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Introduction

I do not think I need to explain to you what is going on in Eastern Europe right now – you probably know it from the front pages of every media outlet in the world. The stock market cannot stay away from geopolitics – it has always been that way and will probably remain that way in the future. Our task as investors is to react to what is happening in good time and to leave emotions aside, even if this sometimes seems to be asking too much.

Today I want to tell you about an interesting case that I think presents a compelling opportunity if you have ever thought about investing in emerging European markets. I know that the background for this is not the most favorable now, but every crisis brings a number of investment opportunities. The main thing is to find them. And it seems that I have succeeded in doing just that.

Thesis

Suspension of U.S. trading of Ozon Holdings PLC (NASDAQ:OZON), one of the largest e-commerce platforms in Russia could push growth investors towards another major player in the sector – Polish Allegro.eu SA (OTCPK:ALEGF), which is traded both in the USA (OTC) and on the Warsaw Stock Exchange.

Allegro’s share price dynamics, taken from the company’s IR

My Reasoning

For many Western investors, Ozon’s entry onto the Nasdaq was an opportunity to invest in one of the world’s fastest-growing e-commerce markets, and one where Amazon (AMZN) had yet to establish a significant presence.

Russian online orders, translated by the author

What’s unusual about Russia’s e-commerce landscape is the absence of Amazon.com Inc. Facebook Inc. (FB) and Google (GOOG) have made inroads, but Amazon and many other big overseas companies have been slow to invest in a country that has laws restricting foreign ownership and is under international sanctions for its annexation of Crimea. Even Alibaba, the biggest foreign operator, has only tiptoed in, mostly selling imported goods directly to consumers rather than investing in its own operations in Russia. One big advantage for the outsiders is that they’re not required to collect the country’s 18 percent value-added tax on purchases below about $1,100. “Logistics in Russia are difficult,” says Fedor Virin, a partner at researcher Data Insight. “The cross-border model, without establishing a physical presence, has been the most successful strategy for international online retailers.”

Source: Taken from Bloomberg’s article, dated Nov. 15, 2018

Ozon’s business has long since looked promising in terms of operations growth, which started before the pandemic but intensified in 2020 amid lockdowns and various pandemic-related restrictions. The company’s pace of growth has continued to accelerate even after restrictions were lifted.

Author’s calculations, Ozon’s IR materials

The Russian e-commerce market initially developed with a lag compared to the Western one. When Russians had no choice but to switch to online marketplaces during the lockdown, a significant proportion of customers chose to stay with e-commerce as their preferred shopping method even after the end of quarantine. This explains Ozon’s continued GMV growth momentum after most restrictions were lifted in Russia:

Ozon ended 2021 with a sales turnover (GMV, including services) of 448.3 billion rubles, up 127% from a year ago. The number of orders from marketplace more than tripled during this period and exceeded 220 million.

Source: Tadvisor, author’s translation

Though the company remains unprofitable as it continues to pump investments into infrastructure growth, it seems to be on track to close this gap. Throughout the period of rapid growth and business expansion, the most important thing for Ozon has been boosting sales and market share – and according to the dynamics above, the company is succeeding in that regard. In an e-commerce market that isn’t dominated by a few top players, as is usually the case in the West, Ozon had good prospects of becoming the Russian Amazon.

However, no one has canceled the political risks of doing business in Russia. Ozon, like many other Russian companies, has been affected by Western sanctions. First, by an apparent mistake: the U.S. imposed sanctions on Ozon Bank, the company’s financial subsidiary. The U.S. Treasury Department later lifted the sanctions after the company disputed their validity. At about the same time, Nasdaq unilaterally restricted trading shares of Russian companies including Ozon, which mainly affected its international investors (both in shares and in bonds, as the halt of trading triggers certain covenants for them).

Suspension of Ozon shares trading on NASDAQ entitled the holders of convertible bonds to require redemption of their bonds at principal amount. The company hired professional consultants including Alvarez & Marsal to cope with the situation while a large group of bondholders engaged investment bank, Houlihan Lokey, to conduct negotiations with the company for them. According to the latest disclosure, Ozon has entered into discussions with a group of bondholders and their advisers on the “consensual restructuring” of the debt.

We aim to be in a position to enter into a standstill agreement with a significant number of holders of the Bonds in the near term with a view to continue such discussions and to reach an agreement on the long-term restructuring of the Bonds within the current financial year.

Source: Ozon’s Annual Report (2021) released in early May.

