X5 Retail Group N.V. (FIVE) Earnings Call Transcript & Summary

Ladies and gentlemen, thank you for standing by, and welcome to today's X5 ESG Conference Call. [Operator Instructions] Please be advised that today's conference is being recorded. And I would like to hand the conference now to your first speaker today, Ms. Natalia Zagvozdina, Head of Corporate Finance and IR. Thank you. Please go ahead, ma'am.

Thank you. Ladies and gentlemen, good afternoon, and welcome to X5's first webcast dedicated to the update on our ESG strategy that X5's Board approved last year in December. On its recent September meeting, our Supervisory Board approved ESG goals, which we will both present today as well as the progress the company has made in this respect so far this year we plan on making ESG a dedicated investor event regular going forward. And of course, X5 is always open to your ad hoc inquiries about our ESG matters. On today's call, we have the speakers: Igor Shekhterman, the company's CEO; Elena Konnova, Corporate Communications Director; Yana Synesiou, Sustainable Development Director; Mr. Ivan Kukhnin, Partner, Head of Sustainability Service, Risk Advisory at Deloitte CIS, who will help my IR colleague; Andrey Vasin to moderate the Q&A session today. The format of today's webcast will be the following. We begin with the 20, 25-minute presentation and do the Q&A afterwards. [Operator Instructions] X5's CEO, Igor Shekhterman will open our ESG discussion today. Igor, please go ahead.

Thank you, Natalia. Hello, everybody. First of all, on behalf of our team, I would like to thank you that you have managed to join us for today's call. We really appreciate it. The second wave of COVID-19 begins to spread very rapidly. And I wish you and your families the very best of health and I want you and your loved ones to feel safe and secure. Let us start. X5 is recognized leader in the Russian retail market, and we have unprecedented scale. We operate over 17,000 stores across 3,000 locations, and over 14 million people shop with us every day. Our staff consists of more than 300,000 employees. Our mission is to improve people's quality and life by offering affordable healthy products and delicious food. We also want to help out with everyday routine task. We understand by significance of our scale. And of course, due to COVID-19, we just need to be extremely focused on safety in our stores for our employees and for our customers. Our actions and decisions can have a big impact on our planet and society, and we understand that. This is one of the reasons why we have put sustainable development at the core of our business. In December 2019, the Supervisory Board approved the company's sustainable development strategy. Just a couple of weeks ago, we approved target and metrics for each of our goals. Today, we will share in our presentation. I'm happy that our ESG strategy is an important part of the general X5 strategy that we have developed for 2020, 2023. Part of our strategic targets connected directly with our ESG metrics. We will review our progress in sustainable development, at least twice a year at the level of the Supervisory Board. We believe that our efforts will produce important results for X5 and for our stakeholders. We choose to use U.N. 17 sustainable development goals as a framework for our strategy. These 17 SDGs are recognized around the world as the most universal and comprehensive framework when it comes to ESG. In fact, since March 2020, we became the first Russian retailer who officially joined U.N. Global Compact to show our long-term commitment. We have done a detailed analysis to identify the goals that are most relevant for our company. We selected the ones where we will have the greatest positive impact on the environment and society. We also relied on the opinions of our customers and employees. We conducted research and surveys regarding which areas are most relevant to