Barron's(9/26) European Trader: Vote For Germany Inc
(From BARRON'S)
By Vito J. Racanelli
Since the Germans appear decision-challenged, will investors get hung up? Probably not. While uncertainty hit German equities last week following the inconclusive national elections, investors in Teutonic equities should take solace from the fact the nation's corporate sector is working hard to improve shareholder returns.
The DAX index, which had been up 17% for the year prior to the vote, fell 2.5% last week. As of late Friday, the two biggest vote-getting parties, the center-right Christian Democrats and the center-left Social Democrats, were yet to come together to form a power-sharing coalition. Many believe it will eventually happen. If they don't, however, another election in early 2006 is still a possibility, so all this uncertainty has given the German market a classic dose of the jitters.
Yet Germany Inc. is getting many things right: cost-cutting, restructuring, a more shareholder-friendly approach and more flexible unions. Declares Credit Suisse First Boston strategist Andrew Garthewaite, "Corporate Germany is changing with or without politics, because it has to." Since 1999, Germany's unit-labor costs have fallen by 11%, the best performance among the big eurozone countries, he says. It's the threat of lower-cost Eastern European labor that's allowed Siemens (ticker: SI), Volkswagen (VLKAY), Heidelberger Druck and DaimlerChrysler (DCX), among others, to obtain lower labor-cost agreements. And at a number of big German companies, like those named above plus SAP (SAP) and BASF (BF), share options for management are increasingly becoming meaningful motivators for executives, he points out.
Even after the jump this year, German stocks are among the cheapest in Europe. At 1.8 times trailing book value, the discount to Europe is about 28%, much wider than the average 10% discount. The price-earnings ratio is a relatively low 13 times 2006 consensus estimates. Of course, the German 9% return on equity and 5% net income margin is lower than the European averages of 15% and 8.5%, respectively. However, if the global economic-growth cycle continues in its favor, German companies will likely narrow that gap. In the U.S., German affiliate income over the past six quarters of about $12.5 billion has about equaled the amount from the previous decade, according to the Bureau of Economic Analysis.
A political stalemate won't stop the corporate changes, adds Wendel Perkins, a money manager at Johnson Asset Management. The one sector where perhaps the election matters most, he notes, is the German utility industry. The market had built in expectations that nuclear-plant operating licenses would be extended by a Christian Democrat victory, but that could be jeopardized by a coalition government. In Deutschland, investors should worry more about the global cycle than politics. That's the real risk.
Contrast that with Italy, a country in and out of recession the last couple of years, and one whose politicians and electorate refuse to come to terms with the hard winds of Asian competition in strategic areas like textiles and shoes. Italy has few world-class-sized companies that can face up to global competition. It needs to shift its labor force as quickly as possible into value-added industries like information technology and health care, for example, in order to compete.
"Without big changes, I would expect a decade of lackluster growth, and the business sector will perform poorly," says Raffaella Tenconi, an economist with Lombard Street Research. Around 90% of the companies have less than 10 employees; they are relatively highly leveraged, using short-term loans, and they are burdened with inflexible labor laws. Since 1999, Italy has exhibited the second-largest growth in unit-labor costs.
The current government seems in disarray with the resignation of yet another economy minister last week and with an ongoing credibility scandal at the country's central bank. The 2006 budget will likely be a fudge job, with the deficit at least 4%, and perhaps 5%, of gross domestic product. This doesn't bode well for Italian treasuries. Expect them to weaken. Italian stocks are up sharply because many of the biggest companies have little competition at home and profits are up sharply, but eventually poor GDP growth will hurt them, too.
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E-MAIL: vito.racanelli@barrons.com
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DOW JONES GLOBAL INDEXES
DJ Global DJ Global DJ Global Point
Indexes, Indexes, Indexes, Chg. % Chg.
