GROUP MANAGEMENT REPORT

Economic and Sector Developments in Germany

Switching into reverse
Due to the disruptions caused by the financial crisis, German economic growth virtually halved to 1.3 % in 2008 (2007: 2.5 %). However, this positive figure conceals the increasingly negative course of events as the year progressed. Following a first quarter which was still robust, Germany switched into reverse gear, sliding into a severe recession in autumn 2008. As disclosed by the Federal Statistics Office, following adjustment for seasonal and calendar factors real-term GDP in the fourth quarter of 2008 (October to December) was 2.1 % lower than in the third quarter. This represented the sharpest quarterly decline in economic output since German reunification. Compared with the final quarter of 2007, price-adjusted GDP fell by 1.6 %.

This quarterly downturn was primarily attributable to the export sector, which shrank by 7.3 % and thus at almost twice the rate of imports. The export sector alone thus accounted for 2.0 percentage points of the decline in overall economic output. The lack of momentum from foreign trade, coupled with the drastic deterioration in financing terms and the ever more severe under-utilization of production capacities led German companies to significantly scale back their investments in equipment. They invested 4.9 % less in machinery, appliances and vehicles than in the third quarter. Prior to this, investments in equipment had risen for eight consecutive quarters, albeit only at low rates of growth in the second and third quarters of 2008.

Construction investments, which were 1.3 % lower in the fourth quarter than in the same period a year earlier, came off more lightly. Given companies’ cautious approach to investment in view of economic developments, no positive momentum was recently to be expected from commercial construction. The promotion of public sector infrastructure projects included in the Federal Government’s first economic stimulus package in November 2008 had no opportunity to take effect before the end of the year due to the customary time lags required for planning and project preparation. The extent to which investments in housing construction will benefit in 2009 from the state measures promoting modernization and maintenance measures remains to be seen. The economic stimulus package will also only impact on official building permit statistics, which decreased by 4.2 % in 2008, following a certain delay.

Notwithstanding the negative asset-price effect of the financial crisis, private consumer spending proved to be relatively robust in the fourth quarter of 2008, as did government consumption. Price-adjusted consumer spending almost matched the previous year’s figure (minus 0.1 %). For the year as a whole, private household consumer spending remained virtually unchanged. In nominal terms, consumer spending grew year-on-year by 2.1 %. That consumer spending was unable to provide any greater growth impetus was largely the fault of the high rate of inflation in 2008. Together with higher collective pay increases agreed in 2008, the rise in employment totals in Germany through to November led private households’ disposable income to grow by 2.5 %. However, this increase was devoured by the 2.6 % rise in consumer prices. What’s more, the insecurity created by the financial and economic crisis led Germans to push up the savings rate from 10.8 % to 11.4 %.

Marked slowdown in inflation
The underlying framework for consumer spending has been characterized by opposing factors since autumn of last year. On the one hand, inflation has slowed significantly due to the sharp reduction in energy and food prices. The consumer prices index, which at an annual average of 2.6 % showed its highest increase for 14 years in 2008, was due to the high rates of inflation in the first half of the year. From its high of 3.3 % in the summer, the index returned to around 1 % by February 2009. This development has boosted purchasing power. On the other hand, consumer confidence deteriorated increasingly due to the reports on the implications of the financial crisis for the real economy. Not only that, real-term incomes can also be assumed to have suffered from the substantial reductions in prices on the financial markets. Overall, however, consumers seemed to have regained confidence at the beginning of the year. According to the monthly surveys carried out by the GfK Group, the consumer climate improved slightly in February thanks to stable prices and the government’s old car scrapping incentive program. Consumers’ expectations as to future developments in the economy and their personal income situation, which had previously been on the decline, began to make up some ground. The surprisingly large increase in consumers’ propensity to spend in January 2009 has remained at a pleasing level – a positive omen for the retail sector.

Retail proves crisis-resistant
According to sector figures, German specialist construction materials retailers concluded 2008 with slight sales growth of 1.5 %. This was due to business with commercial customers which, thanks mainly to demand in the field of energy-related modernization, grew by 2.5 %. Business demand thus more than made up for the decline in sales in the private customer business (minus 2.3 %), which continued to suffer from the ongoing downturn in owner-occupied housing construction.

