Fitch Affirms Volvo at 'BBB', Outlook Stable

Thu Sep 12, 2013 9:36am EDT

(The following statement was released by the rating agency) LONDON, September 12 (Fitch) Fitch Ratings has affirmed AB Volvo's (Volvo) Long-term Issuer Default Rating (IDR) and senior unsecured rating at 'BBB'. It has concurrently downgraded the Short-term IDR to 'F3' from 'F2'. The Outlook is Stable. The affirmation of the Long-Term IDR reflects Fitch's expectation that Volvo's ratings are supported by its strong and improving business profile, which boasts a good product range and global geographic reach. Management's efforts to improve the group's cost structure will decrease operating leverage in the long-term, a key risk factor in the cyclical truck and construction equipment markets. Volvo's financial profile is weak for the current rating. In particular, the recovery in operating performance has been lower than expected, despite improving truck orders over the past 12 months. We expect higher earnings and cash generation in H213 from improved capacity utilisation due to higher production rates and a better pricing environment in Europe and some early cost savings from the group's programme to overhaul its truck business. However, we expect credit metrics to remain weak at the beginning of 2014, when the full impact of Volvo's RMB5.6bn cash investment in a 45% share in Dongfeng Commercial Vehicles (DFCV) will hit the balance sheet. The downgrade of the Short-term IDR reflects our belief that the group's internal liquidity is commensurate with an 'F3' rating, given weak internally generated cash flow from industrial operations. That said, we do not expect the group to face liquidity pressures, given large external sources of liquidity from industrial cash and undrawn committed credit facilities, which amounted to in excess of SEK57bn compared with SEK12bn in short-term industrial debt maturities. KEY RATING DRIVERS - Financial Profile Weak: Headroom in the current ratings is low. The recovery in operating performance ahead of a SEK6bn increase in net debt to finance the 45% participation in Dongfeng Commercial Vehicles (DFCV) is weaker than expected. Credit metrics are expected to remain weak for the current ratings over the next 12-18 months. We forecast negative free cash flow (FCF) in 2013 from industrial operations, resulting in funds from operations (FFO) adjusted net leverage of around 2.0x and FFO fixed charge cover of around 4.5x. - Product Launches Increase Uncertainty: Fitch considers Volvo's extensive product launch programme as positive to the ratings and essential for the group's long-term prospects. However, we are concerned about the level of uncertainty associated with the concurrent launch of a high volume of new products. We remain somewhat conservative in our earnings forecast for the group, which incorporates some cost overruns related to its extensive product launch programme. - Truck Recovery, Construction Equipment Slump: We forecast a single-digit industrial revenue decline in 2013, based on a recovery in H212. The recovery is likely to be primarily driven by trucks, for which demand in South America and more recently in Europe and North America have bounced back, overcompensating the slow-down in Asia. In comparison, construction equipment (CE) orders dropped 14% year on year (yoy) in H113, against a tough comparison last year, when Volvo's CE business grew by 16%. FCF generation in 2013 is likely to remain negative. - 'BBB' Business Profile: AB Volvo's ratings are supported by its geographic and business diversification as a full-line truck maker, its top-five market positions in major truck markets, and an increasing exposure to high-growth emerging markets through long-term joint ventures and partnerships. The group's sizeable after-market business (23% of sales) provides relatively stable income and mitigates the inherent volatility of truck and construction equipment end-markets. - Improved Business Profile: 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 difficult to access for international manufacturers. Fitch's calculated EBIT margin will not be affected by the consolidation of DFCV, which will be treated as an associate in accordance with the equity method. RATING SENSITIVITIES - Structural Change in Profitability: 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, leading to an FFO margin above 8%. Conversely, negative operating profit from industrial operations for more than two years and an FFO margin below 3% would put pressure on the ratings. - Cashflow, Leverage and Liquidity: Persistent negative FCF, FFO adjusted leverage at the industrial operations above 3x or a significant weakening in liquidity could lead to a downgrade. Conversely, the ratings could be upgraded, if FCF margin is above 3% and industrial FFO adjusted leverage is below 2x. LIQUIDITY AND DEBT STRUCTURE - Healthy Liquidity: Liquidity at industrial operations remains adequate with SEK57.1bn of liquidity sources at end-2012, comprising SEK24.0bn of cash and SEK33.1bn of undrawn committed credit facilities. This compares with SEK45.8bn (SEK12.0bn net of internal funding) of debt maturing in 2013. Contact: Principal Analyst Eric Vogeler Associate Director +49 69 76 80 76 243 Supervisory Analyst Ha-Anh Bui Director +44 20 3530 1566 Fitch Ratings Limited 30 North Colonnade London E14 5GN Committee Chair Frederic Gits Managing Director +33 1 44 29 91 84 Media Relations: Peter Fitzpatrick, London, Tel: +44 20 3530 1103, Email: peter.fitzpatrick@fitchratings.com. Additional information is available on www.fitchratings.com. For regulatory purposes in various jurisdictions, the supervisory analyst named above is deemed to be the primary analyst for this issuer; the principal analyst is deemed to be the secondary. The issuer did not participate in the rating process, or provide additional information, beyond the issuer's available public disclosure. Applicable criteria, 'Corporate Rating Methodology: Including Short-Term Ratings and Parent and Subsidiary Linkage', dated 5 August 2013, is available at www.fitchratings.com. Applicable Criteria and Related Research: Corporate Rating Methodology: Including Short-Term Ratings and Parent and Subsidiary Linkage here Additional Disclosure Solicitation Status here ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: here. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEBSITE 'WWW.FITCHRATINGS.COM'. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE 'CODE OF CONDUCT' SECTION OF THIS SITE. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE.

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