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Germany: strength in depth

Germany: strength in depth

  • 31Aug 17
  • Ben Ritchie Head of UK and European Equities

This autumn, Germany heads to the polls. Ahead of September’s vote and amid heightened speculation about what the migrant crisis might mean for Chancellor Merkel’s declining popularity, the potential outcomes will receive great scrutiny. But although Merkel may yet lead the next grand coalition, we don’t expect the fortunes of Germany's leading businesses to change dramatically.

Whatever combination of parties forms the next government, we expect the long-term prospects of those companies to rest on their enduring competitive strengths and the key strategic decisions that their managements take.

Certainly, Germany’s current political and economic backdrop is favourable for its businesses. With political influence shared across a coalition of ruling parties and limited support for the Eurosceptic and right-wing populist Alternative für Deutschland (AfD) party, the risk of a major political shock appears limited. Meanwhile, the strong domestic economy, weak euro and ongoing economic recovery in the Eurozone remain supportive for GDP growth.

… the real attraction of Germany’s equity markets lies in the strengths of the companies themselves.

Although this stable background is welcome, the real attraction of Germany’s equity markets lies in the strengths of the companies themselves. Many of Germany’s largest companies are global household names: Siemens, Bayer, BASF and BMW, for example. For decades, the country has been exporting its technical and engineering expertise across the globe, and it is now the world's second-largest exporter after China. There is every reason to expect this to continue, given German companies’ market-leading positions and sustained operational excellence.

But beyond the export giants lies a deep pool of medium-sized and smaller businesses commonly referred to as the Mittelstand. These mid-sized companies are much less well-covered than those traditionally associated with Germany’s industrial might and are often overlooked. But a full 99% of German companies fall into the Mittelstand category, and they have played a significant role in the country’s economic success.

One interesting feature of the Mittelstand is that many are controlled by their founders or their founders’ families. Some investors might be put off by the large family-owned stakes that are common among mid-sized German companies. But we view this as a positive feature. Family owners tend to run their companies with an eye on the next generation, aligning their interests with other long-term investors. This long-termism is reflected in their handling of issues such as capital investments, workforce relations (with a sensible approach to executive pay) and the conservative use of financial leverage.

Germany also offers a variety of regional hubs with different specialities and strengths. Take Berlin, for example. While the capital stands apart from the country’s industrial heartland, it embodies Germany’s rich history of innovation, science and education. The city’s complex history has fermented a curious combination of lingering anti-capitalism (it was the scene of some of the 1960s’ most subversive European movements), corporate energy and technological effervescence. Berlin’s world-class education system and unusually young and multicultural population are now contributing to the emergence of a new generation of start-up technology companies.

A good example here is Zalando. This Berlin-based company has become Europe’s leading online fashion retailer, exploiting its first-mover advantage, sizeable European customer base and long list of well-known brand partners. This powerful combination suggests a virtuous circle of growth, underpinned by consumers’ insatiable demand for the choice and convenience that online retail brings.

Some 380 miles from Berlin, the university town of Heidelberg, is home to the global ERP (enterprise resource planning) software behemoth SAP. Meanwhile, Hamburg is the headquarters of Xing, the leading social network for professionals in the German-speaking DACH area (Germany, Austria and Switzerland). Xing is successfully monetising a growing base of paid-for subscriptions while selling innovative ancillary services to recruiters and employers.

Munich’s Nemetschek is a pioneer in 3D design software that serves the architecture, construction, and building-management sectors. The company is growing fast as customers are increasingly automating and adopting building information modelling, having lagged most other industries here considerably. And in Göttingen, Sartorius is another market leader in a niche area. It supplies the fast-growing biotech industry with critical equipment and consumables for the development and manufacture of biologic drugs used to treat cancer and autoimmune diseases.

So, while we expect plentiful analysis of political permutations in the run-up to the election, we think that investors should ignore the election ‘noise’ and focus instead on identifying the best businesses that Germany has to offer. There is certainly no shortage of attractive candidates: robust and well-run companies operating in both traditional and less established industries. We are confident that their competitive strengths will endure far longer than the term of the next German government.





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