Region/
Local Curr. Wkly U.S. $ Wkly U.S. $ on From From
Country
09/23/05 % Chg. 09/23/05 % Chg. 12/31/04 12/31/04 12/31/04
Americas
297.72 -1.64 289.02 +8.70 +3.01
Brazil
4147253.39 +3.91 719.81 +4.79 508.19 +211.61 +41.64
Canada
356.91 -0.90 351.45 -0.08 291.17 +60.29 +20.71
Chile
456.80 +1.85 317.79 +0.93 271.62 +46.17 +17.00
Mexico
1118.94 +1.86 316.51 +1.51 257.25 +59.26 +23.04
U.S.
293.29 -1.88 293.29 -1.88 289.38 +3.91 +1.35
Venezuela
1394.63 -3.79 32.62 -2.33 44.20 -11.58 -26.20
Latin America
378.42 +3.09 289.84 +88.58 +30.56
Europe
255.67 -1.73 246.70 +8.98 +3.64
Austria
338.78 -1.43 318.48 -2.62 277.48 +41.00 +14.78
Belgium
331.00 +0.65 311.32 -0.57 310.88 +0.45 +0.14
Denmark
370.16 -1.19 354.28 -2.44 307.77 +46.51 +15.11
Finland
1077.99 +0.21 906.33 -1.00 833.98 +72.35 +8.68
France
277.99 -0.78 264.87 -1.97 250.47 +14.40 +5.75
Germany
222.64 -1.83 208.63 -3.01 206.76 +1.88 +0.91
Greece
290.08 -0.82 201.28 -2.02 194.13 +7.15 +3.68
Ireland
469.75 -0.27 431.40 -1.47 470.83 -39.44 -8.38
Italy
276.23 -0.78 213.35 -1.97 218.12 -4.78 -2.19
Netherlands
301.40 -0.98 282.59 -2.18 279.43 +3.16 +1.13
Norway
308.09 +1.06 285.41 -0.15 228.18 +57.24 +25.08
Portugal
218.16 +0.53 178.05 -0.69 196.83 -18.78 -9.54
Spain
411.86 +0.85 291.01 -0.37 279.70 +11.32 +4.05
Sweden
464.58 -0.15 352.73 -1.73 348.90 +3.82 +1.10
Switzerland
395.50 -0.37 416.11 -1.82 393.81 +22.29 +5.66
United Kingdom
226.69 +0.04 215.48 -1.48 207.29 +8.20 +3.95
South Africa
237.37 -1.28 218.73 +18.64 +8.52
Pacific Region
117.53 +0.57 108.59 +8.94 +8.23
Australia
309.09 +0.32 308.38 -0.82 280.65 +27.73 +9.88
Hong Kong
274.33 +0.36 274.98 +0.38 255.81 +19.18 +7.50
Indonesia
343.40 -3.45 66.90 -4.16 72.51 -5.61 -7.73
Japan
88.04 +2.09 97.96 +1.34 90.60 +7.36 +8.12
Malaysia
169.25 +0.01 122.21 +0.04 120.69 +1.52 +1.26
New Zealand
183.03 -1.08 232.46 -3.52 235.08 -2.63 -1.12
Philippines
201.46 +2.50 93.05 +2.39 84.18 +8.87 +10.54
Singapore
176.51 -0.51 169.73 -0.70 158.63 +11.10 +7.00
South Korea
238.05 -0.21 175.14 -0.21 131.98 +43.16 +32.70
Taiwan
148.54 -1.80 115.40 -2.50 124.68 -9.29 -7.45
Thailand
134.32 +2.78 77.07 +2.61 72.96 +4.11 +5.64
Euro Zone
253.62 -1.93 247.53 +6.09 +2.46
Europe (ex.U.K.)
276.21 -1.88 267.19 +9.03 +3.38
Nordic Region
404.87 -1.44 375.84 +29.03 +7.72
Pacific Region (ex. Japan)
229.62 -0.74 211.79 +17.83 +8.42
World (ex. U.S.)
184.87 -0.69 172.72 +12.15 +7.04
DOW JONES WORLD STOCK INDEX
222.91 -1.27 214.00 +8.92 +4.17
Indexes based on 12/31/91=100.
2005 Dow Jones & Co. Inc. All Rights Reserved.
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