Annual Report 2015

Selling space grew by 29.6% year-on-year in 2015. While this is an impressive rate of growth, it only tells part of the story. X5 added 760.9 th. sq. m. of new selling space during the reporting period, about 80% of which was organic. By sheer volume, this is a major accomplishment, and the 668.4 th. sq. m. that Pyaterochka alone added during the year represents the largest ever single-year expansion by any chain in the history of the Russian retail market.

The current market environment poses a challenge to businesses serving domestic consumers, but as we demonstrated in 2015, we have the ability to adapt and grow even in difficult conditions. One of the core foci for each of X5’s retail formats is to continuously adapt their value propositions to meet changing customer needs, including the generation of value for customers in the current economic environment. This has enabled X5 to grow and take advantage of Russia’s ongoing shift towards modern retail, which represents massive potential for market leaders over the coming years.

Setting a sustainable course

The Board of Directors has provided strategic guidance to X5 Retail Group management through a period that saw the Company transform itself from growing slower than the market in 2012 and 2013, to expanding significantly faster than either the food retail market as a whole or the top-10.

This has been achieved with the help of a strategy that aims to put X5 Retail Group on a sustainable path to long-term market leadership based on the following key elements:

• A multi-format operating model that combines scale with flexibility
• Continuous adaption of value propositions that allow us to satisfy key shopping missions in food retail
• Intelligent growth, with a disciplined focus on organic growth, in-house construction and selective, tactical acquisitions
• Continued focus on excellence in operational execution end-to-end
• Strong leadership team with substantial Russian and international experience

The Board set ambitious growth targets for management while, at the same time, maintaining profitability levels. And management delivered on both last year. Strong top-line performance in 2015 was achieved without any compromise on our adjusted operating margins, which even saw a slight increase from 2014.

Corporate responsibility

At X5, we take corporate citizenship seriously and recognize that, in order for the Company to continue to grow and develop, the communities in which we operate must do so as well. Being a good employer, working hand-in-hand with suppliers and delivering quality products to our customers is part of our sustainable, long-term, winning proposition. The Company also implements a number of projects designed to help people in need, including the new Basket of Kindness programme, which is the first food bank of its kind in Russia.

In the area of corporate conduct, the Supervisory Board also aims to ensure that X5 acts as a responsible partner with key stakeholders like employees and customers. In 2015, a new code of corporate conduct and ethics was introduced across our businesses, and every employee must acknowledge their understanding of this code. We ensure that the Company implements robust policies in key areas like workplace health and safety, as well as product quality and safety. The Supervisory Board also monitors the work of customer feedback and whistle blower hotlines, which process and investigate complaints in a timely and appropriate manner.

For shareholders, we aim to uphold high levels of transparency and disclosure, including as part of our rapid business expansion: despite a focus on organic growth, X5 also engages in tactical M&A, and the Company discloses the details of any such material transactions to the market, in line with best practice.

Governance and the Board

X5 maintains a solid governance framework, and our Board has a strong independent composition with relevant retail, finance and strategy expertise. This diversity provides management with valuable counsel and support as they translate our strategic objectives into X5’s operations.

I was pleased to take over as Chairman at the end of last year, after playing a more direct and hands-on role in leading X5’s turnaround as CEO. As Chairman, I will be able to focus more on providing strategic guidance and to setting the direction for our future growth, value creation and continued customer orientation. This is where I believe I can add the most value going forward. I was particularly grateful to note the very high level of support for this move from the Extraordinary General Meeting of Shareholders that voted to approve my appointment. I believe this is a strong endorsement of the success we have achieved in recent years, and of the importance of continuing on our current strategic course.

Outlook

I remain optimistic about the long-term outlook for the Russian retail market, as there is significant room for modern retail to grow as it replaces traditional trade formats. We have set X5 on track to be one of the consolidators of this transition, meaning the Company and its shareholders stand to benefit significantly from the change.

At the same time, we must continue to deliver on our ambitious targets in a market where consumers are actively searching for promotions, trading down within categories and formats, decreasing consumption and are more conscious about where to find the best value. In this environment, operational excellence, efficiency and swift adjustments to value propositions are critical to continued expansion with stable margins.

X5 has an excellent management team in place, led by Igor Shekhterman, who took over the reins as CEO at the end of last year. Igor is the ideal candidate to lead the management team in building Russia’s best modern retail business across all of our formats. I remain committed to guiding X5 to help it deliver on its current strategy as Chairman of the Supervisory Board, and all of us are committed to helping X5 deliver on the very ambitious target of doubling the size of the business over the next three years.

The Board and I believe that X5 is on the right track to create value for its customers as it expands and adapts, which will translate into value for shareholders as we lead Russia’s structural shift towards modern food retail.

Thank you for your continued support of our Company.

• Revenue 2012–2015: up 64.7 % to RUB 808.8 billion
• Customer visits 2012–2015: up 37.6 % to 2.5 billion
• Selling space 2012–2015: up 69.2 % to 3,333 th. sq. m.
• Number of stores 2012–2015: up 84.6 % to 7,020
• X5 now operates in nine of Russia’s federal districts, which account for 88 % of Russia’s population.

