Stocks to Play in Germany's Revival

With the country's growth continuing to expand at a healthy pace, S&P likes ADRs of select companies, including 5-STARS ranked Bayer

The VAT (value-added tax) hike in Germany at the start of this year had been a cause for concern. The increase raised questions such as how would consumers react and how would the economy cope after it had just started to pick itself up again?

Yet the tax increase could not have been better timed. The mid-May release of a report showing a better-than-expected rise in German GDP (gross domestic product) indicated the German economy survived the VAT hike without major disruptions. Indeed, the economy continued to expand at a healthy pace in the first quarter of 2007.

Although strong advances in private consumption in the second half of 2006 were followed by a downward correction at the beginning of 2007, solid momentum in investment and production limited the slowdown in the growth dynamic after the VAT hike. The result is that economists at many of the major German banks are expected to revise economic growth numbers upward.

High Quality, High Demand

Investment in the manufacturing and construction industries sets the tone for further growth. Although the construction industry benefited in particular from the mild winter, analysts predict further upside in the sector throughout the next year. There's evidence that companies have increased capacity utilization, especially in commercial construction, and more investment is required to meet rising demand.

The booming construction sector should trigger further demand in the services industry, for example in financial products, mortgages, insurance, and legal expertise. Continued growth is expected to be driven by exports of electro-technology, cars, and machinery, fueled by steady demand from Western Europe as well as growing demand from Eastern Europe and the Middle East, especially Saudi Arabia and the United Arab Emirates, where oil profits are used to diversify the countries' infrastructure for roads, airports, and buildings.

During a recent fund manager survey conference, Karen Olney, Merrill Lynch's (MER) head of European equity strategy, said despite a strong euro, companies have been able to sell their capital goods for high prices. While Europe has recently seen more competition on cheaper goods from emerging markets, German high-quality products are back in fashion, Olney thinks—not only for exports but, more importantly, because of rising domestic demand.

Pick of the Crop

After Germany's recent drawn-out period of low growth following reunification, could this be its second Wirtschaftswunder (economic miracle)? While such a suggestion could be viewed as an exaggeration, it would appear that the country is finally facing a healthy upturn, or Aufschwung. Germany looks set to remain a top performer within the eurozone this year.

What are some ways investors can play the German upturn? S&P Equity Research favors the American depositary shares of these German companies: Allianz (AZ), BASF (BF), and Infineon Technologies (IFX), each of which is ranked 4 STARS (buy); and Bayer (BAY), ranked 5 STARS (strong buy).

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