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Edited Transcript of MGNT.MZ earnings conference call or presentation 29-Oct-19 2:00pm GMT

Q3 & 9M 2019 Magnit PAO Earnings Call

Krasnodar Nov 1, 2019 (Thomson StreetEvents) -- Edited Transcript of Magnit PAO earnings conference call or presentation Tuesday, October 29, 2019 at 2:00:00pm 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

* Ulyana Lenvalskaya

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

* 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 Third Quarter 2019 Trading Update and Financial Highlights Conference Call. Today's conference is being recorded.

And at this time, I'd like to turn the conference over to 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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Good afternoon. This is Jyrki Talvitie. Welcome to Magnit's conference call dedicated to the operating and unaudited financial results for the third quarter 2019. Our speakers today are our President and CEO, 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 a 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. Yes. The third quarter total revenue grew by 10.5%, and so our EBITDA margin came in at 5.8% and net profit totaled RUB 3.3 billion. Like-for-like sales in the convenience and cosmetics formats continue to be positive. While weaker results in the bigger formats, [of course] , the overall like-for-like sales declined to a minus 0.7%. Like-for-like drogerie is recovering, but still negative with basket continuing its positive trend, driven by assortment improvement and investment in enterprising. I'll come back to this later on.

The third quarter was difficult for the whole Russian food retail sector with slowing food inflation and a high base for us for the third quarter 2018 affecting the results. We experienced further downward pressure on our results due to our decision to sell in July-August over half of the passive markets we held after the second quarter. This sales of almost RUB 17 billion and a negative effect on EBITDA of 1.44 -- sorry, 144 basis points through a combination of price reduction and cannibalization, and the like-for-like sales were actually affected by 117 basis points.

So adjusted pre-sell-off EBITDA margin was 7.4%, which was a 0.4% better than last year, and the like-for-like sales were plus 0.49%. Despite this one-off effect, I felt strongly that this should be done as not taking decisions or [delaying] of actions will be delaying the implementation of the new assortment.

The passive matrix SKUs at the end of the second quarter represented actually 40% of the overall SKUs, and we are clogging up shelf space. By this sales we now have reduced the passive markets to 13%, which is much closer to our target of around 8%. The remaining passive markets will be sold gradually as it consists of SKUs that are of seasonal nature or such where deep discounting makes no sense as we will be able to sell it off over time with minimum discounting.

We additionally modified the KPI structure of the category management. We streamlined it with the sales side operations allowing us to control inventory more efficiently going forward. After the sale in July-August, we have already seen the numbers improving in September with sales growth at 10.5% year-on-year and convenience like-for-like sales at 0.8%.

Now let me step back a bit from the previous quarter and look at where we are in a broader scope. It's obvious we lost some time this year with the leadership changes and the recalibration of the management focus from growth to fixing the existing business. My main focus is now on improving the existing business while slowing down expansion to a moderate level. There, we see a couple of initiatives. And the first group of initiatives is we're doing this by better serving customers, which in turn will drive like-for-like sales improvement. And [they are] the key areas in customer service we are focusing on and have already seen progress are the assortment improvements.

So our target assortment is established and the passive market's [slowed] down allowing shelf space for full new assortment. In addition, the foundation work to ensure further improvement through regular efficient processes has been done. New assortment management system was introduced with currently over 80% of the assortment migrated, which allows for faster implementation of assortment changes down to 4 weeks coming from 10 weeks in the past. And we have significantly strengthened our team in category management with 50% new people, both in the head office, but also primarily in the [region] with 35 out of 45 management level positions filled this year.

The KPI system for category managers was also updated to streamline it more efficient with sales. Getting the assortment right is key, and research shows that it was the main deficiency in comparison to the CVP of our competitors. Although customer recognition of assortment changes usually takes time, 2 to 3 quarters, we see already the first positive signs as units per check are on the rise and customer perception study show us fast closing the gap with competition regarding the assortment. The appreciation for our assortment is clearly growing.

Then private label. During the next few months, we will finalize the launch of our 26 new private label brands representing all 3 category levels of good, better and best. And our own production will play a significant role in that development with over 800 new SKUs, with a strong emphasis on health, ecology and providence, which are growing change among consumers' brands like made in Q1 will differentiate mainly the assortment from the competition.

And then loyalty program. After a very successful pilot launch of our multi-format loyalty program in the second quarter, we started nationwide rollout in August with final regions coming online by the year-end. Today already we have over 6 million activated cards, and percentage of sales with the loyalty card is at the moment 64%, and per number of [checks] it is 46%, allowing us to understand customer data and increasingly drive our decision-making and customer -- communication with our customers.

