June 2, 2016 / 4:05 PM / 3 years ago

Fitch Affirms Volkswagen AG at 'BBB+'; Outlook Negative

(The following statement was released by the rating agency) BARCELONA/LONDON, June 02 (Fitch) Fitch Ratings has affirmed Volkswagen AG's Long-term Issuer Default Rating (IDR) at 'BBB+' and Short-term IDR at 'F2'. The Outlook on the Long-term IDR is Negative. A full list of rating actions is at the end of this commentary. The ratings reflect the effects of the emissions scandal, which came to light in September 2015. Volkswagen's profitability fell significantly in 2015 as a result of EUR16.2bn of provisions booked to cover risks stemming from the emissions crisis and we expect free cash flow (FCF) to be significantly affected until at least 2018. We assume extraordinary cash outflows related to the diesel issue of EUR12bn in 2016, leading to a negative 2.9% FCF margin, and a further EUR5bn in 2017. However, the ratings also reflect the group's resilience in the face of this crisis and the greater visibility that has developed in the past few weeks about the magnitude of the scandal's cost. Although full details of the EUR16.2bn provision booked for the emissions crisis are not publicly available and we expect further charges in 2016 and possibly 2017 for yet unknown compensation claims, litigation costs and criminal and regulatory liabilities, we believe that visibility of the total cost of the crisis has moderately improved. Some uncertainty remains about the total amount and timespan of cash outflows, but we believe that our latest estimates remain manageable for the group at the current rating. Volkswagen's financial structure is robust, including low funds from operations (FFO) adjusted net leverage, which we project to increase slightly above 0x in 2016. In addition, we believe that Volkswagen has the ability to cut or postpone capex and dividends and sell assets to limit the effect on its financial profile in case of a material increase of the total costs of the crisis. The Negative Outlook reflects the possibility of further important findings to be uncovered as a result of ongoing investigations, the remaining uncertainty regarding the final impact of all criminal and regulatory liabilities and the potential for further reputational damage to the group and its brands. An upgrade is unlikely in the absence of stronger internal control and corporate governance, in line with main peers. KEY RATING DRIVERS Hit to Profitability Before exceptional items related to the emissions crisis, Volkswagen's industrial operating margin decreased to 5.8% in 2015 from 6.1% in 2014, excluding the robust double-digit margins from Chinese joint ventures. In particular, the core Volkswagen brand's profitability declined further to 2.0% in 2015 from 4.0% in 2011, highlighting the relentless heavy challenges in streamlining the cost structure. In addition, the group booked EUR16.9bn of provisions for exceptional items, including EUR16.2bn for the emissions crisis, pulling down group operating margin to negative 3.4%. We assume a further decline of the industrial operating margin before extraordinary charges to 5.6% in 2016 and a gradual recovery thereafter to about 6.0% by 2018, but we will reassess our assumptions as liabilities are updated and become more precise. FCF to Suffer The FCF margin declined marginally to 1.9% in 2015 but we project a substantial effect from the emissions crisis in 2016 and 2017 as provisions taken in 2015 will lead to cash outflows in the foreseeable future. We assume EUR12bn of cash outlays in 2016, EUR5bn in 2017 and EUR2bn in 2018 but expect to revise our projections in the near future when we gain further clarity on fines and compensation agreed with US authorities and customers. Governance Below Peers Key areas of corporate governance weakness include a 20% blocking minority in voting resolutions, potential conflicts of interest on the part of some board members, and lack of independence and diversity at the supervisory board level. The ongoing emissions crisis has also highlighted serious internal control issues. We expect the new management to take measures to strengthen corporate governance, but believe that their implementation and an overhaul of the company's culture may take time and meet resistance. Strong Business Profile The ratings are supported by the group's unparalleled product portfolio in the auto and heavy-truck segments. They also reflect Volkswagen's broad diversification, leading market shares and an unrivalled potential for cost savings and economies of scale. However, the group's business profile is likely to be damaged by reputation issues stemming from the ongoing emissions crisis. KEY ASSUMPTIONS Fitch's key assumptions within our rating case for the issuer include: - Industrial operations' revenue decline of just less than 2% in 2016, rebounding to about 1.0%-2.5% in 2017-2018. - Industrial operating margin declining to about 5.5% in 2016 excluding exceptional items, recovering to about 6.0% by 2018. - Further exceptional charges of EUR3bn in 2016, related to the emissions crisis. Total cash outflows of EUR19bn spread over 2016 (EUR12bn) to 2018. - Capex to reduce moderately to around EUR17bn in 2016 and increase thereafter between EUR17.0bn-17.5bn in 2017-2018. - Neutral working capital movement on average over 2016-2018. - Dividends reduced slightly to about EUR2bn in 2016. RATING SENSITIVITIES Negative: Future developments that could lead to negative rating action include: - Further material reputational damage to the group and its brands. - Further substantial negative findings as a result of ongoing investigations. - Operating margins remaining below 3% (for industrial operations) and 4% (at group level) (industrial: 2015: 5.8%, 2016E: 5.6%, 2017E: 5.9% -- group: 2015: -1.9%, 2016E: 4.0%, 2017E: 6.1%). - Significant deterioration in key credit metrics, including FFO adjusted gross and net leverage above 2x and 1.5x, respectively, (gross: 2015: 1.0x, 2016E: 0.9x, 2017E: 0.7x ; net: 2015: 0.0x, 2016E: 0.2x, 2017E: 0.1x). - Cash from operations on adjusted debt below 50% (2015: 119%, 2016E: 110%, 2017E: 136%). Positive: Future developments that could lead to positive rating action include: -Tighter corporate governance practices. -Evidence that core brands have not been impaired by the emission test crisis. LIQUIDITY Resilient Liquidity We expect liquidity to remain healthy despite the substantial upcoming cash drains. It is supported by EUR22.1bn in cash and securities at end-2015 after Fitch's adjustments for operational and non-readily available cash, an unused EUR5bn credit line maturing in 2020 and an additional one-year syndicated credit line granted in December 2015. In addition, syndicated credit lines worth a total of EUR3.1bn at other group companies were available at end-2015. Group companies had also arranged bilateral, confirmed credit lines with national and international banks in various countries for a total of EUR7.3bn, of which EUR2.6bn was drawn down. FULL LIST OF RATING ACTIONS Volkswagen AG - Long-term IDR affirmed at 'BBB+' - Senior unsecured notes affirmed at 'BBB+' - Short-term IDR affirmed at 'F2' Volkswagen International Finance NV - Senior unsecured notes affirmed at 'BBB+' - Subordinated notes affirmed at 'BBB-' Contact: Principal Analyst Thomas Corcoran Associate Director +44 20 3530 1231 Supervisory Analyst Emmanuel Bulle Senior Director +34 93 323 84 11 Fitch Ratings Espana. S.A.U. 85 Paseo de Gracia 08018 Barcelona Committee Chairperson Paul Lund Senior Director +44 20 3530 1244 Media Relations: Peter Fitzpatrick, London, Tel: +44 20 3530 1103, Email: peter.fitzpatrick@fitchratings.com. Summary of Financial Statement Adjustments -Restricted/unavailable cash: We adjusted cash for intra-year working capital swings (EUR3.7bn at end-2015 and EUR3.6bn-EUR3.8bn for 2016-18). 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. Applicable Criteria Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage (pub. 17 Aug 2015) here Treatment and Notching of Hybrids in Non-Financial Corporate and REIT Credit Analysis (pub. 29 Feb 2016) here Additional Disclosures Dodd-Frank Rating Information Disclosure Form here _id=1005491 Solicitation Status here Endorsement Policy here ail=31 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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