The Wall Street Journal - 21.08.2019

B14| Wednesday, August 21, 2019 THE WALL STREET JOURNAL.**

Don’t Bet on German Fiscal Stimulus

Even if officials allow Berlin to run a small budget deficit, the economy won’t get much of a push

HEARD

ON

THE

STREET

FINANCIAL ANALYSIS & COMMENTARY

The company warned tariffs’ effect on consumers could weigh on growth.

CHARLES KRUPA/ASSOCIATED PRESS

Baidu , once considered China’s

answer to Google, needs to search

harder for growth.

The search-engine giant has lost

$63 billion in market value in the

past 15 months. The selloff seems

overdone, but the company’s long-

term prospects are still highly un-

certain.

Late Monday, Baidu reported flat

revenue and a 62% drop in net

profit for the quarter through June.

However, expectations had gotten

so low that these dismal results

beat consensus estimates, according

to S&P Global Market Intelligence.

Baidu’s Nasdaq-listed stock jumped

4% in Tuesday’s trading.

The company used to get lumped

together with Alibaba and Tencent

under the BAT umbrella, but that

acronym for Chinese tech’s holy

trinity is getting outdated. In terms

of market value, Baidu has slipped

behind other Chinese internet com-

panies like Meituan and JD.com.

However, it is privately owned

Bytedance , valued at $78 billion in

a funding round last year, that

poses the greatest competitive

threat to Baidu. Bytedance owns

two apps with viral content: news

aggregator Toutiao and short-video

app TikTok.

These addictive apps have

soaked up ad dollars. Bytedance’s

share of online advertising in China

is expected to rise to 19% this year,

according to Bernstein estimates,

from 4% two years ago. Bytedance

also has launched a search portal.

Baidu, now valued at $36 billion,

may find some support in the short

term. The stock fetches just 1.5

times book value. Excluding roughly

$10 billion of net cash and short-

term investments, and an additional

$11 billion invested in other internet

companies, the core Baidu business

is valued at just $15 billion.

But a cheap valuation is no strat-

egy. Baidu desperately needs new

platforms for growth. So far, there

is little sign it has the kind of popu-

lar apps necessary to turn its core

business around. —Jacky Wong

China’s

Answer to

Google Has

Lost Its Way

Bytedance and others

take a bite out of Baidu

In splurging for Bayer ’s animal-

health business, Elanco Animal

Health is playing a long game.

Elanco , the animal-care unit

that was spun out from Eli Lilly

last year, announced Tuesday it is

paying $7.6 billion in cash and

stock for the German conglomer-

ate’s portfolio of pet and livestock

medications. Elanco shares fell

more than 8% on Tuesday.

Elanco had reasons to pounce.

The deal will make it the second-

largestplayerinagrowingcate-

gory, behind Zoetis. Pet ownership

is on the rise in the U.S., and own-

ers are spending more on their an-

imal companions. Pet health is also

a fairly concentrated industry, so

opportunities to build that sort of

scale are scarce.

Bayer’s recent struggles with a

high debt burden and potentially

massive legal liability surrounding

its weed-killing product Roundup

meant that high-quality assets,

such as Bayer’s top-selling flea-

and-tick collar Serestro, were

available.

As a sweetener, Bayer’s animal

business had a gross profit margin

of 64% in 2018, significantly better

than Elanco’s 50% margin.

Elanco has to pony up for that

extra muscle, however: The com-

pany is paying about 19 times

earnings before interest, taxes, de-

preciation and amortization for

the deal. That is at the high end of

expectations—analysts at Citi had

projected that Bayer’s business

might fetch anywhere between 15

and 20 times Ebitda.

As a result, Elanco’s debt bur-

den will be about five times pro-

jected Ebitda once the deal closes.

The company expects to pay down

that debt to three times by 2022.

The business generates significant

cash flow, so that timeline seems

credible.

