Photographer: Andrey Rudakov/Bloomberg

Big Western Companies Are Pumping Cash Into Russia

  • Ikea, Leroy Merlin invest in new stores, betting on growth
  • After two years of recession, consumers seen bouncing back

Even before the U.S. presidential election raised hopes of warmer ties with the Kremlin, some big Western companies were betting Russia’s economy will soon come out of the deep freeze.

Big retailers like Sweden’s Ikea Group and France’s Leroy Merlin SA have begun pumping billions of dollars in new stores and factories, counting on Russia’s consumers to start emerging from hibernation after two years of recession. 

Ikea is putting $1.6 billion into new stores over the next five years or so. Leroy Merlin in September announced a 2-billion-euro plan to more than double the number of outlets in Russia over the same period. Pfizer Inc. is building a new drug factory, while Mars Inc. is expanding plants for chewing gum and pet food.

“This is the moment for investment,” said Walter Kadnar, country head for Ikea, which last launched a new store in Russia five years ago but this fall opened a $60 million furniture factory near St. Petersburg and acquired land for a third Mega mall near the city. “I strongly believe in the potential of the Russian market long-term.”

Situation ‘Changing’

Foreign investment all but ground to a halt as the country sunk into recession and conflict with the West over the last two years. Companies including General Motors Co. slashed local operations. For many of those who stayed, now is the time to reopen their wallets to get a jump on rivals. The ruble’s plunge, though it decimated the value of local earnings in dollars and euros, has driven production costs in Russia down sharply. By some estimates, they’re now lower than those in China.

Read more: Putin’s popularity and the economy -- QuickTake

“The last 2-3 years have been a disaster,” said Frank Schauff, head of the Association of European Businesses in Moscow. “Now, the situation is changing as the ruble exchange rate has stabilized and the Russian economy is forecast to return to growth soon.” 

The government said its annual meeting of foreign investors in September drew the most top executives in a decade. Foreign direct investment surged to $8.3 billion in the first nine months of this year, more than the $5.9 billion reported for all of 2015, according to central bank data.

That’s still far below the levels seen before the Ukraine crisis, which together with U.S. and European Union sanctions and the plunge in oil prices and the ruble made many big companies reconsider investing.

Still, the rise in foreign investment is a modest bit of good news for the capital-starved economy. Overall, businesses in Russia are still holding back on expansion, with capital investment down 2.3 percent in the first nine months of this year. The government expects only a tepid recovery with growth of 0.8 percent next year. The middle class -- the target market for most big foreign investors -- has shrunk by 14 million people over the last two years, according to Sberbank CIB, a local investment bank.

Geopolitics Optimism

Alexis Rodzianko, president of the American Chamber of Commerce in Russia, said geopolitical tensions have been a big deterrent for potential foreign investors. 

The election of Donald Trump, who praised President Vladimir Putin and questioned the sanctions during the campaign, could change that. “Trump has a more open mind regarding the U.S.-Russia relationship,” Rodzianko said. “It’s clear there is room for improvement and that in itself is hopeful.”

Read more: a QuickTake explainer on Putin and Trump

For those companies not put off by the chilly political winds, adapting to the plunge in the ruble’s value -- it’s down about 50 percent since the crisis began in early 2014 -- and the drop in Russians’ incomes has required some ingenuity.

Ikea is selling fewer big-ticket items like kitchens and more pots and gadgets for Russians who increasingly cook at home because they can’t afford to go out. At the malls it owns, managers note the “lipstick effect’’ -- makeup and lingerie stores are thriving as consumers treat themselves to lower-cost luxuries, while those that sell more costly clothes and shoes have seen sales plunge.

Ikea and the other big foreign players say their sales have actually gone up in ruble terms over the last two years. Overall, retail sales in Russia are down 5.3 percent this year, having dropped 10 percent in 2015.

“We are seeing signs of improvement,” PepsiCo Inc. Chief Executive Officer Indra Nooyi said in September. Even after the plunge in the ruble, Russia remains the company’s third-biggest market after the U.S. and Mexico. The company expanded cheese output after the Kremlin cleared the market by banning most imports. This month, it announced plans for a new $40 million baby-food plant in southern Russia.

Ford Motor Co. said this month it sees signs of a rebound in car sales, which had been hit especially hard by the recession.

French do-it-yourself retailer Leroy Merlin says its same-store sales are up 5 percent in ruble terms as Russians turn to its low-cost products.

‘Long-Term Approach’

“We are taking a long-term approach, economic growth is set to return, and we are already seeing some improvement,” said country head Vincent Gentil.

Foreign companies are also increasing local production to capitalize on the ruble’s drop. Ikea aims to bring the share of Russian-produced goods to 80 percent in the next few years and is already exporting Russian-made folding beds to China and linen curtains and wood furniture to Europe.

Of course, the legendary local bureaucracy remains a problem for many investors. Although Russia has moved up in international rankings for ease of doing business, big foreign players often seem to be targeted.

Wracked by conflicts with local authorities and corruption scandals, Ikea has threatened at least twice since it came to Russia to suspend all investments. Last month, it faced a criminal probe on a five-year-old tax claim the company said it paid in full. The company is also fighting lawsuits relating to deals that date back to the 1990s.

“It slows us down and distracts us when these old cases come back that we’ve already resolved and paid for,” said Milen Gentchev, who heads Ikea’s shopping-center unit in Russia. “But that doesn’t influence our confidence that Russia is a market we should be in.”

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