Bottom Fishing in Sick Man's Land

A Winter's Tale on Germany and German companies

Disclaimer: This is not investment advice. The author is long some of the companies mentioned in this article. He may buy or sell more shares at any time. The views expressed are his own and the information provided is not to be relied on. Please do your own research.

Im traurigen Monat November wars
Die Tage wurden trüber
Der Wind riss von den Bäumen das Laub
Da zog ich nach Deutschland hinüber

It was in the dreary month of November,
The gloomy days grew shorter,
The wind tore the foliage off the trees,
As I approached the German border.

The lines conveying such a dark mood when approaching Germany in late autumn were redacted by one of the most famous German poets, Heinrich Heine. They mark the start to his masterpiece “Germany. A Winter’s Tale” , an account of Heine’s journey from his exile home of Paris via Cologne to Hamburg where his mother lives in the winter of 1843. The epic poem is full of irony, humor and criticism about the political, societal and economic circumstances in Germany which at the time was not politcally unified but a loose construct of about 36 states. I delightfully read the Winter’s Tale once a year. In the Winter of 2024, Germany is clearly in much better shape than 1843, but the atmosphere in many places and for sure the sentiment on social media is just as sombre.

So how bad are things in the Germany of 2024?

And, to be sure, a lot of things are not going well in Germany, due to a combination of a more diffcult economic environment and a number of self-inflicted problems. Here is a selection of major issues:

• The economy has barely grown from pre-Covid levels. We are likely to see a slightly negative growth rate for the second year in a row. One perception is that there are too little incentives to work, i.e. the welfare state is too generous and taxes for achievers are too high. There is also a feeling of an overarching and outdated bureaucracy which slows down economic activity of any kind, including private investments.

• A lot of people think that the country has not invested enough in projects which will benefit us in the future, in particular in schools/universities and infrastucture. There is a clear understanding that we will need to spend more on defence going forward, given that the German army needs to get more prepared than it is given the challenge posed by an aggressive Russia.

• Energy prices are high as Germany still heavily relies on the import of fossile fuels. We have abandoned nuclear power earlier than any other country and while the buildout of renewables is happening, it is a lenghty and costly process. At the same time, we are upholding ambitious targets to decarbonize.

• The ageing of the society is taking a toll. Some companies find it difficult to replace retiring employees with qualified younger ones. The public schemes of health insurance, pension insurance and nursing care insurance are facing increased expenses.

• There a diffuse sentiment that the “country does not work anymore”. People sense a loss of control over migration, lack of reliability at Deutsche Bahn, or perceived or real increase in crime.

• The “German model” of an interconnected economy which trades with everyone across the globe is challenged by ideas like protectionism or economic nationalism.

• Finally, the German “traffic light” coalition just broke, leaving a government without majority in the Bundestag. Germany, proud of having been politically stable for decades is currently run by a lame-duck government at a time of immense challenges. New elections are scheduled for 23 February.

All of these problems are real and we could add a few more. So is Germany in terminal decline and forever doomed? For several reasons, I do not think so. The primary one is that a lot of reckoning has already taken place. While over the past decade, a number of problems were ignored just because it was possible and the overall situation still seemed okay, this is just not an option anymore. There is pressure to act and the overall analysis of the problems is shared by most politicians of the mainstream parties. Also, given that a good bunch of the problems have been self-inflicted, it means that improvements can be achieved with the correct measures. Germany has been in a tough economic spot before, most recently around 2003 when a number of reforms labelled as “Agenda 2010” managed to unlock the potential of the country. I believe our system is flexible enough to develop solutions for these challenges.

Also, it is not all bad. While incentives are imperfect, people get up for work every day, there are prospering businesses and the substance of the country is still strong. Germany still has a AAA credit rating and one of the lowest public debt levels of developped countries.

A chance for contrarians?

If you have read until here, you may start to become slightly bored because you probably read this blog for investing ideas rather than economic policy. Yet, to a large extent, the mood in German businesses and in the German stock market resembles that feeling of stagnation and agony depicted above. And you can see it in the stock prices. When I started investing, I tried to make sure to avoid a home bias and look for shares internationally. My contrarian instinct makes me sympathize with whoever has been beaten down, like the “Club Med” (in particular Greece) in the euro crisis. My observation is that a disproportionate number of bargains can be found in countries where the macro looks gloomy. These days, it seems like the US stock market, in particular, big tech, in particular anyting related to AI and cypto, in particular NVIDIA and Microstrategy, is shining while the rest of the world underperforms. Some bloggers have picked up the theme like the excellent Guy Davis at Superfluous Value for who looked at “UK Carnage”.