The German retail sector has been valiant in the face of the economic crisis since September. According to the Federal Statistics Office, price-adjusted retail sales (excluding automobile retail and gas stations) were 0.4 % lower in 2008 than in 2007. In nominal terms, the retail sector was able to boost its sales by 2.1 %. Given the 0.6 percentage point rise in the savings rate, this represents a positive result, especially since the previous year’s sales had still fallen in both nominal terms (minus 1.3 %) and real terms (minus 2.3 %) following the introduction of a higher sales tax rat as of January 1, 2007.

A glance at the individual segments within the retail sector reveals no uniform trend. Food retail sales fell by 2.9 % in real terms as consumers reacted to the drastic rise in food prices in the first three quarters of 2008. Non-food retailers reported overall sales growth of 2.6 % in nominal terms and 1.2 % in real terms. Having said this, individual non-food segments also felt the effects of price sensitivity on the part of consumers, who were more reserved when it came to making larger-scale purchases, such as furniture and fitments.

DIY sector maintains ground having raced to catch up
The German DIY and garden center sector (DIY retail / DIY) maintained its ground well in a difficult economic climate in 2008. According to the Federal Association of German Home Improvement, DIY and Specialist Garden Stores (BHB), the sector was caught out by a sobering start to the year, but nevertheless managed to make up for this shortfall virtually in full in the second half of the year. Sales at large DIY stores with indoor sales areas of at least 1,000 m² per outlet amounted to € 17.55 billion at the end of the 2008 calendar year, and were thus 0.5 % down on the previous year’s figure (€ 17.64 billion). Including sales at DIY shops with sales areas of less than 1,000 m², the market volume of all DIY and home improvement stores in Germany based on the harmonized calculation undertaken by the BBE and BHB sector associations and the GfK Group also declined by 0.5 % to € 21.6 billion in 2008 (2007: € 21.7 billion).

In terms of demand for DIY and garden articles, the consumer climate can best be measured by reference to the development in sales in the German DIY sector adjusted to exclude newly opened and closed stores. The unfavorable weather conditions compared with the spring season in 2007 severely impaired the garden business. Over and above this, DIY enthusiasts’ desire to shop was cooled by high inflation rates. As is apparent from the findings of the BHB/GfK report, likefor- like sales slumped by 6.9 % between January and March 2008. The turn for the better only came in May which, with growth of almost 18 %, was the strongest month in terms of sales since the BHB/GFK panel was launched more than ten years ago. The downturn in sales for the six-month period thus reduced to 3.7 %. In the third quarter, companies achieved like-for-like growth of just below one percent. The months of October to December 2008 did not bring any noteworthy impetus for sales. The German DIY sector concluded the 2008 calendar year with a 2.0 % reduction in like-for-like sales. DIY retail thus proved resilient in spite of the sudden economic slowdown since the autumn.

As the data in the BHB/GfK report shows, products of a decorative nature had especially good turnover potential in 2008. Within the sanitary / heating product group, which with growth of 4.9 % had a clear head start over other product groups, the bathroom furnishings segment reported the strongest growth. Sales in the garden furniture and decoration product group rose by 1.9 %. The wallpaper / flooring / interior decoration product group improved, due in particular to increased demand for home textiles. Construction materials / construction chemicals and garden hardware were also slightly up on the previous year (0.1 % in each case). All other product ranges failed to match the level of sales seen in 2007. There remains a backlog of demand for some traditional DIY products which, like tools and machines (minus 4.7 %), came under pressure from competing sales formats. Not only that, DIY and home improvement stores also reported more drastic reductions in sales in the fields of leisure / handicrafts / handiwork (minus 13.4 %), as well as small and selfconstruction furniture (minus 4.1 %).

The BHB sector association sees the performance of the various product ranges as confirming the theory that people are particularly prone to withdraw into their private spheres in times of economic uncertainty, and thus to invest in embellishing their own four walls and gardens. As a result, decorative design ideas are thus coming even more sharply into the foreground, as are renovation projects such as “interior lifestyle”, “feel-good bathrooms”, and “garden paradise”.