Research Division - Research Analyst

* Yulia Gerasimova

Goldman Sachs Group Inc., Research Division - Equity Analyst

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Presentation

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Operator [1]

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Good day, and welcome to the Magnit Second Quarter and First Half 2019 Trading Update and Financial Highlights Conference Call. Today's conference is being recorded. At this time, I'd like to turn the conference over to the Director of Strategic Communications, Jyrki Talvitie. Please go ahead.

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Jyrki Talvitie, Public Joint Stock Company Magnit - Member of the Management Board & Director of Strategic Communications [2]

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Thank you very much, and good afternoon, everybody. So welcome to Magnit conference call dedicated to the operating and unaudited financial results for the second quarter of 2019. Our speakers today are our President and CEO, Mr. Jan Dunning; and our CFO, Elena Milinova.

The presentation and announcement published this morning are available on our website. We will start with some prepared remarks followed by the Q&A session.

With this, I would like to hand over to Jan Dunning, President and CEO of Magnit. Jan, please.

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Jan Gezinius Dunning, Public Joint Stock Company Magnit - CEO, President, Chairman of Management Board & Director [3]

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Yes. Thank you, Jyrki. Good day, everyone, and thanks for joining. On our journey, 2019 is a year of transformation. The company is going through an enormous amount of changes, and we still have many challenges to overcome. With real disposable incomes continuing their negative trend and the Russian regions hit harder than big cities, our operating environment remains challenging.

With all this in mind, I'm pleased to report second quarter results close to our expectations. The main highlights include positive like-for-like sales for the third consecutive quarter. Traffic is still negative, but with an improving trend. Sales growth accelerated to over 11% during the quarter, and EBITDA margin came in at 7.1%.

But are we satisfied? Not yet. The journey continues.

I'd now like to touch upon some of the key areas we are focusing on. As already mentioned before, we're not changing the course of our strategy, but rather prioritizing and focusing efforts on the crucial parts that drive the transformation.

One -- my main focus areas is the team at the moment. We are now putting a lot of efforts to unifying the team and making sure our organization model serves the implementation of our strategic goals. As you know from the previous calls, we split the former COO role into 2 parts, and I'm delighted to say that during the quarter, we found 2 exceptional individuals to fill these vital roles.

And as a result, we have significantly strengthened our operations, maintenance and development functions, which are crucial positions for further implementation of our new CVPs. We're also making minor changes to other head office departments in order to strengthen the organization, lessen the proxy and trying to increase speed of implementation of decisions-making.

The regional (inaudible) continued to roll out, but we're fine-tuning the way formats are being managed within the business.

I'd like to take you through some of our priorities. The first one is the team has done a good job developing tailored CVP performance and adopted 4 big cities and rural regions. However, we now need to focus more on CVP implementation, speeding up the process and working on the differentiation of our offering as well as messaging it to our customers.

The second [assessment]. For the second quarter, we achieved 95% of all assortment in the greens and 80% in the cosmetic store, although we have to bear in mind that to achieve our target of best in local, additional work needs to be done with local SKUs where new regional category managers are fully in place.

Throughout new production, we have a unique opportunity to distinguish the Magnit offering, especially in fresh categories. Fruits and veg for all of Russia had been historically supplied from the southern region, our own base. We are -- where also most of our own production is located, by the way. We are the only retailer that can truly control the products from field to place, and we will capitalize on this through an expanding range of private label products. We also think that our one brand multi-format concept helps to differentiate us in the eyes of the customers, in addition to bringing us synergies.

In March, we launched a cross-format loyalty program. Results have exceeded our expectations. To date, actually, we have issued over RUB 1.4 million of cash for the piloted. Over 800 store sales penetration ratio has reached 59%. We will roll out the program for the whole network starting this quarter.

As our transformation progresses, we will give up our communication to our consumers extensively concerning the new CVP as well as what the new Magnit stands for that we're all out to be Magnit.

With our focus on fixing the existing business, we have reduced the number of store openings and increased the number of store renovations. In the second quarter, we added 322 convenience stores, which, by the way, is 160 less than in the first quarter. We opened a 4 -- 340 cosmetic stores; 53 less than in the first quarter, and this format is still showing strong performance in synergies with our convenience stores.

As all new stores are being opened in the new CVP and we refurbished 509 convenience and 256 cosmetic stores during the quarter, the share of stores operating with the new CVP insight reached 63% and 40%, respectively.

On average, redesigned stores demonstrate high single-digit sales uplift, mainly driven by traffic improvement. The CVP for supermarkets is in the piloting phase. As the CVP implementation, including assortment review progresses, we see the growth of average ticket outpacing the like-for-like sales growth.

Our customers' spending provisions are increasing, which is in line with our ultimate goal of gaining a larger share of the customers' wallet. Our analysis shows that customers focused on the low-budget SKUs visit us less, but we attract new customers who buy P3 and P4 category interests. Our CVP and newly launched loyalty program are designed to stimulate people to spend more in the family of Magnit stores.

I would like to emphasize that we are trying to get more out of the visits, and our loyalty program is based on the premise of the more you spend the more you get. I believe this approach adds more value to our business.

With this, I would like to hand over to Elena who will comment on our financial performance. Elena, go ahead.

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Elena Milinova, Public Joint Stock Company Magnit - CFO & Deputy Chairman of the Management Board [4]

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Thank you, Jan. Hello, everyone. As you all have seen the press release and presentation, let me just focus on a few of the main points of the second quarter from my point of view.