And with Germany facing all the issues described above and being the official “sick man” within the “museum” of Europe, here comes a selection of companies which have suffered a lot. They have been and may very well continue bad investments. Still, at Augustusville we try to be contrarian and engage in bottom-fishing. We also do not mind catching a falling knife here or there. What still matters is that we try to find companies, large or small which are growing or have a path to grow and on a normalized basis generate good returns on capital. The selection is not exhaustive, so please feel free to add. Here we go:

Bayer AG: A few years ago, the producer of drugs, pharmaceuticals and crop sciences used to be Germany’s most valuable company. Then this happened:

In 2018, Bayer acquired Monsanto and became a company burdened with debt and litigation cases due to the controversial product, glyphosat. Bayer paid 63b USD for the Monsanto equity back then, similar to today’s equity value. Prior to Mosanto, Bayer generated double-digit returns on capital. Since 2018, the cumulative net income generated has been negative, largely due to legal settlements and goodwill writedowns. The crop sciences segment proved more cyclical than expected and the environment for agri commodities more difficult than anticipated. In addition, Bayer, maybe a canary in the coalmine for the German economy, was overburdened by an inefficient organization and self-made and regulatory bureaucracy. The reckoning has taken place at Bayer - there was just no other way: Efficiency programs are happening and the number of employees is being reduced (in the first 9 months of 2024 from 100K to about 95K). The dividend which stood at 2€ or more in every year since 2012 was slashed to 0.11€. The company is slowly reducing its net debt position from about 34b EUR. Analysts see no imminent catalyst but to me, it seems like under CEO Bill Anderson, Bayer is moving in the right direction. I see the risk of a dilutive capital increase to be limited because the company is generating cash in its core operations and it has access to the credit markets with a BBB/Baa2 rating while its bonds (in EUR) yield <4%. The company has a history of relatively successful spin-offs (Lanxess, Covestro) and (used to) be one of the most shareholder-friendly German large caps.

It would not be Bayer’s first comeback. In 2003, when Germany was the sick many of Europe, after a scandal around their Lipobay product, the stock briefly traded down to 10 EUR (from its previous high of 50) only to hit 60 EUR again in 2007. Today you can buy Bayer at 6x EBITDA (TIKR says 5x, but ignores legal provisions in their net debt assessment). We find this attractive and therefore bought shares, hoping that the company will learn to win again, just like the Bayer Leverkusen football team:

BMW:

It is impossible to write a doom-and-gloom post about German companies and leave out the autos. Carmaking is by many still considered the backbone of German (industrial) economic activity. Yet all the German carmakers are suffering. After many years of growth driven by the oversea markets of the USA and China, the prospects loom much worse. Chinese carmakers are now serious and technically sophisticated competitors. The German car industry was at late to the electric car party where Tesla ruled and the Chineses challenged. The recession at home, high energy and labour costs and bureaucracy do not help.

The carmakers are later in their reckoning than Bayer. Painful adjustments are taking place right now with all large German producers announcing job cuts and in some cases factory closures. Like Bayer, the autos have seen bad times before, but there is a sense that this time, the decline might be terminal.

The big three carmaking groups, Mercedes-Benz, Volkswagen and BMW have materially different characteristics. Volkswagen competes for the largest carmaker in the world and has a sizeable portfolio of brands including VW, Skoda, Seat, Audi Porsche and Lamborghini. There is a big influence of the state of Lower Saxony which owns a quarter of the company and is represented on the Board of Directors. In addition, there is a relatively intransparent holding structure for the families Piech and Porsche which results in 3 listed entities on the stock market (Volkswagen, Porsche Holding, Porsche SE). This is not my favourite setup and a reason why I have skipped VW as an inverstment.

Mercedes-Benz and BMW are both premium brand companies and they have less brands than VW. I consider them both generally investable but have a preference for BMW. The company is still family-controlled by the Quandt/Klatten family who overall have been decent stewards of capital, including distributing capital via dividends and buybacks. BMW’s product portfolio also appears to be relatively flexible and they have advanced significantly in terms of electrification.

