December 14, 2016 / 4:32 PM / 7 months ago

Fitch Affirms AB Volvo at 'BBB'; Outlook Stable

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(The following statement was released by the rating agency) LONDON, December 14 (Fitch) Fitch Ratings has affirmed AB Volvo's (Volvo) Long-Term Issuer Default Rating (IDR) and senior unsecured rating at 'BBB' and Volvo Treasury AB's senior unsecured rating at 'BBB'. The Outlook on the IDR is Stable. Fitch has also affirmed Volvo Treasury AB's EUR900m 5.5 year non-call and EUR600m 8.25 year non-call subordinated fixed to reset capital securities at 'BB+' .The securities are unconditionally and irrevocably guaranteed by Volvo. The affirmation reflects continued improvement in profitability and leverage, despite falling sales on the back of weak demand in most markets in 2016. Profitability has increased following the completion of the 2013-2015 restructuring programme. We expect the industrial operations EBIT margin to stabilise at around 5% in the medium term and funds from operations (FFO) adjusted net leverage to decline and remain below 1.0x. However, a longer track record through the cycle at these levels would be necessary to warrant a positive rating action. KEY RATING DRIVERS Decreasing Revenues Volvo's operating performance fell short of Fitch's expectations in the first nine months of 2016. Industrial revenues fell to SEK289.1bn (3Q16 LTM) from SEK 301.8bn (3Q15 LTM), as truck and construction equipment sales fell in most regions outside of Europe. Based on current orders, Fitch expects demand in emerging markets and North America to remain stressed. Therefore, we expect 2017 revenue to fall 0.9% against our previous forecast of a 2.4% rise. We do not expect growth to return until 2019, but then only at low levels. Cost Cuts Support Profitability Volvo largely completed its three-year restructuring programme in 2015, delivering results in line with expectations. This has supported profitability despite weak market conditions. Adjusted for one-off items, Volvo trucks 3Q16 LTM EBIT was up 8.5% from 7.6% at end 2015, driven primarily by cost-cutting measures. Fitch forecasts industrial profitability margins to normalise around 5% in the medium term, reflecting harder pricing conditions in all geographies, including mature markets. Leverage Commensurate With Ratings Fitch forecasts FFO-adjusted net leverage below 1.0x in the medium term, with additional room for improvement depending on Volvo's non-core business disposal strategy. Volvo's hybrid issue in 2014 improved the company's maturity profile and leverage metrics to a level that provides headroom for weak market conditions in emerging markets. Disposals Offset Acquisitions Volvo's M&A approach of funding acquisitions through disposal proceeds is credit-positive. The SEK8.9bn proceeds from the sale of Volvo Rents and its commercial real estate business offset a SEK6bn increase in net debt from a 45% stake purchase in DFCV and the SEK1bn Terex acquisition in 2014-2015. The subsequent sale of Eicher, Volvo's basic segment brand in India, for SEK4.5bn in 2015, the divestment of IT operations in 1Q16 and the sale of properties in Gothenburg in 4Q16, show that disposals continue to be a part of Volvo's strategy towards improving internal efficiency and profitability margins. Strong Liquidity Liquidity at Volvo's industrial operations is sound, comprising SEK16.2bn of cash and SEK39.7bn of non-current undrawn committed credit facilities at 3Q16. This compares with SEK35.6bn of debt maturing in 2017. The group's policy is to maintain sufficient liquidity to cover 12-18 months in case access to capital markets is restricted. 'BBB' Business Profile The ratings are supported by Volvo's geographic and business diversification as a full-line truck maker, its leading market positions in major markets and growing exposure to high-growth emerging markets. The group's services business (25% of sales at end 2015) provides stable income and mitigates the inherent volatility of its end-markets. DERIVATION SUMMARY The ratings are supported by Volvo's geographic and business diversification as a full-line truck maker, its leading market positions in major markets and growing exposure to high-growth emerging markets. The group's services business (25% of sales at end-2015) provides stable income and protects against the inherent volatility of its end-markets. Volvo's technological leadership and strong market positions mitigate the cyclicality of the truck and construction equipment sectors, but only to a certain extent. Notwithstanding the decline in its end-markets in 2016, the company's profitability and leverage have improved on the back of a leaner cost base achieved through its restructuring programme. We expect gross and net leverage to be in line with a strong 'BBB' rating. Furthermore, we expect operating margins, which have historically lagged behind competitors, to improve to 5.0% in the medium term. KEY ASSUMPTIONS Fitch's key assumptions within our rating case for the issuer include: - Continued growth in Europe in all business segments, although at lower levels and not enough to fully offset declines in other regions - Decline in industrial operations revenues until end 2017, with muted growth only in 2019 - Falling truck sales until end 2017 driven primarily by stressed demand in North and South America - Operating EBITDA margin for industrial operations of approximately 9.5% in the medium term RATING SENSITIVITIES Future Developments That May, Individually or Collectively, Lead to Positive Rating Action - Structural improvement and reduced cyclicality of group operating margin (FY15: 5.5%), particularly at its truck division. - FFO margin (post-capitalised R&D) of more than 8% (FY15: 8.8%) through the cycle. - FFO-adjusted net leverage of less than 1x (FY15: 0.7x) through the cycle. Future Developments That May, Individually or Collectively, Lead to Negative Rating Action - Negative EBIT margins for at least two years. - FFO margin (post-capitalised R&D) of less than 4% through the cycle - Persistent negative FCF, actual or expected (FY15: SEK11.8bn) through the cycle - FFO-adjusted net leverage of more than 2x through the cycle - Significant weakening in liquidity. The above credit metrics refer to industrial operations on a sustained basis LIQUIDITY Liquidity at Volvo's industrial operations is sound, with liquidity sources at 3Q16 comprising SEK16.2bn of cash and SEK39.7bn of non-current undrawn committed credit facilities. This compares with SEK35.6bn of debt maturing in 2017. The group's policy is to maintain sufficient liquidity to cover 12-18 months in case access to capital markets is restricted. Contact: Principal Analyst Cigdem Cerit Associate Director +34 93 467 88 40 Supervisory Analyst Dr. Georgy Kharlamov Director +49 69 768 076 263 Fitch Deutschland GmbH Neue Mainzer Strasse 46-50 D-60311 Frankfurt am Main Committee Chairperson Bram Cartmell Senior Director +44 203 530 1874 Media Relations: Peter Fitzpatrick, London, Tel: +44 20 3530 1103, Email: peter.fitzpatrick@fitchratings.com. Date of Relevant Rating Committee: 13 December 2016 Summary of Financial Statement Adjustments Operating leases: operating lease expenses were capitalised using a multiple of 8x times as the company is based in Sweden. Additional information is available on www.fitchratings.com. 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