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

DBRS has today 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 firmly entrenched as the world’s second largest truck manufacturer and the third global player in construction equipment. The trend on the ratings has been changed to Positive from Stable, recognizing the Company’s strong recent financial results that demonstrate a solid and sustained recovery (from the 2009 global economic downturn), with 2011 sales and profitability reaching record levels. DBRS notes that the solid earnings performance (which commenced in 2010 and progressed further through the first half of 2012) has significantly bolstered Volvo’s financial profile, with most credit metrics (particularly income- and coverage-based measures) exceeding levels commensurate with the current ratings. Moreover, the Company’s balance sheet stands to be moderately bolstered by the forthcoming divestiture of Volvo Aero, with DBRS expecting the majority of the sale proceeds to be applied toward debt reduction. While DBRS acknowledges that headwinds are increasing in some of the Company’s end markets, DBRS expects this to be significantly offset by ongoing solid performance across the Company’s other businesses, with Volvo’s financial profile remaining on track and within levels typically associated with an A (low) rating.

The Company’s 2011 annual results represented a substantial improvement for the second consecutive year, with both revenues and operating income attaining record levels. Sales of the industrial operations increased by approximately 18% relative to the prior year, reflecting ongoing solid growth of Volvo’s core truck and construction equipment segments. While the truck business benefited from generally favourable industry conditions worldwide, DBRS notes that performance was also bolstered by material gains in share achieved across major regions. In Europe, the Company’s market share increased to 26.3% (from 24.4% the prior year) while in North America, share also grew significantly to 18.2% (from 16.2% in 2010), indicating strong market acceptance of Volvo’s new engine and transmission offerings. Moreover, global construction activity continued to recover from previously very weak levels, with the Company also making significant progress in many emerging markets, notably China, where Volvo has become the market leader in wheel loaders and excavators.

Through the first half of 2012, the Company’s solid performance continued, with total sales growing further from record 2011 levels. Overall profitability, while still strong, did however soften somewhat, mainly reflecting moderately weaker earnings for the truck segment, primarily attributable to challenging conditions in Southern Europe (resulting mostly from the region’s sovereign debt crisis) and Brazil (where 2011 volumes were boosted by pre-buying activity in advance of the tighter emissions standards introduced this year). As a function of the above, the relative proportion of North American truck sales (to total segment revenues) has increased, while the relative representation of European and South American sales has in turn moderated. Given that unit margins in Europe and South America are typically higher than in North America, this change in market mix has adversely affected profitability, although DBRS notes that the truck segment’s operating margin of 7.6% generated in the first half of 2012 remained very solid (and materially above historical norms). In construction equipment, performance continued to trend positively amid mostly favourable industry conditions, with the notable exception of China (reflecting government measures aimed at controlling inflation). Sales increased materially year-over-year, with operating leverage and additional efficiency gains further increasing the segment’s operating margin to a solid 12.6%.

Going forward, DBRS acknowledges emerging headwinds across some of the Company’s key end markets, notably truck industry conditions in Southern Europe and Brazil in addition to slowing construction activity in China. However, this is expected to be significantly offset by ongoing solid results across most of Volvo’s other businesses, recognizing the Company’s solid geographic diversification with emerging markets representing approximately 40% of total sales. Additionally, aftermarket sales, which typically generate high margins while being relatively resilient to market downturns, also represented a significant 23% of 2011 revenues. Moreover, the Company is implementing organizational changes with the aim of improving its future financial performance. In the beginning of 2012, Volvo introduced a new, flatter organizational structure to increase customer focus as well as its ability to react more expeditiously to changing market conditions. In July 2012, the Company also announced an agreement to sell its non-core Aero business to British engineering firm GKN PLC (GKN); (the transaction remains subject to regulatory approval). Most of the SEK 6.9 billion in anticipated proceeds from the pending sale is expected to be allocated toward debt repayment, thereby moderately strengthening Volvo’s balance sheet while also enabling the Company to place greater emphasis on its core businesses.

While total earnings are likely to soften somewhat over the near term, DBRS expects the Company’s performance to remain strong. Should Volvo’s financial profile over the next twelve-month period remain consistent with levels typically associated with an “A” rating (including a material reduction in industrial indebtedness), notwithstanding less favourable conditions in the Southern European and Brazilian truck markets (and lower construction activity in China), this would likely result in an upgrade of the ratings. However, in the event that the Company’s performance weakens appreciably as a result of the aforementioned headwinds, the trend on the ratings could revert to Stable.

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.