Moreover (and that is highly subjective), there is a number of BMW drivers I know who are fairly aware of and loyal to that brand. In general, I do think that cars are not just a business of building the most efficient and reliable vehicle, but also a symbol of status and sometimes identity. This applies in particular to the premium segment.

Over 20 years, BMW (orange) has performed a bit better than Mercedes (blue).

Yet, Year-To-Date, BMW’s performance has been abysmal:

BMW has a preferred and a common stock outstanding. The prefs have no voting right but get a slightly higher dividend and typically trade a bit cheaper because the commons are included in the indices. The prefs trade at 63 EUR while BMW might do 12-13 EPS. The company has a sizeable financing division which contributes to its profits. If it was taken out, the remaining industrial part would be net cash and trade at an EV/EBIT of around 1. The dividend will probably be cut from the 2023 level of 6 EUR, but it should still be around 4 EUR. The company has a share repurchase program and has so far bought 1B EUR of its stock in 2024.

Again, there are reasons to be pessimistic about BMW, but if you like bottom-fishing it might be an interesting one.

Sixt

One of BMW’s largest clients is Sixt, Germany’s and Europe’s leading car company. I wrote up Sixt a while back and can gladly tell you that you can buy the businesse now for less than back then :-) . There are also some good write-ups on V&O, the most recent one here. For the pref shares, the price is down 15% this year and 14% p.a. over the last 3 years.

Unlike for example Bayer, Sixt has shown a pretty solid operating performance. Revenues stood at 2.9B EUR in 2018, tanked to 1.5B EUR during Covid and may hit 4B this year. Operating profit is also up significantly. In 2022/2023 Sixt benefitted from high resale values for its cars, a factor which reversed in 2024 and weighed on the company’s result. At the same time, residual values have declined, in particular for electric cars, and Sixt has been working to reduce the electric share of its fleet. Overall, the market has become more competitive after companies like Sixt posted really good results from 2021. Sixt’s growth strategy largely relies on the US market which the company entered and where it has focused on acquiring airport licenses. I can understand the growth potential there, at the same time, these are likely competitive locations to do business. Sixt is owner-led with the two sons of the founder Erich Sixt acting as Co-CEOs. This fact is the greatest risk to the investment thesis because one should be critical of (1) family members following in the top seat and (2) a Co-Head role at the top of the company. At the same time, this constellation has been in place for some time - and so far it has worked. Sixt has generated consistend returns on equity of 15%+ in the last 10 years (except for 2020). For the last 12 months, this measure reaches 12% due to a loss in Q1 of this year. There is a common/pref share structure in place similar to BMW and you can pick up the pref shares for cheaper and get a slightly higher dividend. The pref shares trade at around 10x of what one can consider depressed earnings. Finally, the company is continuing its tradition to humorize political events, even if they might be depressing.

Amadeus Fire

If you think the Sixt chart looked bad - remember that it can get worse. Here comes Amadeus Fire, a company offering temporary staffing and professional training company. Extensive pitched were prepared by V&O and Searching4Value .

The company’s business is focused on Germany where they mostly cover the market of white-collar workers, engineers and IT staff. To be fair, the poor performance of the last 3 years can be attributed to the fact that the share price ran up so much before and the company had become expensive. Here is the 10y EV/LTM EBIT

So that ratio above 25x proved unsustainable. However, the pendulum has swung to the other direction, currently reaching 9x, close to a 10y low. Amadeus Fire has been a highly successful company. Sales have tripled since 2016 and operating margins in most years reached 15% or more. The company does not require a lot of capital to run and therefore generates ROEs above 20%. The business fluctuates with the labour market which has weakened in Germany. Some cite AI as a concern. On the other hand, the company has a professional training segment which is still growing and can be expected to be fairly resilient. Most of the earnings are distributed via dividends but Amadeus Fire has also done share repurchases before and they have the authorisation to buy back more shares. Open market buybacks or another tender would be a great signal. For 2024, I would expect a dividend reduction to 3.50-4.00 EUR for a yield about 5%. The company has just 20m EUR in financial debt (excluding lease obligations) and is therefore conservatively financed. If we ever grow again, Amadeus Fire could go parabolic. On the other hand, if things get worse before they get better, we may even suffer further, so this one, like most things German, requires patience as of November 2024.