us. As a result, we decided to focus on 4 main goals. By working towards these goals, we will also have an indirect impact on achieving our 7 secondary goals. So X5 will focus on our 4 goals. Zero hunger through our support of local commitments -- communities, which includes the development of social investment and charitable product, such as food drive. Health and well-being. We already promote healthy lifestyle. We offer a wide collection of high-quality and healthy goods. We are also expanding our assortment in the fresh fruits and vegetable and healthy lifestyle categories. Decent working conditions and economic growth. X5 employs over 300,000 people. We aim to ensure decent working conditions and equal opportunity for all of them. We also want to provide them with meaningful career development opportunities. And finally, promotion of rational use and sustainable consumption of resources. We must do our part to contribute to solving global environment issue. We are doing this by setting and development -- and delivering on specific targets in areas like reducing CO2 emissions, energy efficiency, lower waste generation, recycling and development of our sustainable supply chain. X5 goals are also aligned with the Russian National Development Goals that were set this July. For instance, by supporting our community and promoting a healthy lifestyle, we contribute to the Russian national goals of preservation of health and well-being. Through our work of sustainable use of resources, we'll help ensure a comfortable and safe living environment. Since approving our strategy in December 2019, a lot has already been done. We have been developing specific metrics to monitor progress. Those metrics were incorporated in our strategy until 2023. And now we are our main focus in the near future. But we also haven't waited to start working on achieving certain milestones. Elena and Yana will share more information on that note, I hand over you in a few minutes. Before I hand it over to them, I wanted to share our long-term vision, sustainable development in our company. We call it 30 x 30. As I said earlier, sustainable development has become part of our whole decision-making process. It is integrated into all of our key business process. Our commitment goes beyond short-term plan. We have a clear vision of what we want to achieve by 2030. This long-term growth included: 30% reduction of CO2 emissions for Scope 1 and Scope 2, 30% of renewable energy in our own logistic operation, 30% reduction of waste generation to retail sales coefficient, achieve an annual growth rate of number of family supported through Basket of Kindness as high as 30% in -- per year. We also committed to monitoring the responsible origin of suppliers' goods, expanding our assortment of healthy lifestyle products, maintain a #1 position in employee rating and one production food retailer, ensuring the implementation of an appropriate standard for the organization of healthy and safe work space for our employees. These goals are clearly ambitious, but we believe, we are ready on the right path to achieving them. We must actively maintain a dialogue of sustainable development and social responsibility. For this process, society gives X5 its license to operate. In the modern world, a company has to dissolve and prove its right to do business. We can do this through dialogue and contribution to solving key issues. This approach will help ensure the long-term sustainability of our business. As a market leader, we understand that we are not only responsible for our activities in society. In many ways, we set the bar for the entire industry. We are committed to helping those in need, helping our customer to be more ecofriendly and to practice responsible consumption and resources usage and help them lead healthy lives. Thank you for your attention. Now Elena will share some of the details on the metrics we have set until 2023.