Availability, which is actually the fourth lever. On the supply chain side, record improvements across all the KPIs, better availability, lower out of stock level and especially service level of deliveries from our distribution centers, which increased by 6% in comparison to previous year.

Last point is big boxes. As I mentioned before, the big boxes that have taken our like-for-like performance down, as we have discussed before, are supermarkets below the 2,100 square meters. The supermarkets plus in the Cash&Carry formats or so-called big boxes have dragged down the like-for-like. Now the smaller formats have shown clear improvement. This has been a result of Magnit always being focused around the convenience format, and the big box is not actually receiving adequate attention and full focus.

We feel however that as even our superstores are on average only around 2,500 to 3,000 square meters, and they're located in urban areas rather than outside town, we think we will be able to avoid the negative trends related to hypermarkets as we transform the customer value proposition for the superstores. We've now set a separate team to handle the transformation of these formats, and we're building a separate category management team for the big box formats to build on the core SKUs of the communities to add on especially fresh and ultra-fresh and few other traffic-driving categories. We're reducing nonfood category groups, but bringing in comprehensive selections in the chosen categories.

We already have one pilot run in Moscow. And the second one will be opened in Krasnodar the next month with further rollout to be expected next year. Then concerning the organization. We are continuing to build up the 12 regions, but 7 of them are fully launched but with a stronger emphasis than before on separate format-based operations. The head office is also going through various changes. There are a few. We have been [2 verticals] , which makes the management too far away from the customer and also separating marketing from the commercial department as we get ready for a stronger push to attract customers back to experience our transformed customer value proposition.

Since July, I've spent a considerable amount of time concentrating on our most valuable asset, our people, to restart building a culture of collaboration, initiative and responsibility. We've had strategy meetings with the top 150 and 450 managers. And I'm regularly traveling into the regions to connect to them as well. The new approach has already shown turnover numbers declining. There are occasion of staff coming down, but we still have lots to do on that front.

Cost. On the cost side, cost is another focus area for Magnit, has always been. Supply chain efficiency programs have been running for some time now, and we are actually improving logistics costs on a monthly basis with September beating a historical. Staff costs should start showing improvements in the quarters to come as we finalize the organizational changes relating to decentralization of front-office functions and centralization of back-office functions.

As we focus on improving the existing business, new store openings are slowing down. Simultaneously, we have tightened the return criteria and selection process for new project. In the third quarter, we opened just 276 new stores -- new convenience stores, actually, which is less than in the second quarter as well as in the third quarter 2018. And in the quarter 4, this declining trend will continue compared to the quarter 3.

Now, I would like to shortly hand over to Elena to discuss the guidance.

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

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Good afternoon from my side as well. I would like to update you on our guidance for 2019. We guided EBITDA margin to be sustainable. And in 2018, we showed 7.3%. We are now correcting it down to 6.5% for 2019. The change is due to effects of the one-off items of inventory sales, the fire at Voronezh DC and the extra expenses related to management changes and consulting. Adjusted to this one-off effect, the EBITDA margin will be 7.2%, so practically at last year level.

We guided for positive like-for-like sales this year, and there is no change to this. We promised to open convenience stores at similar level to 2018. That is around 1,500 net openings. As we are concentrating more on the existing business and slowing down openings, our new guidance is around 1,200 net openings for the convenience format. We plan to redesign around 2,000 stores, but expect to outperform this to hit around 2,303 redesigns. We maintain our CapEx guidance for RUB 70 billion to RUB 75 billion, and now back to Jan.

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

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Yes. Let me finish with some last input. I think with the changes that we are implementing, we are seeing for the first time in a long time customer satisfaction numbers rising and actually also the migration reports showing neutral results vis-à-vis the main competitors. And although these developments are very positive, we have not yet been showing those in our like-for-like numbers. But with [green shops] not only in our business, but in the overall environment, with disposable income rising 3% in the third quarter and consumer confidence starting to improve and overall retail space growth slowing, I am actually looking to the coming quarters with more confidence. Our journey of transformation will continue for some time. The deeper changes like culture and IT systems lasting longer, but I feel that with our focus on the key GDP drivers, we're making good progress, and commercial results will see improvements already in first half year 2020. Thanks.

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Jyrki Talvitie, Public Joint Stock Company Magnit - Member of the Management Board & Director of Strategic Communications [6]

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Now we are ready to go to Q&A.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And we'll take our first question here from Ulyana Lenvalskaya with UBS.