Mainly, it's one-off items as well as working capital and shrinkage. In the second quarter, we had several one-off factors affecting our P&L, namely fire at the Voronezh DC. The results in higher logistics costs and a negative impact on gross margin and EBITDA in the amount of RUB 1 billion. Additionally, due to the accident, part of the equipment was written off, thus the impact on the net income -- net income was higher, RUB 1.2 billion.

Operational expenses in the second quarter includes EUR 900 million relating to a long-term consultancy contracts that were expensed in the second quarter as the projects were finished.

Also, I would like to mention LTI expenses, which affect year-on-year comparisons as we started to accrue them only in 2019. The amount of LTI accruals in the second quarter was RUB 557 million.

Working capital. As you know, working capital is currently one of the main focus areas. Earlier, we announced all gadgets (inaudible) 25 RUB billion, RUB 30 billion from working capital by the end of this year. We stick to that plan, but due to transformation of our category management, it's not so visible in our balance sheet yet. However, we plan to achieve this proven combination of optimization of inventory as well as improvements in the table base by the end of this year.

Our inventory turnover date, our longer-term target is 49 days. This is higher than the food retailing industry average of 35 days. But the high number is reflecting our business structure, which includes our grocery segment as well our own production and indirect imports. We also see further scope for improvement in the payable days of 9 days in the long term. The negotiation campaign for 2020 starts in September, and we will use this opportunity to increase the payable base by 2 free days. The (inaudible) survey improvements going forward will have adjusted the KPIs to power commercial department so that inventory and payable days are now a whole part of KPIs.

Shrinkage. And regional growth for shrinkage as a percentage of sales started in the third quarter last year, in relation very much to the transformation process and assortment results.

In the second quarter, cross-functional working groups come to address the issue and we already see the improvement of 7 basis points compared to the first quarter. The projects we are currently implementing include: First, the improvement of promo [campaign] applying introduction of our (inaudible) system for ultra-fresh items we changed (inaudible) in our operations. We enhanced our partnership with the suppliers to improve the information-sharing and review quality requirements of fresh items. We will transfer part of the deliveries onto a cross-docking supply chain solution.

That's all from my side.

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Jyrki Talvitie, Public Joint Stock Company Magnit - Member of the Management Board & Director of Strategic Communications [5]

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Thank you, Elena. I'd like to open the floor for the Q&A session now.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And our first question is coming from Ulyana Lenvalskaya of USB (sic) [UBS].

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Ulyana Lenvalskaya, UBS Investment Bank, Research Division - Director and Analyst of Media & Technology [2]

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This is Ulyana from UBS. The first question will be of a traditional one, on traffic. With the current pace of the turn -- or a turn at (inaudible) when do you expect to see positive traffic?

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Jan Gezinius Dunning, Public Joint Stock Company Magnit - CEO, President, Chairman of Management Board & Director [3]

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Yes, that's an interesting question, Ulyana. I remember my first mention at economy where I was taught that economy was all about trying the highest output from the lowest input. So seeing customers spend more, which is a bit of an impact from our CVP, and therefore, coming less, is something that we will need to monitor. But I do not see this as a real big issue, because what we see in our analysis and I think that's a bit of inside information, we see that we lose the smaller basket. If I look at the migration report, and by the way, the migration report is available because GFK reports that on a quarterly basis. Then you see that we actually are losing the small baskets, the very low-income customer. And that is a basket that comes very often with very low spend. What we gained instead is the more -- the (inaudible) customer, the P2, P3 customer that comes to us that has a bit of a different habit of purchasing. So if you net that out, I think -- and that's also what I guide the team with is it is very, very important that we look at the like-for-like performance. It is also important to look at the visits in itself but kind of with the migration of customers. Yes, we are affected by recent drop. On the other hand, we clearly show that the customers that we gained are spending more and the customers that stay are also picking up with regards to the CVP efforts that we do. Although there is a small amount of stores because it's -- as you have noticed, we do this -- because we have 800 stores, but we are rolling out the loyalty card. Our loyalty card is actually also not trying to push customers to come more, but actually to spend more as they come. And we've had discussions. We know that there are all kind of promo activities ongoing which stimulates, actually, not even a visit increase, but more -- a check increase. I don't find that a proper way or smart way to do business. And like I said, we try to -- we feel that if customers start spending more and therefore come less often, but they stay a customer, that, from business economics, is not so negative.

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Ulyana Lenvalskaya, UBS Investment Bank, Research Division - Director and Analyst of Media & Technology [4]

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Okay. So it sounds that we should not expect a positive traffic, right?

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Jan Gezinius Dunning, Public Joint Stock Company Magnit - CEO, President, Chairman of Management Board & Director [5]

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No. That is not what I say. We will be looking but the -- I think the focus on the traffic, looking at the dynamics and the migration, plus our efforts on the loyalty card is, I think, a focus which currently is not the right one. I think you should focus much more on okay, how are like-for-like and CVP efforts are doing because in the end, that's going to be defining how much we're earning, but also how much we're being perceived by customers. Just as an example, I can do the loyalty card with a couple of different dynamics. You can say -- this is every RUB 550 spend that you spend, you get a point, which means that actually, you stimulate customers to come more often spending RUB 550. We all say, now listen, customer, if you spend RUB 500, you get a point. If you spend RUB 1,000, you get 2 points. Now that's what we have decided to do. When we see indeed that there is a customer out there that starts spending more in order to get more points, is my business then worse because of that dynamics or -- although -- I think that's the question. I think, for me, I'm measuring the CVP, and I find it very important is do I see traction. And just as an example, the sales of new the SKUs that we have implemented and since last September, we have added 893 new SKUs. All those SKUs have a relative share in the category above the category share. So that is reported, which means that we're actually making the right selection of articles, good. And over time, we hope that will translate into a more attractive environment to shop. And I think that will also be translated into people coming more or more customers coming. And at the moment, we see that we are slightly winning customers, but they have a different (inaudible) because the ones that came very often and spend very little have migrated to one of the lower players in the market.