Thank you, Igor. As Igor has mentioned earlier, we have done a lot of progress in bringing our strategy to life. When doing so, we have had 2 main work streams. Firstly, assessing our processes to set targets and develop specific methodologies, and second stream was practical actions of piloting and launching numerous projects. For instance, we piloted a number of projects in ecological sphere, such as recycled plastic bags and baskets, informing and educating our customers and teaching our employees. You can find all the details on the progress in our sustainability report on our website. Yana will also give some flavor around those projects later on. One of the key things that have been achieved is setting up specific metrics for each of our ESG goals until 2023. A few words on how we were set. We have done a comprehensive exercise in understanding our processes to really identify gaps and areas for improvement. Having worked closely with responsible functions across the company as well as external experts, we set quite ambitious, quite achievable targets for each of our ESG goals. One of our 4 goals is to promote rational use of resources and sustainable consumption. The goal is quite extensive as it covers the different areas including waste management, emissions and others. If we talk about emissions, we have made an audit to understand what emissions we have. We calculated our Scope 1 and Scope 2 emissions according to the international GHG Protocol for 2018 and 2019. If I show [Audio Gap] result of international benchmarks. While our reduction for 2019 was 3%, we want to further reduce our emissions to 10% by 2023. We also are keen to start using renewable energy in our operations. We are currently piloting a switch of a view on our, this is the Green Line. And based on that, we will be able to set the targets. We have set a few other targets in regards to rational use of resources. If we talk about waste reduction, here, we identified 3 main targets. Firstly, we aim to set up to 95% of our recyclable solid waste to the recycle. We want to decrease the share of waste to retail sales by 10%, and we want to increase the amount of food waste spend for utilization up to 40%. Food waste recycling initiative is actually quite new for us. We only started it a year ago, and it is providing to be very successful, and we want to continue growing it. If we talk about sustainable supply chain, we have focused on both, the packaging products as well as the origin of where that product came from. To better understand the matter, we took a step back, and did a deep dive on what kind of certificates are out there and what is a sustainable packaging. As there is no uniform Russian guideline, we relied on European decree that outlines their recommendation as well as number of western benchmark. We asked our top 30 suppliers to understand their perspective on the matter. And then that led to a public discussion with all the shareholders from the value chain, from the producers of raw material to the recycling companies to discuss their opinion on those 2 subjects, and which again diversified what sustainable packaging was. Based on all work we've done, we identified -- the recommended [Audio Gap] as well as our definition of sustainable packaging. And we added that to our purchasing policy. And now we are in open dialogue with our suppliers on what products they already have in that packaging and which we need to be further improved. Having done all of that, we will be able to set the targets of how many of our suppliers will have sustainable packaging or certified products by 2023. However, next step we want to achieve is to calculate the actual number of SKUs on our shelf that fit the criteria of sustainable packaging, or come back from sustainable origin. Once we do this, we will be able to enrich our metrics further. For private label, we managed to complete such calculation. We analyzed over 200 suppliers that produce for us over 2,000 private label SKUs. Based on their analysis, we believe that we can achieve over 15% of private label products, being sustainable packaging in 2023. Let's move to our next goal, health and well-being. Our goal is to promote healthy lifestyle and ensure the availability of quality and healthy products. If we talk about our goal of health and well-being, the main metrics we chose was the share of fresh fruits and vegetable, which we are planning to grow to 50% by 2023. We are also going to focus on one expansion of our healthy lifestyle assortment. The next goal is supporting the communities through increased social investments and charitable programs. The main metrics are relating to our current programs. We want to double number of families that receive the food aid, and we also want to make sure that our footprint is growing. We have all of our Pyaterochka stores engaged in the lost person initiative. We are planning to develop new program as part of the updated CDP of our retail chain and come back with more metrics once those programs are finalized. Last but not least is our goal to ensuring decent working conditions and equal opportunities for the employees. We want to focus on growing our employee engagement, which is a comprehensive metric, including various aspects of work environment. And we want to make sure that we are employer #1 in Russian retail rankings. We also want to make sure that all of our workplace for employees are made to be healthy and safe [ improvement ]. The work that we have done did not go unnoticed, and we saw a major improvement in our ESG ratings over last year. For instance, MSCI rating upgraded us to BB ratings, while Bloomberg and RobecoSAM gave us up to 4% increase in score. According to one of the oldest investor ratings, Institutional Investor, X5 was named the best ESG company in the emerging EMEA region this year, overtaking 92 others. Now I would like to hand over to Yana, who will give more flavor around the progress we made over the last 6 to 9 months.

