value and opportunity

The weekend is always a good time to step away from the “micro level” i.e. single stocks to more general considerations.

More recently, if find myself more and more analysing French stockss, as they seem to be technically still quite cheap. In my portfolio, the weight of my French stocks Bouygues, Tonnelerie, Installux, April, Poujoulat is around 15% and growing.

On the other hand if you read especially “Anglo Saxon” media, it seems to be clear that France is in deep trouble.

Perma Bear Mish for instance a month ago saw problems everywhere and as always a quite immediate chance of collapse.

Before that, the (UK based) Economist titled France as the “time-bomb” of Europe with a quite funny cover in on of its November issues:

Germany, in contrast, is considered to be the growth engine of Europe despite a recent slow down.

Let’t go back a couple of years:

In the year 2000, Ireland was the Celtic Tiger as reflected in this famous speech of Mary Harney and a year before that, again the Economist branded germany as the “sick man of Europe”.

The economist article greatly summarizes the overall view on the German economy of that time:

But it is now coming under pressure as never before. As economic growth stalls yet again, the country is being branded the sick man (or even the Japan) of Europe.

The reason was clear: A socialist Government and suspicious company bosses:

The red-green coalition government led by Gerhard Schröder since last October has “encouraged the suspicions of a corporate sector predisposed to fear the worst,” says Alison Cottrell, chief international economist at PaineWebber in London. The dark picture painted by Hans Eichel, Mr Lafontaine’s replacement, to justify fiscal belt-tightening has further unsettled industrial bosses. And a lack of corporate confidence has been one of the main factors that has kept unemployment so high.

The 1999 article mentions all the “standard” prerequisites for a better future like lowering corporate taxes, increasing flexibility but finishes with a quite bleak outlook:

It is, perhaps, not surprising that market-friendly politicians, including one or two in the government, now complain of Germany being a blockierte Gesellschaft (blocked society). Unblocking it will take determination. Without that, Germany is unlikely soon to shed its title as the sick man of Europe.

So what happened in between, how did the sick man of Europe become the (temporary) growth engine ?

Let’s look at Corporate taxes for instance:

It is interesting to see that the biggest drop in corporate tax rates actually happened in the 1998-2005 period where Gerhard Schroeder led a Social Democratic/Green government.

In my personal opinion, a combination of several factors has at least contributed to the change in fortune of Germany at least so far:

– lower tax rates on corporation which stimulated investment in Germany
– Hartz IV which “motivated” people to go back to work quicker when they lost a job
– increased labour flexibility (“Kurzarbeit”, etc.
– a generally cooperative climate between trade unions and employers with modest salary increases and more one time awards
– privatisation of major Government companies such as Deutsche Post, Deutsche Telekom etc.

A second set of developments which in my opinion is not so prominent but were nevertheless equally important:

The end of the “Deutschland AG” which was the description for the fact that almost all German companies were owned locally and/or by each other. Management of German companies did not have a lot of pressure because each manager sat on the board of several other companies. In the center of The Deutschland AG were the big financial institutions such as Deutsch Bank, Muenchener Rück, Commerzbank and Allianz.

The end of the “Deutschland AG” was driven in my opinion by 3 major developments:

– the removal of taxes on investment gains for corporations in 2002
– the problems of the large German financial institutions after the 2002/2003 crash which forced them to sell their shareholdings
– finally the Euro. Before the Euro, German Insurers for instance had to invest 95% of their investments in Deutschmark. So basically if they had to invest in German shares because there was no alternative. After that, the 5% restriction changed to “non Euro”, so suddenly german insurers could diversify their portfolios into the Eurozone.

Although there will always be a special relationship between companies in one country, one can say that the old “Deutschland AG” does not exist any more. One of the big examples for instance was the take over of Hochtief, the German construction company by ACS from Spain. 15 years ago, something like this would never had happened. Deutsch Bank or someone else would have organized a defense.

In my opinion, the end of the Deutschland AG contributed a lot to the positive developement of big German companies like BASF etc. because it put a lot more pressure on management. Ironically as a result, many of the benefits of the German renaissance went to foreign shareholders.