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Ulyana Lenvalskaya, UBS Investment Bank, Research Division - Director and Analyst of Media & Technology [6]

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Okay, makes sense. And the second question, if I may, on the EBITDA margin. Can you confirm the previous guidance to get flat EBITDA margin year-on-year in 2019?

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Elena Milinova, Public Joint Stock Company Magnit - CFO & Deputy Chairman of the Management Board [7]

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Let me answer. Yes, so we confirm. So we will try to achieve the same level of EBITDA margin like last year.

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Operator [8]

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(Operator Instructions) We will next go to Victoria with Crédit Suisse.

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Victoria Petrova, Crédit Suisse AG, Research Division - Research Analyst [9]

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I have several questions. First of all, and I apologize if I missed something while being away. A year ago, when we had this call and Elena was also on the call, you were talking about getting rid of irrelevant SKUs and upgrading the assortment, which was expected to have some impact on margin, obviously, a negative one. Is it done by now? Have the irrelevant assortment been sold off, and what impact on the margin it had in the first half 2018?

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Jan Gezinius Dunning, Public Joint Stock Company Magnit - CEO, President, Chairman of Management Board & Director [10]

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The question is the innovation level of the assortment. Like I mentioned already earlier, there has been around 1,000 items added to the convenience store, and the share of the -- the shelves that they take is over, the average sales per category, so which is positive. What is the problem and it's one of our challenges is the presence of old stock. I think it's fair to say that we have not been too active in trying to get rid of it. And that's one of the -- that's one of the things that we actually will start doing as of now because obviously the (inaudible) that I find on the shelf the presence of new SKUs underrepresented 2 of their sale shares. So what I'm saying is that they deserve more phasing than what they get. I think that's because it's blocked by the presence of old stock. And old stock is...

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Victoria Petrova, Crédit Suisse AG, Research Division - Research Analyst [11]

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Can you quantify anyhow so we can just assume how much this old stock is or how much was it before (inaudible)?

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Jan Gezinius Dunning, Public Joint Stock Company Magnit - CEO, President, Chairman of Management Board & Director [12]

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Elena, I hope you know this.

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Elena Milinova, Public Joint Stock Company Magnit - CFO & Deputy Chairman of the Management Board [13]

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Yes. So we see that it's at the end of 6 months of RUB 33 billion of our -- the stock, which consists of SKUs, which are not anymore in the active matrix, of which, only RUB 2 billion is still in warehouses. That's good. We moved it to the stores, so we cleaned up the system now. However, now it takes time to sell them through the stores and -- so that we have free space on the shelves for the new assortment.

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Victoria Petrova, Crédit Suisse AG, Research Division - Research Analyst [14]

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You have RUB 53 billion of stock in the -- or RUB 51 billion stock now on the shelf?

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Jan Gezinius Dunning, Public Joint Stock Company Magnit - CEO, President, Chairman of Management Board & Director [15]

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(inaudible) RUB 33 billion.

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Elena Milinova, Public Joint Stock Company Magnit - CFO & Deputy Chairman of the Management Board [16]

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RUB 33 billion.

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Victoria Petrova, Crédit Suisse AG, Research Division - Research Analyst [17]

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RUB 33 billion.

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Elena Milinova, Public Joint Stock Company Magnit - CFO & Deputy Chairman of the Management Board [18]

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RUB 33 billion out of RUB 200 billion almost.

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Jan Gezinius Dunning, Public Joint Stock Company Magnit - CEO, President, Chairman of Management Board & Director [19]

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That's around (inaudible)

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Victoria Petrova, Crédit Suisse AG, Research Division - Research Analyst [20]

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And what -- and the margin is obviously lower, right, because you need to get rid of it.

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Jan Gezinius Dunning, Public Joint Stock Company Magnit - CEO, President, Chairman of Management Board & Director [21]

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Yes. We will be selling that assortment at a lower margin, yes.

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Victoria Petrova, Crédit Suisse AG, Research Division - Research Analyst [22]

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And will it be considered a one-off versus your 7 -- obviously, your 7% EBITDA margin estimate? Are you casting the flat EBITDA margin year-on-year with the stock being sold or without?

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Jan Gezinius Dunning, Public Joint Stock Company Magnit - CEO, President, Chairman of Management Board & Director [23]

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Now let's -- the -- we just have had that discussion. I don't think we have quantified the total level, and we also -- and we don't know exactly yet the quality of that stock because some of the stock is actually relatively new that came out in-house, and some of the stock is old. So the question is -- I understand the question, I'm just flagging the idea that we will have to get it off-stock in order to get better presentation of the new assortment. But I have too little view at the moment on the quality of that passive market. In order to give you a definition on how we or how much do we need to cut down. And potentially, there will also be assortment in that we don't even have to.