Thank you, Elena. As my colleagues pointed out, a lot has been done to set our targets, but it wasn't the only area that we worked on over the last few months. For example, to promote responsible consumption and rational use of resources, we focus a lot on reduction of waste sent to landfills. This we'll approach from a few angles. Firstly, we'll come back to the details of this assessment of waste management processes across our company. We did that for internal audit of our sites and facilities. We've benchmarked our processes against the best-in-class retailers and calculated total waste by type and function in order to better understand the most relevant metrics and targets. We implemented a new waste minimization policy and a waste minimization procedure with clear identifications, roles and responsibilities for relevant parties. We have also designed waste management training to educate our employees better on the updated processes and standards. Those efforts are getting backed out by our numbers. For example, we increased the amount of solid waste recycled by 35% over the last year as well as tripling, that is 3x the number, sending the food waste for reprocessing. That, for instance, in 2019, we transferred over 13,000 tonnes of unsold products to farmers. And the number is now growing in double digits through a year-to-year period. We are actively developing the waste collection infrastructure. For example, our e-commerce store, Perekrestok launched the collection of plastic bag service while delivering their orders. All of the bags collected get then sent to recycling. We're also piloting our reverse vending machines that so far, in 6 months period, managed to collect over 750 kilos. Following the pilot projects and based on our customer feedback, the Perekrestok retail chain, have switched to plastic bags containing 35% recycled material. Now it is a compulsory requirement for all our suppliers to have a high content of recycled materials. Same purchase stuff is happening in Pyaterochka right now. To reduce consumption of disposable plastic further, we have implemented the project to promote reusable bags and weighting sacks for fruits and vegetables. We encourage the purchasing of those bags, for increasing the loyalty points for our customers. Next, for instance, in 6 months of 2020, X5 retail chains sold more than 2 million reusable bags and over 145,000 reusable weighting sacks for fruits and vegetables. Our new concept stores use shopping baskets completely made of recycled material and has a mandatory requirement for all of our new stores. Another important area is reduction of energy consumption. As Elena mentioned, we have conducted a detailed calculation of our greenhouse emissions according to the best-in-class GHG standard. We calculated the figures for 2018 and 2019 and realized that we're actually on par with the best-in-class international retailers, which gives us a very solid base to start from. Thirdly, for our responsible supply chain, we developed a detailed recommendation of packaging and certification. We went through a comprehensive process that Elena talked about and became the first retailer in Russia to publish separate recommendations. We issued a separate educational material to all our suppliers. We have implemented a dedicated sustainable development course for our commercial functions internally and business partners outside to make sure that everyone is aware of the right focus. Our next step is to develop detailed recommendations for each of the separate category that we can incorporate the specifics of the category into our recommendations. It is indeed very important for us to educate our customers and employees on the sustainable consumption. To do so, we launched an interactive course with UNITAR and Danone. And within the first few weeks, over 1,000 people have gone through that course. In order to establish an ongoing channel with all of our customers and receive their feedback, we have now incorporated a number of ESG-related questions into our NPS tracker. So from the first quarter 2021, whenever we go through NPS tracker, the questions, such as whether the customers believe that X5 is helping them lead a sustainable life will be asked on a continuous stage. For our goal of health and well-being, Perekrestok has started a big pilot on healthy lifestyle corners in their supermarkets. They also launched a number of other programs, such as Nutritious Food Basket, which is a set of food products that provide the recommended daily intake of calories, proteins, fats and carbohydrates for a month for an adult. The other interesting project that we have launched is a Healthy Habits Route, which is basically an in-store route that helps highlight with special mitigation the products that support the health and balance diet as well as motivating customers towards responsible consumption and rational use of resources. If we talk about our global employees, we actually launched an online course on sustainable development. And this course has already been set as mandatory for all of our office and stores' employees. The course helps the employees to understand what sustainable development is and what X5's strategy is and really pointing out what each and every one of us can do to make it better. We are continuing to run program in the following areas: developing corporate culture and values, boosting employee engagement as well as heavily focusing on feedback channels, such as eNPS and CSI. In 2020, X5 introduced a system of grades and bands to make its position and capability requirements more transparent for everyone. We changed the way we're arranging the designed staff-break areas, so our new concept stores feature more spacious, well-equipped, more functional and comfortable staff areas. Moreover, during the COVID-19 outbreak, we were one of the first companies in Russia to arrange for 95% of our office employees to work remotely, starting from March 2020. We also managed to launch a Home Office project, enable our employees to mix office and remote work whenever they wanted to. And last but not least, for our goal of supporting local communities, we have advanced our efforts in our charity programs. That is the food charity basket and social program to Help for Lost People. X5 gathered nearly 145 tonnes of food that is over 24,000 food sets and donated them to people in need as part of our Basket of Kindness project. We also helped over 700 people return home as part of our lost and disoriented people program. Moreover, during the COVID, we have launched a number of initiatives to support our local communities. And that includes unscheduled Basket of Kindness, supply of various number of parcels where it was 3,500 parcels to doctors of redelivery of teas and coffees to the hospitals and other medical workers. As you can see, a lot has been done for each of the goals, and I can go into more detail if need. So do let me know if you have any questions.

