DBRS Confirms AB Volvo at BBB (high) and R-2 (high)

DBRS has today confirmed the long- and short-term ratings of AB Volvo (publ) (Volvo or the Company) at BBB (high) and R-2 (high), respectively, reflecting the Company’s solid business profile, with Volvo being firmly entrenched as the world’s second largest truck manufacturer and the third global player in construction equipment. The trend on the ratings remains Stable, taking into account gradually improving market conditions across most of the Company’s businesses, which would suggest that the worst of the global economic downturn appears to have passed. Additionally, significant cost reductions executed through the downturn should bolster Volvo’s performance going forward.

DBRS downgraded the Company’s ratings on February 24, 2010, given extended weak results and substantially higher leverage of the industrial operations that caused the Company’s financial profile to deteriorate to a level no longer commensurate with its former ratings. While Volvo’s performance is expected to strengthen going forward, DBRS notes that the apparent recovery of market conditions is from very weak levels and is likely to be quite protracted. As such, profitability in the near term is expected to remain below historical norms, with leverage of the industrial operations persisting materially in excess of the Company’s net debt-to-equity targeted ceiling of 40%.

The Company’s 2009 results were very weak. Revenues for the industrial operations were close to 30% lower year-over-year, with Volvo’s two core segments, trucks and construction equipment, both showing sharp decreases. The decline in volumes overwhelmed implemented countermeasures, with the Company incurring an operating loss of SEK 16.3 billion (as calculated by DBRS) for the year.

Accordingly, free cash flow for 2009 was substantially negative, with leverage of the industrial operations increasing sharply. As of December 31, 2009, industrial debt-to-capitalization amounted to approximately 54%, an elevated level despite the fact that a degree of the higher gross leverage was attributable to Volvo’s increasing liquidity objectives (in the form of higher cash balances) in response to the financial crisis. In the first quarter of 2010, the Company reverted to profitability as market conditions in both trucks and construction equipment began to improve. Also contributing to earnings were significant cost reductions executed through the economic downturn that have significantly lowered Volvo’s breakeven production levels. While free cash flow was negative due to working capital absorption, DBRS notes that this is mostly a function of seasonality rather than repeated adverse effects of the economic downturn.

Going forward, in addition to the aforementioned cost reductions, other factors would appear to support the Company’s performance. Volvo’s increasing presence in emerging markets, which represented 46% of first-quarter sales, should help offset potential ongoing headwinds in developed markets, particularly Europe, which appears likely to lag North America in its recovery. Additionally, Volvo’s ongoing product renewal through the economic downturn should strengthen its competitive position, likely resulting in market share gains and higher sales and profitability. DBRS also notes that the relative proportion of soft product revenues (i.e., parts and services revenues, including aftermarket business) to total sales has been materially increasing in recent periods, with such business typically being less volatile and of a higher margin vis-à-vis hard product sales.

DBRS expects the ratings to remain constant over the near to medium term, with Volvo’s financial profile continuing to improve, although a return to historical levels will likely prove protracted in light of the ongoing challenges in certain markets, most notably Europe. DBRS also notes that the possibility of a double-dip recession still looms, although the impact of this should be sufficiently offset by the Company’s executed cost reductions and other countermeasures implemented through the recent economic downturn.

Notes:
Ratings for Volvo Treasury Canada Inc. are based on the parent and guarantor, AB Volvo (publ).

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

This is a Corporate rating.