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

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My first question will be more focused on this one-off, just trying to understand how one-off was that same. Could you please quantify the old matrix -- passive matrix inventories, which are left and maybe describe what exactly is left? And shall we expect the impacts in the fourth quarter in margin too?

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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. Thanks. Like I mentioned already on the call, we were able to sell down around RUB 17 billion of old stock leaving us with around RUB 12 billion, RUB 13 billion of stock, which is stock that was recently selected into the passive matrix. Therefore, we feel quite confident that -- and we see already that that's selling down that we do not need to discount that as much as we did with the old stock. And there's also stock which is much more seasonal related like end of the year or spring, which we also do not see any need to sell down now. And we believe that's well represented. In the good period of the year, it will start selling as well. What is the best impact of the selling down is that we now have sufficient space on the shelf to present the new assortment, which was selected through a category management method. And I think that's clearly visible for our consumers. And that's why we believe that the first feedback from consumer satisfaction panels is that we're actually starting to see correction on our assortment.

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

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Thank you, Jan. And maybe a bit of a traditional question. Do you expect the positive like-for-like traffic anytime soon? Is it the priority? Or could you at least comment on traffic outlook?

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

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Like I mentioned on the previous call as well, of course, we are looking at traffic, but we're more looking at share award. And now with the loyalty card and getting more insight into behavior of our customers, we are also able to follow this up. So are we losing shares from customers or actually are we gaining shares from customers, but they just come less often. And probably you've seen the Sberbank Ivanov reports. The general trend is that people start shopping less but spend more, and that's exactly what we reflect. But it's more important, do I see customers spend more with me? If they come, do they spend more? And the first results of the analysis of the loyalty card is yes, we see that customer is still coming less, although we see a big uplift in September and as well in October of visits, still negative though, but we're not losing on value. So our customers continue spending with us as they did before.

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Operator [6]

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And we'll take our next question from Yulia Gerasimova with Goldman Sachs.

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Yulia Gerasimova, Goldman Sachs Group Inc., Research Division - Equity Analyst [7]

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I have 2 questions, please. So first, I just wanted to -- for Jan, maybe you can comment on the October trends. How October had been shaping up? And also, there was some improvement in September growth, which is actually the opposite trend that we have seen for some of your peers for whom September was actually a weaker month in the quarter. So if you can also comment what was driving you think an improvement in September? So that's the first question.

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Jan Gezinius Dunning, Public Joint Stock Company Magnit - CEO, President, Chairman of Management Board & Director [8]

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What we've seen since the end of August is we see that the traffic is improving. We're still in a negative area. But where we were [posting] into minus 3%, 3.5%, we see that coming down to minus 1.5%, around that area. And that clearly is a signal that people feel more comfortable to come. What are our biggest focus now is to see the visits pick up is how can we get the basket grow. We see the basket growing. But -- and most exciting for me at least is that I see as well the number of items in the basket grow. And that's actually a confirmation that the activities that we are doing on the category management side are exactly the good alternatives that we offer to our customers.

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Yulia Gerasimova, Goldman Sachs Group Inc., Research Division - Equity Analyst [9]

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And regarding October trends, any specific comment that you may share?

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

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Yes. I think what we've seen in September is what we see in October. What we do see, by the way, in September and October is a stronger deflation of shelf price, which is not helpful for the like-for-like. But okay, we have to deal with this. So you see that the price pressure is strong, and that's partly reflected by the competitive environment we've seen as well as with the reporting of the colleagues that promo pressure is high. I -- on our side, we think that we should take that pressure down as we have done a lot of initiatives in category management. And I think category management should help us to improve our sales instead of trying to boost more promo.

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Yulia Gerasimova, Goldman Sachs Group Inc., Research Division - Equity Analyst [11]

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Okay. And my second question was on dividends outlook. I think previously, your soft guidance was that Magnit would like to maintain about the same absolute amount of dividends. Actually you last year set quite a high standard, about RUB 30 billion. With the net income basically being soft compared to last year, are you still sticking to that? And what's your kind of outlook on the dividends? I mean because I see that your Russian accounting standards is actually ahead of IFRS, providing you the opportunity to pay more than 100% if you wish to do so. But the question -- I mean do you -- are you willing to pay such a high dividend this year?

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

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Yulia, the decision on the [height] of a dividend has not been made yet. So I can't account you today any information. But there is from our side no inclination to change the policy that we did last year. So I guess that you can expect a dividend payment for the second time, yes.