Hello, everyone. Thanks a lot, Igor. Thanks a lot, Natalia, Yana and Elena. First of all, thanks for having me here. I guess, look, we see very big rise in interest to ESG from many companies we work with. And I think it all really boils down to 2 things: responsibility and transparency. And I think in transparency, many Russian companies do well, you know they report a lot and disclose a lot. However, it's the responsibility, I think, where the business needs to do better. And I'm thrilled to see that you followed up on your strategy and you're presenting your goals, and you've got your progress monitoring ongoing and reporting. And I think that's the appropriate approach to ESG because it's not something which can be fixed quickly, it's something which needs to be continuously worked on.

With that in mind, I think I want to ask the first question to Igor. Igor, do you observe changes in the expectations of your stakeholders with respect to sustainability? Or is it just new strategy are largely responding to interest of investors?

Okay. Thank you for the question. We see growing interest in sustainability from many different stakeholders, not just investor. For example, our customers want that we use more packaging from recyclable materials and offer more health food options. Our local communities want a responsible approach to waste and social support programs. Regulators and our employees want to actually provide safe and rewarding job opportunity. So with our new sustainability strategy, we want not only to respond to our stakeholders' interest in sustainability but exceed the expectation. In our view, this is good for business and good for our investors. So we are glad that our investors are asking more questions about ESG. We have seen interest from investors in topics like our approach to plastic waste, our corporate governance practice and our ESG rating. In return, we will continue to listen to feedback from investors, and we will keep improving the depth and frequency of our nonfinancial disclosure. Many of the regulators' priorities are also aligned with sustainability, such as legislation on product quality and the environment. The regulators also expect us to show a responsible approach to our local community, especially in the area next to our stores.

Thank you, Igor. I guess my next question is going to be about governance. Clearly, environmental and social topics often get the most attention in discussions about sustainable development. As a result, we feel that governance of the ESG often gets less attention. What is X5 doing to strengthen its governance of sustainability issues?

Firstly, it is important to say that X5 has, for a long time, followed leading corporate government practice. And in general, our strong approach to corporate governance has been recognized by rating agencies. Talking about our sustainability strategy, our Board members already have many years of experience in implementing ESG initiatives in the retail industry. We, therefore, already have strong governance structure to help us achieve our goals. Looking to the future, we understand that the growth of sustainability means that the growth of the management and the Board are changing. We, therefore, plan to review our current governance practice for ESG and to make sure we are up to date on international best practice.

Thank you, Igor. I think I couldn't miss the question about COVID. Clearly, it's a very important item on the business agenda. So with the COVID-19 pandemic, which has tested many companies, risk management systems, how would you assess X5's performance?

The pandemic clearly presented significant question and challenge for the whole world and for our company. But we at X5 is how we respond and continue to respond to the crisis. In particular, we were quick to strengthen safety measures because our #1 priority is the well-being of employee and customers. In terms of risk management, I am glad to say that our risk management department was closely monitoring the pandemic from its early stage, which helped us prepare different scenarios and take action like increasing stock of socially important goods. Also, thank you of our digital transformation project last year, we transformed around 90% on our office workers in Moscow to remote working within a week in March after the announcement of lockdown in Moscow region. We even quickly increased this figure to almost 100%. So overall, I think it is fair to say that our performance has been impressive.

Thank you, Igor. I think we have a few questions from the participants. The next one would be to Elena, I suppose. How do you plan to implement your new sustainability recommendation for suppliers and what will you do if a supplier does not adapt X5's recommendations?

Thank you for the question. You're right that our sustainability recommendation for our suppliers are not obligatory requirements -- are not yet obligatory requirements. This recommendation covered topics like environmental and social certification and packaging. We understand that implementing new sustainability practices take time, and so as a first step, we have prepared these recommendations based on things like our own policies and industry-based practices. We also did a survey of our, say, larger suppliers. As I said, our suppliers can, therefore, use our recommendations to understand our expectations for ESG performance. In terms of next step, we will monitor our suppliers' performance. Based on the result of this monitoring, we will decide how we can work with suppliers to improve ESG performance. And we are planning to make a detailed recommendation for each food categories. I can say that we will move gradually but persistently in this area.