This is a truly impressive result, and as we discuss throughout this report, X5 is now growing faster than both its peers among the top-10 food retailers in Russia and the market as a whole

Delivering on strategic priorities

X5 delivered tangible results across all five of our key strategic priority areas in 2015:

Multi-format operating model: We were successful in setting all three of our key formats on a path for self-sustained growth. Pyaterochka, with a value proposition that is particularly relevant in the current economic environment, delivered 34.3 % year-on-year growth in net retail sales; Perekrestok grew 12.5 % year-on-year, while Karusel’s net retail sales for 2015 were up 11.6 % year-on-year. This rate of growth significantly outpaced the market as a whole in a year when food retail turnover in Russia grew by only 8.3 %

In terms of net selling space growth, Pyaterochka increased by 668.4 th. sq. m. in 2015, with 1,476 new stores. This represents a record volume not only for X5, but for any Russian retail chain ever. Perekrestok and Karusel also continued their expansion, with 75 and 8 new stores, respectively, delivering 68.2 th. sq. m. and 31.5 th. sq. m. of net new selling space, respectively.

Renewal of value propositions: Each of X5’s major formats targets different segments of the Russian population, and each has worked hard to adapt its value proposition to a changing and challenging operating environment. We have also worked to enable our stores to capture maximum share of wallet and market share by adapting to the current state of the market and customer demands.

Our ability to understand consumers’ needs and adapt quickly to emerging trends has been helped significantly by the implementation of enterprise-wide IT systems that enable us to analyse and gain deeper insight into purchasing trends in order to better understand the shopping mission of our customers.

Intelligent growth: With relatively low penetration of modern retail formats, we must be successful at delivering on organic growth in order to achieve the goals. To this end, the development teams within all formats have gained considerable expertise and are now among the best in the sector when it comes to finding optimum locations, opening stores quickly and carrying out refurbishment while keeping store closures to a minimum.

We use advanced analytics to select new store locations, and X5 has built strong in-house capabilities for land acquisition and construction. This helps us to make quick decisions, control costs and open new stores on time. While our focus is on organic growth, X5 also possesses strong internal capabilities in M&A, helping kick-start our entry into new regions or shoring up a format’s market position in an existing location.

Excellence in operational execution: We have managed to grow our business in a sustainable way thanks to a focus on operational excellence and efficiency. For example, we are one of the world’s largest SAP users in the retail industry, leveraging our innovative IT platform to analyse datasets covering billions of purchases in real time. Our central finance team plays an important role in tracking and benchmar king relevant key performance indicators across our banners and against external competitors, while also improving forecasting.

We have also significantly enhanced our own logistics and transport operations, with a focus on distribution centre efficiency and a significant increase in the fleet of trucks that we own and operate ourselves.

Strong leadership team: One of the keys to our success is building and maintaining the right team of professionals to lead each of the retail formats, and to operate the X5 corporate centre. As I take over as CEO, I am confident that X5 will continue racing forward thanks to the top-quality people running this business with me. I spent several months working closely with Stephan as he transitioned to his new role as Chairman of the Supervisory Board, and have been truly impressed by the calibre of the people in this organisation.

Operating environment

We have delivered strong growth despite a significant downturn in most key economic indicators for Russia. This challenging operating environment will persist throughout 2016 and into 2017.

Prices for locally produced products will continue to increase, while real wage growth continues to slow or even decline. This is leading to a reduction in food expenditure as a percentage of customers’ budgets, and it is affecting behaviour in various ways: customers are spending less per visit, hunting for the best prices, trading down and delaying major purchases.

This presents a challenge not only for X5, but the retail industry as a whole; however, it is one for which we are prepared. Our multi-format operating model allows us to reach a wider group of Russian consumers, while our focus on providing the optimal value proposition has enabled us to continue to meet customers’ changing needs within each segment.

We are committed to providing our customers with a reliable supply of high-quality products at appropriate prices, and this has become increasingly critical to our success, especially for the more affected segments of the population. To this end, we are creating value for the customer by increasing our promotional offers and developing wider ranges of first price products. To help those affected most, we have initiated special offers on socially important products for senior citizens in addition to the regular discounts that they already enjoy.

Longer-term, we remain confident about the Russian market’s potential for growth, as the top players take market share from traditional trade formats and consolidate smaller regional players.

Outlook

Despite a challenging environment, we outperformed the market with our results in 2015, growing faster than the retail market average and the top-10 average while maintaining profitability margins at target levels. In fact, in the fourth quarter of the year we were the No 1 company among publicly traded retailers in Rus sia in terms of net retail sales growth. And looking ahead, we are in an excellent position to continue this performance throughout 2016.

We view the current market conditions as a time of opportunity, and going forward we aim to take advantage of these opportunities to enhance our strategic growth. We have reached key milestones in the business transformation, but we have no intent to rest on our laurels or settle for the current pace of growth. Our strategic focus areas include refining our operating model, efficiency measures and value propositions, while continuing to lead the Russian retail market’s transition to modern retail.

One of my key strategic priorities going forward is to enhance the X5 corporate centre — not only to improve its efficiency in managing our banner brands, but by increasing its capacity and competencies to take advantage of opportunities that will arise in the current environment.

We have made key upgrades to our IT infrastructure and continue to implement modern IT solutions across our whole retail infrastructure. This gives us significant efficiency gains as well as insights into consumer behaviour. We will continue to build out our logistics and transportation operations, where we also see significant potential for further savings and efficiency gains.

As we grow and adapt for our customers, we aim to build value for all our stakeholders — providing consumers with the best value proposition, suppliers with the opportunity to sell through our large and growing chains and shareholders with the opportunity to participate in the sustainable growth of X5’s business.

I would once again like to thank our customers, who are central to our success, as well as our suppliers, shareholders and the Supervisory Board for the support we received during the year.

I also want to thank the excellent management team, and all of the employees of the X5 Retail Group, for their hard work and dedication. Our people are the present and the future of X5, and I look forward to working with them as the CEO as we continue to build this Company into Russia’s No 1 food retailer.