DBRS Confirms AB Volvo at BBB (high), Trend Changed to Stable

DBRS has confirmed the long- and short-term ratings of AB Volvo (Volvo or the Company) at BBB (high) and R-2 (high) respectively. The ratings reflect the Company’s solid business profile, with Volvo being firmly entrenched among the world’s largest truck manufacturers and the third global player in construction equipment. The trend on the ratings has been changed to Stable from Positive. Volvo’s ratings were previously on a Positive trend (for details, please see DBRS press release dated August 22, 2012), incorporating the Company’s prior strong financial performance. While DBRS had anticipated that Volvo’s earnings would subsequently soften somewhat in line with weakening market conditions, it was also expected that the leverage (i.e., gross debt-to-total capitalization) of the industrial operations would be reduced, primarily as a function of the Company’s divestiture of its Volvo Aero business in the second half of 2012. However, DBRS notes that the leverage of the Company’s industrial operations has continued to increase, as proceeds of the Aero divestiture were more than offset by negative free cash flow (in line with weaker earnings, exacerbated by significant working capital usage). DBRS further notes that the Company’s balance sheet is also likely to be moderately adversely affected by its expected payment of RMB 5.6 billion (approximately US$900 million) upon the completion (currently anticipated for early 2014) of the Company’s joint venture (JV) with Chinese vehicle manufacturer Dongfeng Motor Group Company Limited (Dongfeng) (please refer to DBRS press release dated January 29, 2013). In line with the above noted developments, DBRS is now of the opinion that Volvo’s overall credit measures are more commensurate with ratings in the BBB (high) rating category.

Volvo’s financial results weakened in 2012, as increases through the first six months were more than offset by declines in the last half of the year, with this trend persisting through the first half of 2013. The decreases were persistent across all of Volvo’s businesses, including the core truck and construction equipment segments. DBRS notes that this trend moderated considerably in the second quarter of 2013, in which the Company’s financial performance (on a sequential basis) improved significantly relative to the first quarter; specifically, industrial revenues and operating earnings in the second quarter increased to SEK 71 billion and SEK 2.8 billion, respectively, from weak Q1 levels of SEK 56 billion and SEK 0.1 billion. Moreover, the Company’s order book has also increased notably in recent quarters, with incoming orders significantly exceeding current deliveries, suggesting that conditions across Volvo’s key end markets have likely bottomed out.

In the truck business, market conditions in 2012 were softer across all geographic market segments with the exception of North America, which nonetheless also weakened materially in the second half of the year. Earnings in turn were considerably lower, with profitability being adversely affected not only by the reduction in volumes, but also by higher research and development (R&D) expenses associated with the forthcoming Euro 6 emissions legislation (effective as of January 1, 2014), as well as the Company’s significant product offensive. The Company’s recent and/or forthcoming launches are extensive and include the Volvo FH, FM range and FMX models, as well as a new generation of Renault trucks. Volvo is also developing a new model for the value segment. However, DBRS notes that, while this product offensive will primarily serve to defend the Company’s strong competitive position, significant gains in share are not expected, as DBRS considers the market position of the respective leading global truck manufacturers to be rather firmly entrenched. This notwithstanding, upon the formation of the new subsidiary Dongfeng Commercial Vehicles (DFCV) with JV partner Dongfeng, Volvo would become the world’s largest heavy-duty truck producer.

In the construction equipment industry, the situation was somewhat similar, as conditions were rather favourable through the first six months of 2012, only to be followed by material reductions in both volumes and product mix in the second half of last year through the first half of 2013. These decreases were primarily reflective of the recent significant slowdown in global mining activity, with markets such as China and Australia being among the most adversely affected.

Going forward, while weak conditions have possibly bottomed out, headwinds persist across some of the Company’s key end markets. The global truck market is estimated by DBRS to remain roughly flat for the full-year 2013, with conditions in the second half of the year expected to improve notably relative to those in the first half. China is projected to decrease slightly year-over-year, while demand in North America will likely remain flat. The forecast for Europe is for slight growth, reflecting anticipated pre-buying activity in advance of the Euro 6 emissions legislation. Volumes in Japan and Brazil are expected to rise, given significant planned infrastructure investment in both countries. DBRS projects the global construction equipment industry to moderately decline in 2013, with conditions again likely improving in H2, while markets such as North America, South America and China are expected to remain roughly flat, i.e., +/-5% in activity year-over-year. This will likely be more than offset by anticipated declines in Asia (excluding China) and Europe.

The Company is still in the early stages regarding the implementation of its extensive transformation plan, scheduled to extend through 2015. DBRS notes that this plan features several significant objectives for the truck segment, including but not limited to the following: a material increase in profitability, with vehicle gross profit margins increasing by 3% and Volvo emerging among the top two industry participants in terms of profitability; improved distribution capabilities, with the Company increasing its product availability across its customer base, while also growing the penetration rate of its various after-market services; and substantial revenue growth targets in emerging markets such as Asia-Pacific and Africa. With respect to its construction equipment business, Volvo has established similarly noteworthy objectives, including the global growth of the value SDLG brand while also further developing Volvo-branded products in emerging markets. The Company also aims to achieve greater production efficiencies through the increasing implementation of modular architectures across its various product groups.

The Stable trend applied to the ratings incorporates DBRS’s expectation that Volvo’s financial performance will improve significantly in the second half of 2013, with negative free cash flow moderating substantially. In the event that the Company’s cash burn persists at significant levels, this could result in negative rating implications. Over the medium to long term, DBRS notes that future rating actions will likely be significantly dependent on the successful advances of Volvo’s transformation plan, as the Company seeks to increase its global presence while also meaningfully improving margins.

Notes:
All amounts are in SEK unless otherwise specified.

Ratings on Volvo Treasury Canada Inc. are based on the parent and guarantor, AB Volvo.

The applicable methodology is Rating Companies in the Automotive Industry, which can be found on our website under Methodologies.

This rating is endorsed by DBRS Ratings Limited for use in the European Union.