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Victoria Petrova, Crédit Suisse AG, Research Division - Research Analyst [24]

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I understand. But you're starting this process only now in the third quarter 2019. Have I understood it correctly?

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Jan Gezinius Dunning, Public Joint Stock Company Magnit - CEO, President, Chairman of Management Board & Director [25]

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Yes. I think the biggest part of that, we will see in the third quarter. Yes. One thing I want to emphasize is that the -- that it's an exercise that we have to do, but underlying, we -- I see actually a quite healthy development.

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Elena Milinova, Public Joint Stock Company Magnit - CFO & Deputy Chairman of the Management Board [26]

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We have several options actually, so we could do it faster. Then, of course, that's more. We could do with the low risk fees and then of course (inaudible) and that's the options we evaluate, and we adjust our selling depending on the results we see every month. So therefore it's difficult to say now what exactly the effects that will get into the P&L because the effects follow the business decisions. And Jan just started it this year, now because this option cost is stable, with the current plan, we are able to maintain the margin at the prior year level.

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Victoria Petrova, Crédit Suisse AG, Research Division - Research Analyst [27]

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And just -- on this, just one last clarification question. What is this not innovated enough stock could be? Is it something like, I don't know, like, I don't know, some nonfood product, which is irrelevant? Or is it something? What -- can you give an example of the worst sort of irrelevant...?

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Jan Gezinius Dunning, Public Joint Stock Company Magnit - CEO, President, Chairman of Management Board & Director [28]

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I will give you. I can give you some examples. (inaudible) it's not an article where your first initial idea is run to the convenience store to buy one. So the -- so if you're (inaudible) -- we will be sending part of that stock to the IFRS, where we know debt function is much less (inaudible). I can try to explain the -- we do not -- I do not know at the moment exactly the quality of that assortment. And some of these should not even be priced down at all as it's an article, which is positioned in the wrong place, and therefore, became old stock, but there will also be some assortment in which, okay, we will have to find solution. Other old stock is of passive markets that we call (inaudible) are promos that we've done with the suppliers like some shampoos that now the packaging has changed. We have a different shelf, but the old packaging is still in some of the stores. Now is it harmful? Now we need to see. The -- I'd like to say this. I am already 3 weeks CEO. I need to get a better view on what's the quality of that stock and how I'm going to organize this.

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Victoria Petrova, Crédit Suisse AG, Research Division - Research Analyst [29]

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My second question, if I may, is related to this consultant cost. It's around RUB 900 million. What exactly has it been paid for? I know, Jan, you were not around, but in general, and what impact it had on the company performance, what sort of view? What has been done for this RUB 900 million?

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Jan Gezinius Dunning, Public Joint Stock Company Magnit - CEO, President, Chairman of Management Board & Director [30]

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Okay. I need the support of Elena, but what I have seen, I have seen several consultancy agencies, having done actually pretty good work on developing the strategy, supply chain, for instance, HR employer brand and the whole transformation and CVP exercise. And then there's all kind of smaller stuff that has been done as well on IFRS logistics. Elena, did I miss something?

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Elena Milinova, Public Joint Stock Company Magnit - CFO & Deputy Chairman of the Management Board [31]

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No, no, no. Logistics and basic strategy results were a big part of catchup as well. I just wanted to -- sorry, it was the number of consultants and we almost finalized.

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Victoria Petrova, Crédit Suisse AG, Research Division - Research Analyst [32]

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Yes. And we will see the positive impact on this logistics and IT changes in the future quarters, right?

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Elena Milinova, Public Joint Stock Company Magnit - CFO & Deputy Chairman of the Management Board [33]

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Of course, that's -- these plans includes the action plan with the exact project and the actions we have taken to achieve decrease in logistics costs and improvements of our IT systems and so on.

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Victoria Petrova, Crédit Suisse AG, Research Division - Research Analyst [34]

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Do you have any consultants working in Magnit as of now? And should we expect any more costs related to that -- sizable costs, obviously?

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Jan Gezinius Dunning, Public Joint Stock Company Magnit - CEO, President, Chairman of Management Board & Director [35]

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There are -- Victoria, there are 2 projects that have to be changed and that will be finished in August. Then -- and we discussed that in the team. I think the team's view is we need now to organize troops. We need to organize ourself as a team. And I think there's competence enough in the team itself to pull it forward even though there's a few that we need more expertise from outside. And of course, we will be looking at consultants. But one of the -- one of my comments to the organization was as well, in a transformation, I would like to have focus. And I think we've done too much that has led to distraction, and we need now to get our focus together and focus on the issues that are outstanding. The good thing is -- and like -- and I want to repeat that is that the results second quarter have actually been in line with the expectations. So we feel confident that we are on the right track. But yes, is it perfect at the moment? Not yet.

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Victoria Petrova, Crédit Suisse AG, Research Division - Research Analyst [36]

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And in terms of the results, obviously, should we -- we are always trying to find sort of the bottom level. Results was on the issues being obviously taken into consideration impact on the front, sort of leftovers from different teams, et cetera. Should we consider some positive trends we are observing in the second quarter as the beginning of a different trend or is there a lot of things being done and we should -- should we expect sort of an improvement in like -- for example, we have seen like-for-like positive dynamics between first and second quarter 2019. Should we expect even better like-for-likes into -- in the third quarter? Should we expect better like-for-likes in July? Maybe you can comment on that. And in terms of profitability, do you think we are in a stable trend as well or should we -- or if there is, was this done before the company restarted?

