Economy 18 November 2014, 5:10pm

Hungarian gov't could blow Spar and Auchan out of the water

Portfolio

A new bill submitted to Hungary’s Parliament by Economy Minister Mihály Varga can seriously rearrange the commercial retail market. New legislation would benefit Hungarian players, whereas its message for the foreign-owned chains is clear: You either start to make profits or it will be doom and gloom for you here. The cabinet assumes that the foreign-owned players are deliberately in the red, that they have been incurring losses merely for competition policy reasons. If the affected companies want to adjust to this situation, they have three years to show profit. However, they are to achieve this while they are subject to a massively raised supervision fee that retail chains must pay. Considering this, it seems the multinational retail chains have come a full circle. What can they do with their heads in the vice?

Varga submits tough proposal

A new bill submitted by Varga to Parliament landed with a loud bang. The law would set new regulations for the retailers of fast-moving consumer goods (FMCGs). It states that “that commercial business which: a) generates more than half of its net revenues from the sale of FMCGs
b) has net sales revenues of any two consecutive business years of at least HUF 50 million each;
c) has zero or negative balance sheet earnings in both years defined under section b)

may not conduct retail activity of FMCGs after the approval of the earnings report of the second business year as defined in section b)" ".

As to every rule there are exceptions here, as well.

the above rule is not applicable in the first four business years from the establishment of the commercial business.

This section of the law would enter into effect on 1 January 2018.Three strikes

This would be the third strike to the FMCG sector in a short time. Lawmakers have just approved a major hike to the supervision fee for food retail chains. For Spar only this would increase burdens by HUF 8-9 billion annually.

Parliament is also to discuss a proposal by the Christian Democratic People’s Party (KDNP) that seeks to ban stores from opening on Sundays and holidays, which would also deal a blow to retail chains.

Who is the government threatening?

The legislation proposed by Varga would leave locally-owned chains (CBA, Coop, Reál) unscathed, because most of their facilities operate as separate business units therefore their annual revenues are way below the HUF 50 m threshold. According to the online company database of the Justice Ministry, however, all of the multinational retail chains have annual revenues north of the HUF 50 m mark.

Consequently the new rules would apply to them from 2018. The reason for this, as the cabinet explains, is exceedingly simple: because they can afford it. Yes, the proposal states capital-strong retail chains can afford themselves to make losses by keeping their prices low. And, unfortunately for them, they have pissed off the cabinet for crippling smaller rivals with such low prices.

What can the companies concerned do?

1. If they want to comply with the regulations they have no choice but to swing their Hungarian operation back to the black by 2018. In our view, this may be achieved the following ways (more than one action is possible at once):

a. They will boost revenues , and raise prices in the meantime. This move would benefit those competitors that will not be subject to the new rules, but consumers that could buy these products at lower prices at these foreign-owned retail chains will have to dig deeper into their pockets. As a result of the profitable operation the state budget would have larger tax revenues, which would definitely be a positive consequence.

b. They will reduce operating expenses: in practice this could mean layoffs, the closure of stores and cancelled expansion and investments (SPAR Hungary said today that such countermeasures were indeed among their options). If a whole sector reacted this way, the economy would definitely take a hit too.

We should highlight at this point that if the companies in question turn profitable again, the cabinet’s other blow will start to hurt more. The higher supervision fee, which could easily send these companies back where they started: into losses. And they have practically come a full circle.

2. They may decide they do not want to comply with the new rules and exit Hungary. This would lead to the loss of jobs and competition would be weaker, which would once again be detrimental for the consumers.

3. The third option for multinational retail chains is to try and circumvent the new regulation , i.e. reorganise every single store into separate business units, as if they were operating a franchise.

The counter action

At first glimpse it might seem a logical step that the multinational retail chains start to invest and expand in the following period (in the remainder of 2014 and in 2015) in order to make the bed for a revenue boost and profitable operation in 2016 and 2017. As far as we see the proposed rules, these are those two years when these companies should post profits to avoid the Sword of Damocles (sorry, Varga).

However, expansion in 2014-2015 and achieving a positive balance sheet are to be hindered by other government measures: the companies will have to generate resources for the much higher supervision fee payable by food retail chains and there are also restrictions on constructions (the ‘mall stop’ and the expulsion from world heritage areas).