Gaming the Gamers

High-Level Whining

daimler in USA_reuters-DISTORTED
Daimler boss Dieter Zetche. Companies with a strong presence in the U.S. will fare well.
  • Why it matters

    Why it matters

    Major German corporations are lowering expectations for their future performance. They are doing so to avoid disappointment, but most companies are in a relatively strong position.

  • Facts

    Facts

    • Handelsblatt companies’ expert, Ulf Sommer argues that lower profit targets are not a reason to be concerned about DAX companies’ future performance.
    • Despite companies announcing lower expectations for 2015, share prices held steady.
    • Only companies that do not have a presence in the United States have reason to worry over future earnings, he argues.
  • Audio

    Audio

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Many of Germany’s large industrial corporations are using their third-quarter business results to prepare the public for lean times ahead.

Executive boards are lowering forecasts for next year, or they are tempering expectations by holding out the prospect of only minor increases in revenues and profits. Last Thursday, sporting goods maker Adidas announced that it expected growth to decline in 2015. Lanxess, a specialty chemicals company, is slashing 1,000 jobs to achieve future savings in the triple-digit millions.

But instead of plunging, share prices are holding up surprisingly well. In fact, Adidas has been one of the biggest winners on the market. Are shareholders simply refusing to believe what executives are telling and showing them? No, shareholders are interpreting executive caution as high-level whining – and they’re right.

Companies are determined not to make the same mistake again of setting expectations too high and then being unable to meet them. A year ago, analysts expected the 30 companies listed on the DAX, Germany’s blue-chip stock index, to increase their net profits by at least 15 to 20 percent this year. Such hopes were fueled in part by the companies themselves, which were feeding analysts their optimistic outlooks and numbers. In reality, profits will increase at no more than half the rate predicted at the beginning of the year.

Companies have learned from these miscalculations. Given the mixed economic outlook in Europe, they are setting the bar lower than they did last year, to avoid falling short of expectations. From Europe’s largest chemical manufacturer BASF to software giant SAP, industrial gas supplier Linde and Lufthansa, all are trimming back their targets, which in turn leads the financial markets to gradually lower their earnings expectations.

 

Stagnating Profits at German DAX companies overview 2000-2014

 

This time, the unanimous message is that the economic environment is becoming weaker. As a result, ambitious assumptions for the coming years, some of which were published much earlier, such as those Linde’s former chief executive, Wolfgang Reitzler, left to his successor, are no longer realistic.

The economy is too weak in Europe, where German companies that rely heavily on exports still sell a large share of their products.

Meanwhile, China can no longer offset the weaknesses of Germany’s neighbors as effectively as it did in the past. In China, German companies are no longer seeing revenue and profit grow by double digits, but in the high single-digits instead. 

If companies are cautious today in their predictions for the future, those predictions are not harbingers of a recession in Germany or a sharp drop in corporate earnings.

Still, the effects of this slowdown are limited.

There are no signs that the weaker economy and geopolitical crises in Russia and the Middle East will adversely affect corporate balance sheets in the long term – as was the case in 2002, a crisis-ridden year in which the 30 DAX companies combined did not even achieve a net profit, or in 2008, when net profits declined by 65 percent over 2007, a boom year.

In 2014, the majority of publicly traded German companies will earn only slightly more in the first (DAX) and second (MDAX) tier than in 2013. This is also the timetable for 2015, if these companies’ cautious forecasts are to be believed.

The only German companies that could face real difficulties are those that are underrepresented in the United States, making them unable to benefit from the growth and sales boom there, such as truck manufacturer MAN.

But MAN is one of the few exceptions. Most major German companies expanded their involvement in the U.S. market early on, including BASF and the three carmakers, BMW, Daimler and Volkswagen – knowing full well that the world’s biggest economy was only expanding its dominant position.

Therein lies the true strength of German companies: To bet on tomorrow’s markets early on by setting up their own production and research facilities there, which enables them to achieve disproportionate increases in sales and profits. After the turn of the millennium, these markets were Asia, primarily China, and now, 10 years later, they include the United States.

The bottom line is that if companies are cautious today in their predictions for the future, those predictions are not harbingers of a recession in Germany or a sharp drop in corporate earnings. Instead, they signal a slowdown to historically normal rates of between 5 and 7 percent – rates that seem realistic for this year and for 2015.

Ulf Sommer covers companies and markets. To contact the author: sommer@handelsblatt.com

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