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Jan Gezinius Dunning, Public Joint Stock Company Magnit - CEO, President, Chairman of Management Board & Director [37]

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Yes. Let me answer the question. I think the dynamics that you see in the like-for-like is something that we expect to continue. There are sorts of new initiatives stepping in like the private label like I mentioned, redesign of private label. I think we are also starting to message -- the different message about Magnit than what we've done before. So that -- that, I think, will be the direction. The profitability, I do see underlying that we're actually having a healthy basis. But there is like -- that you mentioned previously, the old stock or passive markets that it is something that we will have to clean up, and that -- but that's not structural. It's just -- it has to be done. And then the impact you will see on the working capital. And I expect as well with the better finishing of goods that have sold well that is also helpful to boost sales.

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Victoria Petrova, Crédit Suisse AG, Research Division - Research Analyst [38]

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And my very last, I promise, question is, Jan, with you being a new CEO and having much more power, when do you expect order -- are you taking any -- sort of when do you think the full impact of all those changes which are being implemented right now would be seen in the results of the third, fourth quarter and the first or more likely first half 2020?

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Jan Gezinius Dunning, Public Joint Stock Company Magnit - CEO, President, Chairman of Management Board & Director [39]

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Now first of all, I have the same power as the previous CEO. I don't think there is gains. The second thing is there are initiatives, which will start this year, and I expect actually that it will -- the biggest impact that you will see end of 2019, beginning of 2020 where we also said that should then actually be the implementation, that you should see impact of our efforts. And that's also where we work on. So just on the redesign of private label, I know that those products will arrive in August. That's clearly the private label with the price hike, with a clear definition of what to expect. I trust that, that's still to be much better than what we currently have. There's other innovations in the assortment that's coming that is stepping back a bit more from the promo. So I think very slowly, we will see that translate into the top line. We, by the way, also see quite good impact of -- although we went back with store growth, we see actually quite a good impact as well with the new stores which has delivered good returns and are close to forecasting. So there are a lot of positives we see as well.

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Operator [40]

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Next, we'll go to Maxim with Goldman Sachs.

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Yulia Gerasimova, Goldman Sachs Group Inc., Research Division - Equity Analyst [41]

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It's Yulia Gerasimova from Goldman Sachs. I have 3 questions, please. For the first one, I would like to start with the guidance on the 4 openings in the CapEx. I think you promised us that potentially on the second quarter call, you will update us on the number of stores you plan to open this year and the CapEx, how it's going to be adjusted. That's the first question. I think let's take it one by one.

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Elena Milinova, Public Joint Stock Company Magnit - CFO & Deputy Chairman of the Management Board [42]

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The guidance for this year was RUB 70 billion to RUB 75 billion of CapEx, and we have confirmed that. We are also was going to open 1,500 of convenient stores and we are doing as well to stick to that plan, so nothing changed.

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Yulia Gerasimova, Goldman Sachs Group Inc., Research Division - Equity Analyst [43]

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And then the follow-up here, what does it mean to slow down in the expansion program to focus fully on the turnaround? So when do we see that slowdown, because you're clearly not slowing down? You're opening the same number of stores.

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Jan Gezinius Dunning, Public Joint Stock Company Magnit - CEO, President, Chairman of Management Board & Director [44]

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Actually, in the second quarter, we opened considerably less than what we did in the first quarter. It was in my fifth, it was around 322 stores less. So looking forward, we're actually currently discussing the pipeline. And I do not see a need to hurry. And why not? Because, yes, the -- like I mentioned on the call, there is -- there are things that we have to solve. That is a good development, but we're also going through organizational changes. So there was a tendency in my view to do too much. I think we should focus, get things done. And then we're confident we can step again on the gas because there is -- the market provides us with opportunities. And I think we should go over them provided we are confident enough that it does not create additional problems to our organization.

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Jyrki Talvitie, Public Joint Stock Company Magnit - Member of the Management Board & Director of Strategic Communications [45]

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Just to clarify, Jan's point on the slowdown. It was -- it was from first quarter to second quarter. So as Jan mentioned now again, 322 stores less opened in the second quarter than the first quarter. And I'd just like to point out also that in the first half of the year, we opened 0 supermarkets. So we -- that has been put on hold until the CVP shows that it works.

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Yulia Gerasimova, Goldman Sachs Group Inc., Research Division - Equity Analyst [46]

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And also the question from this one is should we then consider that this annual pace of expansion of 1,500 stores is something that you're comfortable with even during your proceeding the turnaround progress. So only when you complete -- the turnaround is achieved, the question of turnaround, you may see yourself increasing that pace. But 1.5, that's something you're comfortable with, even in the current circumstances. Is it a correct assessment?

