DBRS Confirms Volkswagen at A (low) and R-1 (low), Trend Stable

DBRS has today confirmed the ratings of Volkswagen AG (VW or the Company), including VW’s Issuer Rating at A (low). The ratings incorporate VW’s strong business profile as the world’s third largest automotive manufacturer with impressive product and geographic diversification. The Company’s financial position continues to be robust, with the automotive operations having a sizeable net cash position. The trend on the ratings remains Stable, reflective of VW’s solid operating performance, with the Company continuing to outperform its competition across most geographic markets and achieve ongoing gains in global market share.

VW’s 2009 results were substantially weaker year-over-year, with operating profit of the automotive division amounting to EUR 1.3 billion (vis-à-vis EUR 5.4 billion in 2008). The reduced profit was attributable to lower production, exacerbated by negative mix impacts, particularly in Germany, where volumes were supported by vehicle scrappage incentives, which, however, disproportionately boosted the sales of small cars, given their higher affordability. Adverse foreign exchange effects represented an additional negative factor. Through the first half of 2010, DBRS notes that the Company’s results, while remaining below historically high levels, were nonetheless significantly improved relative to 2009. Higher volumes and favourable pricing and mix effects, along with ongoing cost efficiencies, were the primary contributing factors.

The Company’s premium Audi brand has proven resilient to the downturn, emerging as VW’s most profitable brand from 2009 through the first half of 2010. Earnings of the core Volkswagen brand were significantly weaker in 2009 but have rebounded strongly this year, with these two brands accounting for 95% of automotive operating profit in the first half of 2010. Of the Company’s other brands, only Bentley and SEAT have incurred losses, with the latter hit hard by severe economic headwinds in its native Spanish market.

While the Company ranks as the third largest global auto manufacturer and the leader in Europe, VW’s business profile is further bolstered by its strong and increasing presence in emerging markets, particularly China. DBRS notes that ongoing significant sales growth in that market amid the automotive downturn more than offset decreases in mature markets (operating results of Chinese joint ventures are accounted for using the equity method). As of 2009, emerging markets represented 47% of the Company’s total unit sales and will likely account for the majority of VW’s volumes over the long term. The migration of VW’s global sales footprint positions it favourably, since emerging markets will likely represent the predominant source of growth in the automotive industry going forward. To that end, the Company increased its presence in emerging markets in late 2009 through its EUR 1.7 billion investment to acquire a 19.9% equity stake in Suzuki Motor Corporation (Suzuki). The strategic partnership will serve to expand VW’s product portfolio to include minicars, while also increasing its presence in markets such as India, Southeast Asia and Japan.

Regarding North America, VW’s operations in this region have been adversely affected by the sharp downturn in that market. The Company continues to generate negative earnings in this region, with losses in 2009 further exacerbated by the drop in volumes and the relative weakness of the U.S. dollar vis-à-vis the euro. Despite some foreign exchange tailwinds this year and a moderate increase in volumes (resulting from market share gains and a slight recovery of the industry); VW’s North American operations are expected to continue incurring losses over the near term. However, the forthcoming production facility in Chattanooga, Tennessee (scheduled to open in 2011) will alleviate adverse currency effects, with additional product introductions (beginning with the New Mid-Size Sedan to succeed the Passat) and an eventual recovery in the U.S. market helping to improve earnings prospects.

With the planned merger with Porsche AG (Porsche), the Company’s portfolio will increase to ten brands. While integration risks do exist, DBRS notes that VW has a very strong track record in this regard, having successfully incorporated numerous brands and original equipment manufacturers over the past two decades. VW completed in April of this year a EUR 4 billion capital increase in support of the merger as well as its investment in Suzuki, thereby defending the Company’s strong financial profile. (Porsche’s associated planned capital increase will be debated at its upcoming shareholders meeting on November 30; if approved, the capital increase would likely be executed in 2011.)

DBRS expects earnings to improve significantly over the near to medium term, although profitability is expected to remain materially below the historically high levels of 2007 and 2008. Going forward, VW’s increasing use of modular platforms should improve its cost position and further support earnings. DBRS notes that the Company is very well positioned to benefit from the eventual recovery in the automotive industry; its strong presence in emerging markets bolsters growth prospects, with DBRS expecting the ratings to remain constant over the medium term.

Note:
The ratings of Volkswagen Canada Inc. and VW Credit Canada Inc. are based on the guarantee of Volkswagen AG.

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