Maschinenfabrik Berthold Hermle

Another industrial small-cap a great business model, a number of current problems and with a terrible sentiment and stock market performance is Hermle. Based in Gosheim in the Swabian Alps, the company is a leading producer of CNC milling machines and as such a supplier for many other manufacturing companies in the context of machining centers and automation. Controlled by the founding family, Hermle has built a reputation for engineering excellence. The company depends on the German, European and US manufacturing cycle, but also used to benefit from a secular trend towards automation and performs a sizeable service/maintenance business.

Over the past 20 years, Hermle’s profitability has been the envy of many. The company generated positive net income in each of the last 20 years, including in 2008/09 and 2020. Operating margins have routinely reached 20%+, overall sales have grown. The company, valued at 837m EUR equity value sits on 100m+ of net cash. Despite employing no financial leverage, returns on equity are impressive:

You can buy Hermle for 7x LTM EV/EBIT as I write this. The most recent dividend was 15 EUR/share on a current share price of 167,50EUR.

There are clear headwinds: The company has cautioned its outlook for 2024 and expecting a decline in sales and profitability (and a lower dividend is likely ahead). The order situation is bad enough for the company that the company has announced it will look into “Kurzarbeit” ("short-term work”), the German scheme to reduce staff costs without firing people. The German problems and the geopolitical situation with potentially looming tariffs are not helpful. The company is still investing against the cycle, establishing a new production facilities and has overall increased its number of employees in the last year. Given its strong balance sheet and liquidity, Hermle will be able to survive even a prolongued ebb in economic activity and at the same time prepares to go full-speed as soon as any recovery materializes.

Funkwerk

It has been almost two years since we published a piece on Funkwerk, a German company specialized in train radio systems. The share price hast not moved much ever since and over 3 years, it still looks pretty scary, admittedly there was a run-up before this.

Funkwerk’s financial results have been rock-solid for some time. The company has a market cap of 160m EUR and a net cash postion of about 40m EUR. The business is a bit less cyclical than, for example, Hermle because Funkwerk goes after larger framework contracts and is also very active across Europe. They posted a record H1 revenue and gross profit (with a lower net profit) and are expecting an EBIT of 20-23m for 2024. The order book is at receord levels. Given their history of conservative guidance, they may well end at 25m EUR in EBIT which might bring their EV/EBIT to 5x or so. Funkwerk has successfully acquired smaller competitors and the acquisition of Hörmann KN which I questioned in the 2023 write-up has thus far worked pretty ok even though it is a lower-margin business than the traditional Funkwerk. The company keeps on executing and at some point the market may actually notice.

The best time of the year for bottom fishing?

While we are normally no believers in calendar effects, there is one exception: We find that November/December is normally a good time to look at the YTD losers. This is because of two reasons, tax-loss selling and window dressing:

• Investors are selling their losers before year-end to offset gains in other securities, in particular in strong market years like 2024. This behaviour will save them some payments to the taxman.

• Funds are unwilling to show that they hold the losers of the year in their portfolio overviews as of 31 December because it does not bode well for gathering more assets. Therefore, the part ways with the biggest losers of the year in order to not look stupid.

A game of patience

Any type of contrarian investment requires a lot of patience, in particular if it is not catalyst-driven. There is a big risk or looking stupid at least for some time and the line between being wrong and being early is blurred. From our perspective, having some time to wait how things play out is actually a big advantage. This is particularly true at times when people invest in meme stocks and post their daily or weekly returns on social media. In my view, there is a too much focus on what the stock price will do next as opposed to how the business is performing. Many investors are proud of having read their Peter Lynch but few of them seem to remember that he wrote that you should give a stock 3-5 years. It is worth remembering that Warren Buffett sits in Omaha because he did not want to be in a Wall Street environment when the mind was stimulated/distracted by the latest market chatter all the time. In the age of smartphones, we can all have that Wall Street atmosphere, irrespective of where we live. It is up to us how we handle it.

What do you think?

I am highly interested in your feedback on this post. Who is your favourite poet? Is Germany/Europe doomed or is there any hope? Is the contrarian strategy stupid and what is smarter (apart from Bitcoin)? What do you think about the German companies mentioned and which ones are missing? What do you think about tax-loss selling and what are your favourite candidates?