Ozon has sufficient cash to keep business running from OPEX and CAPEX perspectives, as the money is kept in Russian accounts. On the other hand, bonds were issued by the company’s holding company in Cyprus, and transferring capital between Russia and Cyprus is restricted these days due to new capital control measures introduced by the Kremlin in response to sanctions. In these circumstances, restructuring the bonds looks like a win-win solution for both bondholders and the company which may continue to execute on its strategy without critical disruptions.

Despite geopolitical tensions, Ozon remains solid as a business and seems well prepared to weather this storm. The company still plans to increase sales turnover by at least 80% this year. The company’s logistics infrastructure is set to expand by a third in 2022 as the bulk of investments to allow this expansion was made last year, while this year the management will focus on cost efficiency. In other words, Ozon remains one of Russia’s top growth stories – even if Western investors are currently barred from taking part. But until we gain more clarity on the geopolitical situation and the future of Russian stocks, foreign investors will probably be looking elsewhere to build their portfolios.

This is the main argument of my thesis – large investment funds (institutional ownership in OZON stock equals >31%) will likely be more cautious in selecting the components of their portfolios under the current circumstances and avoiding exposure to Russia. In this situation, investment capital from large funds is likely to flow to nearby geographic areas with similar demographics and end-market dynamics, but with much lower risks. Poland, in my opinion, can replace Russia in this regard, and Allegro can replace Ozon.

Why Poland? First, this country is a member of the European Union, and therefore the political risks for investors there are much lower than in Russia. As I said, I think this is very important for institutional capital in the current conditions. Secondly, the e-commerce market in Poland is growing quite fast – the projected 5-year CAGR of the market’s revenue is 11.97%, according to Statista:

Statista, author’s notes

Allegro operates through a number of its subsidiaries on the territory of Poland: Allegro.pl, Allegro Pay, Allegro Finance, Ceneo.pl, eBilet Polska, Opennet.pl, X-press Couriers, and SkyNet Customs Brokers. The broad diversification of the business units allows the company to grow evenly but quickly while building its own ecosystem. We can judge the results of this approach from the last annual income statement:

Allegro’s income statement

For 2021, the company reported revenue growth of 33.9% (YoY), managing to keep direct and indirect costs from spiking too much. Operating profit increased by 31.2%, net profit by 160.3%. The observed discrepancy in net income growth is explained by the absence of write-off of deferred borrowing costs, as was the case in 2020, and higher financial income (+577.2%, YoY).

Allegro’s cash flow statement

Using the statement of cash flows, we see how working capital changes steadily – the growth of inventories and accounts payable on the balance sheet is even. In addition, the company is not increasing receivables as much as it is increasing payables, which is also a good sign – Allegro is generating more free cash flow that it can put into further business development.

And business development is precisely the company’s aim: CAPEX almost doubled in 2021 compared to the previous year. Of course, this is partly due to the low base effect, but it is clear that Allegro has, and is very likely to have in the future, the opportunity for global expansion that management is seeking, primarily because of its profitability and the absence of the need for debt financing or shareholder dilution.

Allegro’s plans to go international, the company’s website

In my opinion, Allegro has every chance of attracting the most attention from institutional investors of developed capital markets – when one Eastern European market closes, a replacement can always be found. The same goes for the most promising companies in these markets.

Risks And Bottom Line

The biggest risk of my thesis is the risk of a wrong choice. Allegro may not be the best option to divert investors’ attention from Ozon and Yandex. Nevertheless, in my opinion, the company has every chance of becoming one precisely because of its fundamental attractiveness.

Another risk you should keep in mind is the strained economic situation in the world, especially in Europe. The war inevitably leaves serious economic problems that European companies, including Polish ones, might have to deal with in the near future. This could limit growth and challenge Allegro’s plans for international expansion.

In any case, I do not doubt that the process of institutional capital flow has already begun. Russian issuers are now effectively cut off from Western financing, and Western investors will continue to look for a replacement – Polish companies seem to me to be the most suitable option, both politically and demographically.

Ozon continues to grow rapidly today, gaining an ever-increasing share of the Russian e-commerce market. Investors liked that – up until geopolitics got involved. Against this backdrop, Allegro seems like an obvious option to replace Ozon in the portfolios of institutional investors – their domestic markets are generally very similar, the company is growing fast and generating profits, and has ambitions to go international. Moreover, the company’s shares are quite liquid on the Warsaw Stock Exchange, to which all Western investors have access. Therefore, I recommend paying attention to Allegro, considering how much the stock has corrected in the past year – if the recession scenario does not materialize, the company’s shares could become favorites for recovery.