Still, credit-ratings firms have

their doubts: Fitch Ratings on

Tuesday placed Elanco debt, which

already carries a junk rating, on

watch for a possible downgrade.

Elanco also could issue addi-

tional shares to help pay for the

transaction and satisfy bondhold-

ers, but that likely wouldn’t bene-

fit the stock price.

On the bright side, Elanco now

trades at a clear discount. After

Tuesday’s decline, its shares sell

for less than 23 times forward

earnings, according to FactSet. Zo-

etis trades at about 33 times.

But bargain hunters needn’t be

in a hurry—it could be some time

before investors are ready to bring

Elanco home.

—Charley Grant

ElancoAnimalHealthshareprice

Source: FactSet

$34

26

28

30

32

Aug.7121520

The German economy needs new
sources of growth. Investors
shouldn’t count on fiscal stimulus
to be one of them, even if the gov-
ernment loosens the purse strings.
On Monday, the Bundesbank said
Germany’s economy could shrink
between July and September for a
second quarter in a row, plunging
Europe’s powerhouse into a reces-
sion. Expectations that the Euro-
pean Central Bank will need to
slash interest rates further have
driven yields on 10-year German
government bonds to around mi-
nus-0.7%.
A “golden decade” for the Ger-
man economy seems to be at an
end, but investors are finding some
solace in the idea that the govern-
ment will finally make use of nega-
tive borrowing rates to boost de-
mand. They will likely end up
disappointed.
Ever since the creation of the
euro in 1999, Germany’s expansion
has been based on suppressing
wage growth and using a cheaper
exchange rate to boost industrial
exports. After the 2008 financial
crisis, officials redoubled their bet
on this strategy, and Germany’s cur-
rent-account surplus ballooned to
become the biggest in the world
relative to gross domestic product.
Analysts often criticize how this
sucked sales away from companies
in other eurozone nations, hamper-
ing the wider bloc’s recovery. But
Germany itself also became more
vulnerable by relying heavily on

China—the world’s biggest importer

of goods—and successive spending

sprees launched by Beijing.

This bet has begun to sour. The

Asian giant’s economy is decelerat-

ing, hurting manufacturers across

the globe, and is likely to import

less as it develops further. Ger-

many’s mighty car industry—which

accounts for almost one-quarter of

cars sold in China—could be partic-

ularly affected.

According to local media, Ger-

man finance minister Olaf Sholz—

who may be a contender in the next

general election—is now willing to

allow the government to run a

small budget deficit. But investors

shouldn’t confuse running a budget

deficit with fiscal stimulus.

Usually, government deficits

widen on their own during eco-

nomic downturns because tax reve-

nues tend to fall as social-welfare

expenditure increases—an effect

that economists dub “automatic

stabilizers.” Officials can fight this

tide by slashing spending, but risk

damaging the economy further.

Over the past 10 years Germany

has solved this conundrum by rely-

ing on export revenue to boost cor-

porate earnings and accumulate

huge government surpluses. It also

has forced its eurozone peers to do

the same, with far less success. Now

that this isn’t possible anymore, the

German government may be willing

to let the automatic widening of the

deficit run its course.

But there are no signs that Ger-

man politicians are willing to cast

deeply ingrained economic ortho-

doxies aside and design a fiscal-

stimulus plan to get the economy

back on its feet.

Despite some talk of infrastruc-

ture spending, the German constitu-

tion caps the deficit at 0.35% of po-

tential GDP—an ill-defined measure

that allows some extra flexibility

during recessions, but not much.

And the economy is still skewed to-

ward exports rather than domestic

spending.