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Yulia Gerasimova, Goldman Sachs Group Inc., Research Division - Equity Analyst [13]

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Can you just, for me, to clarify what do you mean no change to the dividend strategy compared to last year? What does it mean?

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Jan Gezinius Dunning, Public Joint Stock Company Magnit - CEO, President, Chairman of Management Board & Director [14]

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Now we have always been paying twice a year. We paid here in June, July. And I think we expect to have a dividend payment as well in January. We don't have any change in absolute terms as well.

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Operator [15]

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(Operator Instructions) And we have another question here from Elena Jouronova with JPMorgan.

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Elena Jouronova, JP Morgan Chase & Co, Research Division - Research Analyst [16]

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So I have a few questions. I guess we can start with store openings guidance. It's clear that for this year, you're slightly reducing that. But what are your initial thoughts about plans for next year? Do you think that we should expect convenience store openings to be around the level where they will be in 2019? Are you slowing? Are you intending to pick up?

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Jan Gezinius Dunning, Public Joint Stock Company Magnit - CEO, President, Chairman of Management Board & Director [17]

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Now like I mentioned in the call, Elena, I think, for us, it's very important that we focus on our like-for-like business. There is a lot of stuff to do. And I see as well, the initial -- the first efforts to improve the business are clearly recognized. So that creates more courage, for me, at least to continue. I don't think that I will increase the speed of openings. I think it's more important for me to make sure that the existing business gets back to speed. First, let's be honest. We are the biggest retailer with regards to number of stores in the country. It makes a lot of sense for us to focus on like-for-like as that's where our potential is. I'm not sure that there is no potential in drogeries, but we can check that [start] anyway over time. And it's better to be more convinced of our like-for-like in order to grow than distract the organization from where we can improve. And having said that, I think we will continue the growth streak of the convenience -- sorry, the cosmetics, because we see that that's actually a business that is performing well and also like-for-like is performing well. And by the way, that will help us as well on the margin side. So I think that's an initiative that I will support.

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Elena Jouronova, JP Morgan Chase & Co, Research Division - Research Analyst [18]

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But just to quantify because, effectively, this year, Jan, I don't think that at the start to the year, you were deciding on the number of openings, and you're slowing down openings in the second half. Is it fair to assume that next year you might open even lower number of convenience stores than in 2019? Or for the sake of modeling, we just assume flat openings next year compared to this year?

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

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I had already the suspicion that it was because of your modeling that you want to know that. Let me be honest. We have raised the bar for accepting projects, and I mean the IRR bar, the return bar, in the middle of the year. To the extent that if they would reach that number, it would really not be clever not to open them, and that's what we do currently. So the stores that we are opening are -- we are actually pretty convinced that the returns are good. I think that approach, which still leads to a good number of store openings, we should continue in next year as well. And by focusing the development teams on certain areas, we believe as well that we should be able to open a similar amount of stores next year as we do this year. What I do tell you is that the [composition] of cosmetics and convenience might be a bit different, but just a bit. And I hope that this helps you to model because there is no intention to stop growing. I think we see opportunities. This market is certainly not matured. We also feel that we should look at potential M&A, smaller ones, as in certain market areas it makes more sense to replace than to add. But having lifted the return bar is, I think, the best guarantee for the investors and the shareholders that we're at least using their money smart.

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Elena Jouronova, JP Morgan Chase & Co, Research Division - Research Analyst [20]

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So effectively, you are aiming to increase the [quality] of openings. Then if I can ask another question on the assortment sales. Has everything that -- all this RUB 16.7 billion worth of inventory, this passive assortment, was it actually sold or something was written off, just to be clear? Because if my math is correct, then you've sold these products with virtually zero gross margin.

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Elena Milinova, Public Joint Stock Company Magnit - CFO & Deputy Chairman of the Management Board [21]

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May I answer that question? So it was sold with discounts. And the effect, which would be at -- splitted by 2. So first, we lost some [prompt] margin because we sold it with discount. It's about RUB 1 billion, yes. And also, we've got cannibalization of regular sales, which cost us RUB 4 billion. That's the effect on EBITDA in total we got, but there were no write-offs. So we sold some with deep discount.

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Jan Gezinius Dunning, Public Joint Stock Company Magnit - CEO, President, Chairman of Management Board & Director [22]

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And actually to confirm what Elena is saying, I mean we see also the shrinkage numbers. There's normally -- if you write-off, the part of it gets into your shrinkage numbers. We see the shrinkage numbers moving into the right direction as well. They're improving quite a lot.