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Jan Gezinius Dunning, Public Joint Stock Company Magnit - CEO, President, Chairman of Management Board & Director [47]

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No, this is actually totally under discussion. My view is that looking at the returns, we should try to increase the number of cosmetic stores because they actually -- that's an exciting business, as you have seen. I mean clients say that we might want to do that at the cost of [MM], so do less MM in the future, convenience. But keep an eye open for the opportunities in the market, so not stock like we do in supermarkets at the moment. I mean the hypers, but more slow it down to, say, 100 convenience stores in the market, so around 1,200. And what I also think is that we should -- we've got a considerable amount of supers and hypers. It's also time that we get them under control and that we deliver better results there. And when that's done, we can start looking at, okay, what's the optimal mix of growth. I think -- the good thing on our side is that leverage wise, we're in a good position. We've got an attractive dividend. So we will be in a situation to start looking at core capital allocation. But I won't -- first, and sort of the message to the organization, let's first solve the internal issues. Let's first make sure that like-for-like is a convincing like-for-like in all the formats, and then see which formats do we grow. What are the other opportunities in the market as well. Because the market in itself is not consolidated than our opportunities, and we should have a clear view. But I also -- just one of the things that we're also looking at is if you look at our capability of production and the returns on those, that is also an interesting direction to look at and not by adding more but making sure that we have the capacity to actually fulfill all our demand. If I look at the tomatoes, cucumbers, yes, we currently are producing. We produce for a certain amount of stores, but they're still in the east and still in the north stores out there, which we can't provide because we don't produce enough. The -- you will see in the third quarter, by the way, is rather we open (inaudible), which is an investment plan of 2016. We invested 30,000 hectares of greenhouse in this. Also, that will help to improve. The core message that I have is let's focus on the like-for-like. Let's focus on the formats that we have. Let's make sure that all the formats are going to work the way we would like to see, and then see what are the best ways to allocate our CapEx.

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Yulia Gerasimova, Goldman Sachs Group Inc., Research Division - Equity Analyst [48]

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And did you see like there is some of this -- some of them -- of this target that you're right now still discussing internally, do you think you will be able to update the market on those things on the Capital Markets Day? And have you set the date yet or still discussing this one?

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Jyrki Talvitie, Public Joint Stock Company Magnit - Member of the Management Board & Director of Strategic Communications [49]

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Yes. So the timing right now is that we're looking at this kind of strategy review in the early part of September, October. And once we know when we get the results of that, we will announce the date of the Capital Markets Day. So it's a bit early. I hope to be able to announce it to the market in September when that date will be exactly.

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Yulia Gerasimova, Goldman Sachs Group Inc., Research Division - Equity Analyst [50]

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Okay. And my last question. And my last question was about the monthly trends that you have disclosed in your press release. There is a clear trend that month-by-month, the performance have been deteriorating, and June was actually the weakest month. So first of all, can you comment on the trends and what was actually driving the June performance? And secondly, I would like to just once again follow-up on what Victoria had been asking about the July trends. Can you just comment on how July is shaping up?

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Jan Gezinius Dunning, Public Joint Stock Company Magnit - CEO, President, Chairman of Management Board & Director [51]

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Yes. The rate on June in comparison -- by the way, we see a bit issue in July as well, although July is performing better than June. June was clearly affected by the World Championship last year and much worse weather than last year as well. Maybe you'll recall that last year the June month was actually quite a warm month. This year, we see different temperatures. And we see that this is well reflected into the sales of ice cream, soft drinks, beer. So the typical football game assortment is -- it got a hit in June. If you look at July, July is actually performing better, also over the trend of the second quarter.

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Yulia Gerasimova, Goldman Sachs Group Inc., Research Division - Equity Analyst [52]

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I just wanted to -- clarification -- quick clarification question. I think Elena mentioned about the RUB 33 billion of stock that is still needed to be moved. And I didn't catch the number of the amount of the stock, which actually was moved from the DC to the stores. Was it RUB 2 billion? Can I confirm that number, please?

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Jan Gezinius Dunning, Public Joint Stock Company Magnit - CEO, President, Chairman of Management Board & Director [53]

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No. What Elena said is that there is still RUB 2 billion net in the distribution centers that have to be transferred to the stores.

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Jyrki Talvitie, Public Joint Stock Company Magnit - Member of the Management Board & Director of Strategic Communications [54]

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So 31 has been transferred.

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Jan Gezinius Dunning, Public Joint Stock Company Magnit - CEO, President, Chairman of Management Board & Director [55]

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So the good thing is that from the passive stock, RUB 31 billion is already in the stores, so there where it should be sold.

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Operator [56]

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We will next move to Elena with JPMorgan.

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Elena Jouronova, JP Morgan Chase & Co, Research Division - Research Analyst [57]

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I have a question going back to like-for-like sales. Jan, frankly, I am puzzled by the comments, because if I look at the sales density, it is down 3% in the second quarter. It was down 3% in the first quarter of this year. I'm talking about convenience format standalone. And food inflation is around 6%. That said, you're commenting that you already see a positive effect of the new CVP on the shelf, where like-for-like and what 63% of stores where you have in your CVP is positive. So why are we still in a situation when sales densities are going down? And I could have taken the explanation that there is competition, et cetera. But competition is there for all. And I'm not seeing the same sales density trend as some of your competitors who also face the same competition and cannibalization. So can you please help me understand that sales density trend? That's my first question.

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Jan Gezinius Dunning, Public Joint Stock Company Magnit - CEO, President, Chairman of Management Board & Director [58]

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Yes. The -- it's a complicated question, but I've seen that myself. Elena, part of it is the refurbishment in which actually the stores are closed. And what I've seen as a trend, which I think we should stop is that there is a -- there has been a desire to extend the sales pace at the cost of the back rooms, which creates, by the way, not always the right dynamics inside the store, so that's one. The second one is, if you have seen the openings in the first and the second quarter, those are ramping up and come off -- come with a clear lower sales density as the existing ones. Those are 2 explanations I have for now. Seeing that 60% of the convenience stores have gone through a remodeling, and they have led to an extended sales area where actually the catchment area is not getting bigger. This is something that we need to rethink. Certainly, if I see what's the consequence for the back room. So there is -- like I said, there are certain issues that we have to solve. And looking at the food inflation, that is a legitimate comment because that means, indeed, that, that's not the like-for-like sales that we project. I mean that's also one of the problems that we address. How come we do not cover a 78% of the food inflation in select like-for-like projection? And that means that we're actually losing relative volume. And one of the things I can say there is that, by the way, has also been particular for the sales density. We clearly are affected by the fact that we are a federal chain. We have a relatively big representation in the regions. And some of the regions are economically more in a healthy situation. So that's where we clearly see that we are having issues.

