OREANDA-NEWS. November 19, 2009. We have revised our 12-month Target Price from USD 18 to USD 34.7, on the back of X5’s stronger than expected store roll-out in 3Q09, management’s update on the company’s operational strategy and our new macro forecasts.

Our new DCF value now implies 30% upside potential from current levels and we are thus upgrading our recommendation to Buy. The company trades on a par with EM European peers on its 2010F EV/EBITDA and at a 27% discount on 2011F EV/EBITDA of 6.9x. This means that the market is not pricing in much EBITDA growth, hence creating the source of potential upside.

Forecasts revised on updated numbers and new macro. Taking into account X5’s 3Q09 numbers and management’s comments, we now assume that X5’s organic store opening strategy in 2010 will focus on discounter stores (85% of total openings). In the long term, though, we forecast a higher share of hypermarkets and supermarkets (18% of total store openings). As a result, we revised our long-term top-line number down by an average of 6% and EBITDA by an average of 8%.

We now forecast selling space to increase 29% and average LFL sales to grow 9.5% in 2009-11. In our view, this will drive sales to increase 1.7 times (from USD 8.6bn to USD 14.6bn) and so we are forecasting a long-term EBITDA margin of 8.5%. We expect an increase in profitability levels from better purchasing power and cost optimisation. However, we see the company passing on the gross margin improvement in prices to benefit traffic (particularly in competitive regions).

According to our calculations, operating cash flow in 2010 will allow X5 to finance its capex plans but the company will have to refinance its RUB 9bn bond and USD 1.1bn syndicated loan.

Downside risks. The inability to attract financing would result in slower store roll-out. We also note execution risks due to the company’s reliance on third-party contractors.