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Elena Jouronova, JP Morgan Chase & Co, Research Division - Research Analyst [23]

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I'm sorry, but I'm just not familiar how it works, how were you able to calculate this -- the RUB 4 billion effect of cannibalization of regular sales. What does it actually mean?

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Jan Gezinius Dunning, Public Joint Stock Company Magnit - CEO, President, Chairman of Management Board & Director [24]

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Now if you sell old stock, then the old stock could be a sale on top of the regular basket or it replaces a part of the regular basket. And what we've seen is that the replacement has been pretty strong. That's what Elena was referring to. That's called cannibalization, and the impact of the cannibalization was RUB 4 billion. So that's actually what we lost in sales, yes.

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Elena Jouronova, JP Morgan Chase & Co, Research Division - Research Analyst [25]

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Lost sales, all right. Can I have just a few more questions, please? So did I get your comment correct about margins in -- for the rest of the year? So you gave a guidance -- updated guidance for the full year margin of 6.5%. Again, if the math is correct, this implies that your margins should accelerate in the fourth quarter to something around 7%, which would be flat year-on-year. Is that broadly in line with the management's thinking of how fourth quarter will shape up? Obviously we don't know what competition is doing, but more or less if there's no intention on Magnit's part to invest too much in price, give away too much of the margin. Or -- yes, I mean, just maybe a comment, if I got you correct on the margin point.

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Jan Gezinius Dunning, Public Joint Stock Company Magnit - CEO, President, Chairman of Management Board & Director [26]

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Yes. I'm actually pretty outspoken here. I think we've -- our efforts have been done on improving assortment. I think our assortment improvement should help us to: first, play the bigger basket; second, potentially have customers trade up and what we also see. I do understand that promo is an integrated part nowadays of retail in Russia, but I do not see a need to increase that pressure. I think we should see like-for-like improvement coming out of category management initiatives. And I trust that that's also what we see in the feedback as the feedback where we -- from customers see better appreciation is on assortment. Our pricing is neutral. So if I would lose on pricing, I could imagine that I would push pricing, but that's currently not the case. And I think also in our price comparisons, we see that our pricing is actually pretty relevant. So there's no need to overdo.

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Elena Jouronova, JP Morgan Chase & Co, Research Division - Research Analyst [27]

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And then one other question where I was hoping you could help me, Jan, is to try and understand the sales of Magnit's new concept convenience stores that you've been opening, I think, in the past quarter or so. There's a few of them in Moscow. What are they roughly versus sales in an ordinary Magnit store before the changes in assortment and the redesign? What is like the uplift in sales per store?

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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 understand the question. We -- I can give you an average number. But what I think -- what I mentioned on the call as well is one of the things that we see where we're not strong yet is availability. We have improved with 6% availability from DC to store. But we've run some projects -- and I can give you some examples. We've run some projects in Moscow where we've said, okay, we step out of the regular. We start focusing on availability. And what we have seen, store uplifts from up to 26%, 30%. The regular one -- the average one is around 9% to 12%. And three, if I can show you some average. It's based on availability that we think can be better. And that's what our focus will be on which I mentioned, by the way, as well in the call. I think there's a couple of initiatives that we need to develop still. And one of the initiatives that we're currently working hard on is get better control on store orders and store availability because that's not sufficient. So there's an area to improve. If that's done, we see that we get into pretty good numbers.

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Elena Jouronova, JP Morgan Chase & Co, Research Division - Research Analyst [29]

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And when do you think you'll be able to do it, to improve substantially on shelf availability across the entire network? What's the time frame?

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

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I want at least to see a considerable better availability number in December. So we should use a review start of October [already] to analyze and to understand. And I think we will see also the first impact there in November. And we've done some tests, which clearly show that that's an area if we pay attention and we get that done that, that will really give us good results.

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Operator [31]

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(Operator Instructions) And we do not have any other phone questions at this time.

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Jyrki Talvitie, Public Joint Stock Company Magnit - Member of the Management Board & Director of Strategic Communications [32]

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So thank you, everybody, for participating. As always, if you have any further questions, do not hesitate to contact our IR. And I would just like to remind everybody that we have decided to have our Capital Markets Day on February 12 in London. So obviously hope to see you there. But of course, we will be announcing our annual results before that as well. Thank you, everybody, and have a good evening.

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Operator [33]

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And this concludes today's call. Thank you for your participation. You may now disconnect.