If I look at the south of Moslow or -- should be then actually, those stores do relatively much better. But some of the Volga and center regions are economically in trouble.

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Elena Jouronova, JP Morgan Chase & Co, Research Division - Research Analyst [59]

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Okay. I think the last point in particular does explain the sales density, in my opinion. And my second question was actually on the selling space increase in the stores because I've clearly noted that in Q1 and Q2, it looks as if the average space of the new stores that were opened increased substantially. But what we're probably seeing is actually the increase of selling space in existing stores that drives the numbers up. Is that a fair observation?

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Jan Gezinius Dunning, Public Joint Stock Company Magnit - CEO, President, Chairman of Management Board & Director [60]

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There is a space (inaudible)

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Elena Jouronova, JP Morgan Chase & Co, Research Division - Research Analyst [61]

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And like during the refurbishment, you probably are increasing space.

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Jan Gezinius Dunning, Public Joint Stock Company Magnit - CEO, President, Chairman of Management Board & Director [62]

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Yes, that's a fair observation. Yes.

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Elena Jouronova, JP Morgan Chase & Co, Research Division - Research Analyst [63]

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And by what percentage did the selling space increase in the refurbished stores roughly?

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Jan Gezinius Dunning, Public Joint Stock Company Magnit - CEO, President, Chairman of Management Board & Director [64]

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Sorry, I don't know that percentage. But I've seen some examples where it's reached 10%, 15%. We can -- if you want, I can give you the number.

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Elena Jouronova, JP Morgan Chase & Co, Research Division - Research Analyst [65]

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Yes, that would be actually helpful. And then I wanted to ask a question about the gross margin. So I actually thought that your commercial margin, it must have been pretty strong, because despite the shrinkage, despite logistics costs and the DC incident, you managed to effectively, like meet, like 24% gross margin target. Can you help me understand why the commercial margin is so strong? Is it a situation that you have invested something additional in working capital, special like payment terms for -- to the -- to certain suppliers? Has that been driving the commercial margin up? Or what's going on there? Because it seems to me that it's stronger than I would have expected to see considering the promo intensity in the industry. So has there been any change, any special agreements with suppliers?

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Jan Gezinius Dunning, Public Joint Stock Company Magnit - CEO, President, Chairman of Management Board & Director [66]

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Yes, I think the commercial team has done a good job. So there is clearly -- part of it coming out of better terms. And why those better terms? Traditionally, Magnit was a biased organization. And there was less, call it, joint business negotiations ongoing. And I think, certainly now with Vladimir Sorokin, I must tell you, that is changing.

We have a more end-to-end negotiation with the suppliers with regards to assortment, assortment innovation, promo, promo debt, but also working capital allocation for them and for us, where are we going to keep stock and how are we going to get it as cheap as possible to the shelves.

Like I mentioned before, we've had some consultancy on supply chain and logistics, and that is helping us to get those conditions. Then on top, we -- if you look at the imports, imports are also growing a bit in the fresh departments, which are delivering a bit more margin as well. So overall, positive sign, positive development, and especially knowing that we're not there totally, cause I think the suppliers as well, I think there's lots of space to improve still. But the -- yes, this moves into the right direction. On top, if you look at the project of shrinkage, although still very high in the second quarter, I see also there that we see positive dynamics with regards to drink, so I believe that also there we will see a bit more improvement as well. We don't expect it to get to the level of last year yet. But our target is there to make sure that we keep on seeing the trends that we do now.

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Elena Jouronova, JP Morgan Chase & Co, Research Division - Research Analyst [67]

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And just a few more for me, please. So this incident with the fire, the DC that was not insured, is this generally normal practice in Russia not to insure the distribution centers? And do you consider changing that going forward?

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Jan Gezinius Dunning, Public Joint Stock Company Magnit - CEO, President, Chairman of Management Board & Director [68]

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Yes, the -- that's a good question. No, it took me personally by surprise, but it's not uncommon not to insure, because if you look at the instance and the frequency that happens. This -- which is an example, in 25 years this is the first time that we have an incident in a distribution center.

If you would have paid the insurance premium every year, we could probably have paid for two distribution centers. The problem is always that if it happens in the year, then yes, it is a one-off. Elena and I are currently discussing the -- okay, what's the sense of insuring or should we make provisions or should we continue the way we have done that in the past as well?

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Elena Jouronova, JP Morgan Chase & Co, Research Division - Research Analyst [69]

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All right. And then a final one for me. It's a very broad question, actually. I hear a lot of questions from investors, from my fellow colleagues to you, and everyone's asking when the turnaround happens, when like-for-likes get better, when the margins improve. I want to ask you a slightly different question. What does the turnaround mean for Magnit's management team? And what do you want to see as the CEO in the results, to say, "Okay. Now the turnaround is done. Now the business transformation has taken place. I'm happy for now and I'm prepared to look ahead for the bright future." For you. What does this actually mean, 1 or 2 metrics in financials?