Back to France:

From the German example we know now that a title story in the economist might not be the best indicator for the future of a country. In the cae of France is see a few similarities to Germany in the end of the 90ties:

– everyone is complaining about the socialist president
– the press is full about the “millionaire tax” and guys like Gerard Depardieu and Aranult leaving the country

Without being an expert in French politics, however from my outside view this looks like a brilliant political move from Hollande. He gives his leftwing voters something directly and spectacular to calm them down. I would assume that a guy like Bernard arnault is not paying that much taxes in France anyway, so it doesn’t really hurt seeing him leaving.

On the other hand, Hollande seems to now the German play book quite well and is on the way trying to improve labour flexibility in France. Interestingly, Sarkozy made a similar last minute attempt almost exactly a year ago.

But as history shows, at least in continental Europe, real labour reforms are mostly implemented by Socialist Governments, liberal or conservative ones. As always, the comment says that this is not enough:

Still, this is no Reagan (or even Schröder) Revolution. The unions will preserve counterproductive worker protections and welfare guarantees. The deal includes expanded privileges for union reps within companies and more reserved seats on company boards.

However, you have to start somewhere and together with his “U turn” in corporate taxation, this is a significant green shoot in my humble opinion.

Last but not least I see two other interesting factors at work which might point to a better future for France:

Demographics:

France’s demographic development is much much better than Germany’s as one can read for instance here.

From a demographic standpoint, France and Germany are thus in radically different situations. While France has maintained a satisfactory fertility rate, almost sufficient to ensure the long-term stability of the population, Germany’s low birth rate will lead to a substantial and rapid decline in the total population and to much more pronounced ageing than in France (Figures 3 and 4).

At some not so very distant point in the future, there will be more Frenchies than Germans:

So yes, France has definitely a problem with youth unemployment, but part of the problem is that they actually do have a lot of young people which Germany does not have any more.

Africa

I am not able to comment on Mali or any other political issue here. But if at some point in time Africa will catch up with the rest of the world, French companies will benefit most due to their historical relationship etc.

Summary:

It is clear that France at the moment does not look like the future growth machine of Europe but neither was germany end of the 90ties. However I see a good chance that France finally gets it act together and implements the required reforms. If that happens, France could experience a somehow similar trajectory like germany over the last 10-15 years.

From an investment point of view, this might be one of the most interesting “secular” opportunities going forward despite (or because of) the very negative headline news. From a micro level, I find a lot more well managed, unlevered companies in France than in all the PIIGS countires combined.

From a portfolio point of view, I will accept a quite significant weighting of French stocks if I find additional interesting french companies. I could imagine having up to 30-50% of french stocks in my portfolio going forward.

But make no mistake, this will be a long journey and superior investment returns on French stocks might require more then 1 or 2 years to materialise.

And finally to make this a little bit funnier, the Monty Python take on the epic battle between the English and the French:

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ExpectingValue, a great UK blog has reviewed his Portfolio. Good place to start if one is interested in UK small caps.

Reader Ben forwarded me his great write up for Curanum, the German care and serviced appartment provider for senior citizens which I publish with his permission:

Curanum AG – Write Up (1)

His conclusion was as follows, but I think one should read the whole piece although Ben is not recommending the stock at the moment::

Conclusion
As overcapacity is expected to be reduced in the upcoming years I expect occupancy rates to recover from their current lows. As this will give Curanum some time to breathe, the management will have to make additional investments in their facilities to be able to comply with regulatory requirements. From my perspective there is not much room for additional acquisitions for the following reasons.

First, the company is highly leveraged. Second, the company just increased its number of outstanding shares by almost 20%. Hence, demand from equity holders should be satisfied at the moment and banks are currently reluctant to even refinance existing debt. Given the high cost pressure and limited pricing power a further decline in margins within the next years is highly likely from my perspective. The company is currently generating healthy cash flows, though capex seems to be too low, which will negatively affect cash flow generation in the future. Most of this is reflected in the current share price, so I do not think that Curanum is a prime short candidate.

To the contrary, given the current downside trend in the stock price, the sock seems to be ready for a rebound. A short term catalyst could be a successful refinancing of the maturing debt facility. However, from a long term investor perspective I do not think that the company does offer an attractive risk/return profile.

In case you need a name for your soon to be founded hedge fund, try the HedgefundNameGenerator

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