Thanks, Elena. So the next question probably to Yana. Can you please provide some more information about X5's initiatives on health foods?

Absolutely. So if we talk about the healthy lifestyle and healthy foods, we actually see the healthy eating and a trend that is becoming more and more popular in Russia and especially in Moscow. And in general, the popularity of specialized retailers offering healthy productions is growing. At X5, we have targets to increase the share of fresh and healthy foods in our assortment, as Elena mentioned earlier. For now, we defined our first understanding of what healthy and nutrition is. However, it is only the first step and really is the driver to move toward the full picture of what healthy diet is and how the healthy platter might look like. At the same time, as I mentioned earlier, both Pyaterochka and Perekrestok launched a number of projects focused on developing special areas in our stores for healthy foods. This idea is to help customers find the healthy options more easily and inform them about the potential benefits.

Thanks, Yana. The next question, I think, Elena, maybe you'll take it. Your environmental targets were interesting. In particular, few companies in Russia are participating in renewable energy projects. How do you plan to achieve your goals in this area?

For greenhouse gas emission, our first target is 10% cut by 2023. We made this target based on analysis of opportunities for better energy efficiency. In terms of renewable energy, the industry overall is still immature, and there are very few examples of successful switch to renewable energy. We bought -- we're currently piloting the switch of 9 DCs in Pyaterochka to green energy. If they're successful, we will be moving another 5 until the end of this year. And we are also planning to pilot a transfer to another 4 in Perekrestok. We will then -- we will then have more concrete details on our renewable initiatives in the second half of the next year. It is early days, but we see great opportunities through energy efficiency and renewable energy. That's why we have set more ambitious targets to reduce our emissions by 30% by 2030.

Thanks, Elena. The next question is, what is staff turnover running at this year? Yana, maybe you'll take this one.

Absolutely. Staff turnover is actually an area where we're making a lot of progress. So in 2019, staff turnover fell to around 49% from 69% in 2018, and the unaudited figure for the first half of 2020 is 42%. Just to give you a comparison, the Russian average in the retail sector is about 50%, so we're better than the average already. We're also aiming, of course, for further improvement. For example, improving staff turnover is a part of the short-term incentive scheme for our management team. We have also developed a plan to improve HR management and recruitment and other incentive schemes. So in brief, our actions here are targeted at the different areas of our business. For example, to support our technological development of X5, which is a very sought after industry. We have focused for several years now on recruiting and retaining talented IT professionals.

Thanks, Yana. And maybe one more to you. Your target 50% of assortment to be fresh by 2023, what is it now? As the target sounds high, how realistic is it? Can customers have healthy options that are not fresh?

I think it's 2 questions here. Thank you, Andrey. So if we talk about the target for 2023, actually, a lot of work has been done to really understand the baseline right now. Right now, our number is over 30%. So what we did in order to set our target is we analyzed over 2,000 private label SKUs. We interviewed over 200 private label suppliers. Those 2 inputs helped us understand where we are now and really set the target for the future. Obviously, we're doing it together with our suppliers, so it's a joint process. In terms of our second question of healthy options, not just being fresh, you're absolutely right. So fruits and vegetables is a big part of it, and it is important, but we're aiming at a healthy food platter, so really a balanced ratio of the food that people are eating. And here, internally, we have developed a number of criteria, I would say, that help us identify what is potentially balanced for the healthy platform. However, as I mentioned, it's just the first step. So the criteria is helping us sort of drive the agenda forward. But as we are maturing and developing together, and we're doing it with a lot of stakeholders within the country, we're involving a lot of experts, nutritionists, dietitians, we'll have a better understanding of the balanced nutrition and balanced platter.

Yana, thank you very much. I've got another question for Elena. I mean we heard Igor's perspective on COVID-19 and its impact on the business and how your risk management system coped to it. Can you please comment, has COVID impacted the development of your sustainability strategy?