Even if Germany’s surpluses

come down a little, the hopes of Eu-

ropean investors remain more in

the hands of Chinese officials than

German ones. —Jon Sindreu

Home Depot Withstands Housing Fears

A mixed earnings report is enough to send shares higher as investors apparently were steeled for worse

GermangovernmentbudgetbalanceasapercentageofGDP

Source: FactSet

2

–10

–8

–6

–4

–2

0

%

1995 2000 ’05 ’10 ’15 ’18

Baidu'squarterlyonlinemarketing

revenue,changefromayearearlier

Source: the company

60

–20

0

20

40

%

2014 ’15 ’16 ’17 ’18 ’19

When a company releases results
that can be described as “mixed,”
the natural inclination is to ask
how far the stock fell. For Home
Depot , however, a mixed second
quarter was enough to send its
stock sharply higher Tuesday.
The home-improvement retailer
said that it earned $3.17 a share in
its fiscal second quarter ended Aug.
4, topping analyst estimates. But its
sales of $30.8 billion were a bit
light, and same-store sales growth
of 3% also was short of estimates.
Additionally, the company low-
ered its sales forecast for the entire
fiscal year, saying it now expects
4% same-store-sales growth, down
from an earlier forecast of 5%. This
was partly due to the effects of
lower lumber prices. But the com-
pany also warned that the effects
of tariffs on consumers could weigh
on growth.
Yet investors had apparently
steeled themselves for worse. Home
Depot shares rose more than 4%.
Investors’ low expectations may
reflect ingrained skepticism over
Home Depot’s ability to weather a
weak housing market. Home sales
were down in the first half of this
year from a year earlier and home-
price gains have moderated, so it is
natural to worry the company has
experienced a dent in demand.
But Home Depot appears far less

tied to home sales than it was be-

fore the housing bust. This seems

to be driven in part by many home-

owners’ decision to invest in the

house they already have rather

than going out and buying a new

one.

It also is a reflection of how old

homes in the U.S. are getting. As of

2016, the median age of owner-oc-

cupied homes in the U.S. was 37

years, according to a National Asso-

ciation of Home Builders’ analysis,

compared with 31 years a decade

earlier. The regular upkeep these

aging homes require to maintain

their value provides a steady

source of income for Home Depot.

Home Depot also is benefiting

from the travails of Sears , a once

formidable seller of appliances and

tools, which filed for bankruptcy

last fall and continues to close

stores. Lowe’s Cos. also has been

paring back stores as part of its

turnaround plan, easing the com-

petitive pressure.

That isn’t to say that Home De-

pot is immune to trouble. If tariffs

start hurting consumers, then con-

sumers aren’t going to be so ready

to get started on big home-im-

provement projects and Home De-

pot’s sales will suffer.

So far, however, Home Depot

says its real-time sales figures ha-

ven’t registered any tariff effects.

Its caution seems directed at what

might happen, rather than anything

it is actually seeing. For investors

who have been spending the past

month worrying that the economy

already is sliding into a tariff-in-

duced slowdown, that counts as

great news. —Justin Lahart

Investors Don’t Love Elanco’s New Tricks

OVERHEARD

The Business Roundtable, led by

J.P. Morgan Chief Executive James

Dimon, decided this week to

change its mission to take into ac-

count “all stakeholders”—a group

that includes employees, customers

and society—rather than just

shareholders.

Predictably, this

rekindled old argu-

ments about self

interest, invisible

hands and the in-

genuousness of

the chief execu-

tives running the

business lobby.

But anybody who

has been listening to

what companies have

been saying

shouldn’t have

been surprised. A

Factiva search re-

turns 3,840 com-

pany conference

calls that included

some variant of

the term “stakeholder” in 2018.

That compares with 1,938 five

years earlier. Through July, stake-

holder mentions in 2019 are run-

ning 17% above a year earlier.

An environment in which com-

panies face growing skepticism

over the morality of big business

certainly has something to do with

the stakeholder focus. But the in-

terests of shareholders aren’t

totally being ignored. Investor

cash has been pouring into

funds that specialize in so-

called socially responsible in-

vesting, drawing more money in

the first half of this year

than last year’s record

amount.

Caring about

stakeholders

might just be a

matter of no-

ticing where

the money is.

J.P. Morgan’s

James Dimon

ALEX WROBLEWSKI/GETTY IMAGES