Overview of the course of business
Macroeconomic conditions
The German economy grew strongly for the second consecutive year, despite the massive rise in sales tax. Real (price adjusted) gross domestic product (GDP) rose by 2.5% in Germany (previous year: 2.9%). After adjustment for the negative calendar effect - the year under review had 1.6 fewer working days than the preceding year - the rise in GDP was 2.6% for 2007 (2006: 3.1% after adjustment for the calendar effect).
The positive development of the German economy over the past three years has primarily been driven by continuing high export surpluses. In spite of the euro’s continued sharp appreciation against the US dollar, demand from abroad continued unabated and caused growth in exports of 8.3% (+12.5% in real terms, 2006). According to information from the Federal Statistical Office, the share of net exports in GDP growth in the financial year under review amounted to 1.4 percentage points.
In 2007, the domestic economy retained the momentum gained in the previous year. Investments in construction and capital goods expanded fairly rapidly. Not only capital expenditure, but also consumer spending rose in Germany. Private consumption (excluding private car sales), the most substantial component with a share of 57% of GDP, increased by 1.8% (previous year: +2.1%). At 10.9%, the savings rate reached its highest value since 1996 (2006: 10.5%).
The average rate of inflation for the year was above that of the previous year (1.6%) at 2.3%. This was the highest annual increase since 1994. The development in inflation in 2007 was mainly driven by energy and food prices. Domestic energy and fuel prices rose by 3.9%. Excluding the effect of energy prices, the average inflation rate would have been 1.9%.
On an annual average, the unemployment rate fell to 9.0% (previous year: 10.8%); 3.78 million people (previous year: 4.49 million) were out of work. This significant, renewed, decline in unemployment primarily reflects a cyclical increase in employment liable to social security contributions.
In 2007, the European Monetary Union (EMU) experienced a continuation of the strong economic boom of the preceding years. According to the Statistical Office of the European Communities (Eurostat), real GDP grew by 2.9% in 2007 (previous year: 3.0%) in the EU -27. The euro zone inflation rate in 2006 was 2.1%, similar to the previous year, and unemployment fell to 7.2% (2005: 7.8%).
Economic conditions in the industry
Retail sector
According to provisional figures from the Federal Statistical Office, German retail sales decreased by 1.2% in nominal terms in 2007 and by 2.2% in real terms (after adjustment for prices). However, the comparison with the previous year is influenced by purchases brought forward in 2006 and by the effects of the sales tax increase from January 2007. The German retail sector did not therefore benefit from the positive development in the economy. At €387 billion in 2007, retail revenue was slightly below the previous year’s level (almost €392 billion).
Industries which benefited from purchasing being brought forward due to the sales tax reform posted significant, real, revenue decreases in 2007. According to the Hauptverband des deutschen Einzelhandels (HDE - German Retail Federation) and the Federal Statistical Office this primarily concerned the area of watches and jewellery at -5.8%. On the other hand, retailers with perfume goods and body care products exceeded the previous year’s result with an upturn of 2.8%, fashion with 1.4% and electronic domestic goods with a strong increase of 5.6%.
The floor space expansion in retail and the competition for first-class floor space continued in 2007, particularly in the area of large shopping centers. According to the HDE, total retail space increased by around 1 million m2 to a current 119 million m2, although the growth was predominantly seen in the states of the former West Germany. The highest floorspace share in leases in 2007 was attributable to the textile, book and shoe retail trade. The growing demand for floor space from the specialist ladies’ wear segment was particularly noticeable. Strong demand was also noted from the young fashion sector, though somewhat more reserved than in the previous year. Other important sectors in prime locations were chemists, accessory stores, restaurants/cafes and telecommunications.
According to a survey by Kemper’s, a real estate agent that specialises in retail properties, the retail spaces in most demand in the past year were those in the size class 100 m2 to 250 m2. Larger spaces were also in demand: Every fourth lease was for over 500 m2.
Property market
Fears of massive defaults in the sub-prime area of the US mortgage market triggered turbulence on the international financial markets. As a result, prices of shares with which the US mortgage market was financed slumped heavily; some of these shares lost their market altogether and the risk premiums rose sharply. The property crisis began with an international chain reaction. Financial institutions suffered global defaults and had to accept extensive write-downs on receivables and securities, whereupon their profits declined sharply in some cases. Due to the uncertainty associated with the effects of the sub-prime crisis, short-term lending in the interbank market almost came to a standstill. The consequences of this situation remained largely under control at the end of 2007, since the central banks made cash available to the banks. Even so, the sub-prime crisis expanded into an international financial crisis, severely reducing confidence.
Despite the sub-prime crisis, it must be noted in relation to the German retail property market that investor interest - primarily in specialist markets and shopping centers - was again very high. According to Jones Lang LaSalle, one of the world’s leading estate agents and property consultants, retail properties were the second strongest asset class in the German property sector in terms of transaction volume. With a transaction volume of €11.2 billion (2006: €18.5 billion), they landed behind the traditional leader, office properties, in second place with €31.4 billion (2006: €18.2 billion). The most important group of buyers were equity oriented and non-listed investors.
Shopping centers posted the second highest volume at €3.2 billion; though this was equivalent to a decline of 42% against 2006. This is primarily due to the absence of large, first-class properties on the market. The 2007 investment year was therefore characterised by transactions of smaller shopping centers in two-digit millions.
By comparison, the yields from retail property remained stable over the course of the year despite the credit crisis. Shopping center yields have even declined further as a result of price rises. At the end of 2007, the yield generated by German shopping centers in prime locations as calculated by Jones Lang LaSalle was 4.5% (2006: 4.95%). By comparison, the yield of Deutsche EuroShop’s property portfolio on the basis of the valuation appraisal was 5.40% at the end of the year.
Exceptional events
The rate of corporation tax was lowered in connection with the corporation tax reform from 25% to 15% from 1 January 2008. In this context, we reversed corresponding tax provisions of €29.7 million and reported it in income.
Share price performance
Deutsche EuroShop shares began 2007 with a price of €28.08. On 23 April it posted an annual high of €30.09 on the basis of the XETR A closing price. Since July, the sub-prime mortgage crisis in the US has sparked off a flurry of at times frantic share selling on the international capital markets, affecting real estate companies in particular. Our shares were not able to extricate themselves from this negative pull and the price fell to €23.22 by 20 August. Despite an excellent recovery phase up until mid-November, Deutsche EuroShop shares were not able to escape the generally poor sentiment for financial and property shares and closed the year at a price of €23.50.
Evaluation of the financial year
At the beginning of the last financial year, we regarded 2007 as a ‘year of transition’. We had successfully sold two portfolio centers and had three shopping centers in construction for the first time in the Company’s relatively brief history with the resulting charges.
We therefore anticipated revenue at the previous year’s level of €92 million to €94 million and expected that revenue lost as a result of both shopping centers sold (4.2% of 2006 revenue) would be partly offset by the Galeria Baltycka opened in the autumn of 2007. According to our forecasts, earnings before interest and tax (EBIT) in the financial year should amount to between €71 million and €73 million. We expected earnings before tax (EBT), without measurement gains, of between €30 million and €32 million.
However, at €95.8 million, revenue was 3.1% higher than in the previous year. With an EBIT of €77.2 million, operating earnings before tax (EBT) was €37.7 million. Detailed explanations for the positive deviation are presented below. The fact that we were able to just exceed all three forecasts again emphases the high quality and high profitability of our shopping center portfolio.