OREANDA-NEWS. The recent extension of Russia's ban on food imports keeps in place a protected environment for local food companies, says Fitch Ratings. This will continue to particularly benefit companies that had started to put into the market the output of the investments they had initiated before the ban (eg the pork and poultry sectors) and those able to quickly increase production (eg cheese). However, we do not expect new, large capacity expansion projects following the extension of the ban, as its temporary nature prevents a sufficiently clear horizon to plan long-term investments. Food retailers have adapted successfully, so we expect no further impact from the extension.

On 25 June 2015, Russia extended its embargo on meat, dairy and other food produce imported from the US, EU, Australia, Canada and Norway until 6 August 2016. The list of banned products remained largely unchanged from the initial ban put in place in August 2014. The majority of affected imports were switched to other countries of sourcing, particularly Latin America, Turkey and within the CIS.

For Russian food companies, the benefits of temporarily reduced competition from banned products have been muted by the adverse effects of the rouble depreciation, which has led to high commodity costs and contributed to reducing the purchasing power of Russian consumers. Consequently, we believe it was the rouble devaluation making imported products more expensive, that drove the reduction of food imports (of 26% yoy in volume over the first five months of 2015), a rising rate of food inflation (6M2015: 23% yoy excluding alcohol drinks) and, ultimately, a decline in food consumption by Russian families in the first year of the ban.

The largest food retail chains adapted swiftly to the ban introduced last August by finding alternative suppliers of the banned imports while they were clearing the remaining stocks of banned products. Their profit margins have not suffered as a result of the ban. However, the most notable effect on their trading performance came from the reduction in consumers' purchasing power, which led customers to trade down from more expensive imported goods to locally-produced ones and cheaper categories but without negatively impacting footfall for food retailers. To some extent, this has helped smooth the impact from the disappearance of more premium EU food products on the shelves but has led to significant changes in the range of products on offer.

The revenues and profits of leading food retail chains, X5 Retail Group N.V. (BB/Stable), Lenta (BB-/Positive) and O'key (B+/Stable) should remain unaffected by the ban. However, amid a weak consumer environment, we see risks of further margin sacrifices and increasing competition.

So far, Russian meat producers have benefited the most from reduced meat imports (down by 52% yoy in 5M15 according to Russia's Customs Service) and increased their output by 12.2% in volume terms in 5M15. However, this decline did not just result from the embargo. For the pork segment, Russia already had a sanitary ban in place since April 2014 in relation to African swine fever. This benefited, for instance, local leading pork producer Miratorg (B+/Stable). The poultry segment was already almost fully reliant on local production as imports accounted for less than 15% of consumption before the embargo. It is now benefiting from the ban on US poultry imports and consumers trading down from more expensive, largely imported beef, whose imports contracted by 36% in 5M15.

Local dairy producers, particularly cheese makers have had the opportunity to increase their output substantially due to the disappearance of EU sourced products. Overall cheese production in the country increased by 29% yoy in 5M15. Conversely, cheese import to Russia dropped by 58% yoy in 5M15.

Food processing companies that were reliant on imported supplies, such as meat and fish processors, have been most affected. Aside from the sudden need to find alternative sources of supplies, they faced a significant increase in input costs, exacerbated by the rouble devaluation. Unable to pass over increased expenses to consumers, many processors saw substantial margin contraction. As an example, the processing division of Cherkizovo Group (which represents 4% of its FY14 consolidated EBITDA) reported a drop in its EBITDA margin from 11% in 2013 to only 3% in 2014 and Q115.

In terms of the sustainable effects of the ban, we believe that the temporary nature of the protection of the Russian food market will not necessarily prompt a steady and long-term substitution of imports, particularly in those areas where investments have long-term payback (fruit growing, beef, or raw milk production). However, the extension of the food import ban is likely to encourage further capacity investments in specific food categories, including dairy and fish aquaculture. Moreover, if production expansion does not involve improved product quality or cost efficiency, in the longer term these industries remain vulnerable to import competition in the event of a future lifting of the ban.