Germany, the sick man of Europe, is far healthier than feared

In September I travelled to Munich to participate in Berenberg’s 12^th German corporate seminar. The goal of the trip was not to visit Oktoberfest but to get an idea of “sick man of Europe” Germany and to deepen my knowledge of several German companies, both existing investments and potential new ones for the future. Over three days, I had the pleasure to meet the top management of some 20 companies mainly in sectors such as IT and digital services, industrial technology, automotive, healthcare and consumer. In general, it was noted that despite somewhat poorer development in the overall German economy, the companies continue to develop reasonably well. Some weaknesses in the order books could be seen, but a consistently good price picture, falling raw material prices and input costs combined with falling energy prices are still contributing to good profitability. As inventory destocking, because of the Covid pandemic, are being dealt with, companies are seeing a normalization of demand and improved cash flows. These in turn bode well for a future recovery, when we once again see rising demand for the companies’ products and services.

Today, German small and micro-caps are trading at a price earnings ratio (pe) for next year of some 12x, which is about 20% below the historical average. Economically, the worst should be over in 2024 in terms of the construction and housing market and given that German employment has developed very strongly since 2004 (core employment from 26m to 35m as of today), the German consumer remains strong. We are therefore confident about the German stock market and in particular German small and micro companies as the inflation rate slows down and investments in the country and in the rest of Europe should pick up again during next year. The “energy crisis” that everyone feared in the autumn of last year should also be solved as of today. The public and the private sector continue to invest in energy solutions as well as in cost-efficiency measures in IT and digitalization.

Most German industrial technology companies should benefit from an increase in local investments (near- shoring) in Europe in the future. A trend we see accelerating as a result of the current geopolitical situation. Also previous supply chain problems and the current environmental focus supports local production.

We thus see Germany doing better than feared as a result of

1) record high employment

2) comfortable economic strength and fiscal policy

3) strong Mittelstand corporate segment

4) country tackling key challenges such as energy supply, digitalization, housing construction and infrastructure investments -the government has just presented a 14-point program to create growth in the country, of which one measure relates to housing construction

5) Germany’s dependence on China should decrease in the future combined with a future cyclical upswing in the European and US economies

Thus, Germany, which entered a weaker economic period first, should be the first European nation to come out on the other side when things improves. Here we as investors should remember that the stock market has historically always reacted 6-9 months ahead of the real economy.

Our conclusion is that Germany may not be the superstar we have seen in the past, but it is still in much better shape than the pessimists say.

During the trip, I met with the following portfolio companies: IT and software companies Datagroup and Adesso, industrial technology companies PVA Tepla and Stemmer Imagine, pharmaceutical producers PharmaSGP and Dermapharm, and building materials company Steico, to name a few.

Adesso, which develops software and IT service solutions for sectors such as insurance, banking and finance, healthcare and manufacturing industries, continues to show good growth. The company has continued to hire IT experts as demand has increased despite the fact that the German economy is generally somewhat weaker at the moment. The company continues to see good demand among small and medium-sized companies. The demand for more cost-effective solutions is something that is consistently prioritized despite the economic situation. Another of our investments OTC drug manufacturer PharmaSGP has in recent years shown a profit growth of impressive 20% p.a. driven by the consumer’s desire to focus on their health and well-being combined with an increased demand for local European products. The company’s strategy of distributing its products through online pharmacies such as Dr Morris and ShopApotheke has proved to be a successful strategy. Today, the company’s share is trading at a price of 14x 2024 earnings estimate, which given the company’s earnings growth, seems very attractive in our opinion.

After three days in Munich, I flew home with the conviction that Germany is far healthier than we feared. We also have a bunch of strong niche companies in our luggage. Niche players that should ride out the storm in a confident manner and most likely succeed in gaining market shares and further strengthening their position in the coming years. These companies should develop well when demand picks up again in 2024 and 2025. This bodes well for German small and micro cap stocks in the years to come.

Kenneth Blomqvist
Portfolio Manager, Fondita Small Cap Funds