TEXT-Fitch:No impact on Volvo's ratings from Dongfeng Commercial Vehicles joint venture

Tue Jan 29, 2013 5:12am EST

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(The following statement was released by the rating agency)

Jan 29 - Fitch Ratings says that there is no immediate impact on AB Volvo's ('BBB'/Stable/'F2') ratings from its RMB5.6bn (EUR670m or SEK5.8bn) debt-funded acquisition of 45% of Dongfeng Commercial Vehicles (DFCV). We believe that the negative immediate impact on Volvo's key credit metrics will be offset by the medium to long term benefits from a business and industrial standpoint.

Volvo's business profile will benefit from the increased diversification and exposure to China, provided by DFCV's leading market shares in its domestic market. The Chinese market for heavy- and medium-duty trucks is by far the largest in the world in terms of number of trucks sold, but is otherwise difficult to access for international manufacturers.

While operating synergies will be forthcoming, we expect technology sharing to mainly benefit the group's joint venture partner, Dongfeng Motor Group Company Limited, in the near term, given DFCV's low-spec trucks. However, Volvo will benefit from scale synergies in the medium to long term, as the two companies seek to cooperate in the development, sourcing and production of engine and powertrain components and platforms.

Financial headroom in the current ratings will remain comfortable, despite a SEK6bn increase in net debt to finance the 45% participation in DFCV. We expect the negative impact on credit metrics to be largely offset by an improvement in operating performance in the next two years and cash receipts from the recent sale of Volvo Aero, which reduced net debt by SEK5bn in Q412 according to the company's estimates.

We expect FFO adjusted net leverage at the industrial operations to remain between 1.8x and 1.5x through 2014, when the company expects to complete the transaction. This is predicated on the assumption of a return to positive free cash flow generation in 2013 and 2014, driven by an improvement in truck market conditions.

We forecast moderate growth in Volvo's truck end-markets of 2% to 6% and a recovery in underlying earnings generation from the lows seen in 2012. Fitch's calculated EBIT margin for Volvo will not be impacted by the consolidation of DFCV, which will be treated as an associate in accordance with the equity method. DFCV's operating margin of around 1.4% was substantially lower than Volvo's, whose industrial operating margin was 6.8% in the three quarters to Q312.

An upgrade to 'BBB+' could occur if Volvo demonstrates a structural improvement in, as well as less cyclical, operating margins, particularly at its truck division. Conversely, negative operating profit at the industrial operations for more than two years, persistent negative FCF, actual or expected, and adjusted FFO net leverage at the industrial operations above 2x could be negative for the ratings.

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