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Jan Gezinius Dunning, Public Joint Stock Company Magnit - CEO, President, Chairman of Management Board & Director [70]

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Okay. Now, first of all, a turnaround is not just a switch of the button, there is a process that takes long. What are the important features for me in the turnaround, is that this company starts thinking of customers first. I am exaggerating, but the process has been -- that thing was well organized, but the stores will be ashtray of the organization. And I think that should change.

Let me say for the management's mentality to change, that requires a culture change, and that's what we're working on.

When do I see a finished turnaround? By the way, I don't believe that you're ever ready in retail. I think there's always work to be done. And I think that also is -- that's why it's so nice to retail because you're never ready. One of the other things where I think is a clear feature of a turnaround is, we should, on a like-for-like basis, be able to compensate for inflation. And whether you take the CPI index of 5 and say okay, at least I want to have 80% around to have 100%, but currently the gap is too big. And that's helping over the longer run, we need to have as a clear target, matrix for -- what's important for me is, I think it's very important that if we allocate money that we're very convinced that the returns are appealing. What I want the team to do is to think of how can we differentiate from competitors and make a, call it, an attractive proposition for customers, which is clearly matching the future.

One of the things I use a lot is actually -- what I want to do is, I want us to have a purpose, but I also want us to be fit for future. And then on both aspects at the moment, Magnit falls short, but we're working on it. And I think it's statute people understand. And I think also in the next half year, you will see, if you're just coming up, which are more relevant for the current trends, than trying to be in a neutral environment, all the matrix more increase for you, is returns. Returns are also expressed into sales densities so let the assets spread.

Top line, market share, and I think we should also look at the current Russian investment environment. Dividends is also something that we have to really look at.

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Operator [71]

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We'll now go to our final question from Marat with Gazprombank.

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Marat Ibragimov, Gazprombank (Joint Stock Company), Research Division - Research Analyst [72]

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First question, I'd like to follow-up on Yulia and Victoria's question on July trends. What top line growth are you seeing in July?

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Jyrki Talvitie, Public Joint Stock Company Magnit - Member of the Management Board & Director of Strategic Communications [73]

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Give us a sec.

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Elena Milinova, Public Joint Stock Company Magnit - CFO & Deputy Chairman of the Management Board [74]

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The top line growth for the months of the 24 -- year-to-date is, for retail, is 10.8%.

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Marat Ibragimov, Gazprombank (Joint Stock Company), Research Division - Research Analyst [75]

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Okay. Second question to Jan. Would you have a chance to look at the (inaudible) and what is wrong with margin utility? You may explain probably different -- the different explanations by like-for-like is not going. But will we see that in real terms the average basket is declining, i.e., to adjust for inflation. Also the traffic has declined. What your impression, what's the assessment personally? What Magnit was -- is doing not right, I would say, because Elena said that in a way that's almost 2/3 of its stores? But the renovation part of that involved. What do you think Magnit should do in a different way?

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Jan Gezinius Dunning, Public Joint Stock Company Magnit - CEO, President, Chairman of Management Board & Director [76]

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To economics, I think the decision finished, that are finished are actually quite good on the technical. So it is an instruction to the organization. Where we are struggling is, how do we communicate out to the markets, our customers, what we stand for, what we want them to get from us. And that's something that we will start working on, because, like I said, the CVPs are in place. They're good, they're understandable and they're relevant. The only thing is, it's instruction, it's not a message. And the messaging is something that we have to improve.

The second thing what we have to improve is, call it, culture. I think people should feel respect but also appreciation for what they do in our business, in ahead of us in the stores, in the DCs, in their own factories that we should get a culture in which I mentioned already, we should be proud to be Magnit, and we're proud to be colleagues. And that's something that we need to work on as well. So what I found is a quite strong silo orientation. And I think that, that has to be broken. We have to cooperate. We have to work together. And by the way, there are signs that, that is being picked up.

Assortment is still not finished. I think that's also what we have to work on. By the way, that is part of the situation, but I would like to see that more announced and expressed. I find our marketing not the strongest. And also there I think we have opportunities to improve. Having said that, there is, by the way, quite a lot of things that we have started or that have been initiated that actually are good, going into the right direction and are delivering us results and better results. But what I think we as Magnit have as an issue, is that all the initiatives that have been started, we've forgotten to tell the market what's the advantage. What's your advantage to come to us, why do you think -- why do we think our offer is appealing. And that's what we need to work on. So the store operations there is assortment, there is creaminess, but it's also the messaging on our own production, on our private label that actually improved.

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Marat Ibragimov, Gazprombank (Joint Stock Company), Research Division - Research Analyst [77]

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Okay. And final question to Elena. What's your average cost of debt now?

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Elena Milinova, Public Joint Stock Company Magnit - CFO & Deputy Chairman of the Management Board [78]

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It's 8% -- 8.0%.

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Operator [79]

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That was our final question. So I'd like to turn the conference back to our speakers for closing remarks.

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Jyrki Talvitie, Public Joint Stock Company Magnit - Member of the Management Board & Director of Strategic Communications [80]

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Thank you very much. Thank you, everybody, for participating. And obviously, like always, should you have further questions, our Investor Relations, as always, are ready and happy to liaise and help you. And obviously, we will be talking to you again after the third quarter. So thank you very much, and goodbye.

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Operator [81]

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Thank you, and thank you all for your attention. This concludes today's conference. All participants may now disconnect. Thank you for calling.