DBRS Confirms Volkswagen AG Ratings at A (low), Trends Positive

DBRS has today confirmed the ratings of Volkswagen AG (VW or the Company), including its Issuer Rating at A (low). The trend on the long-term ratings has been changed to Positive from Stable. The rating action reflects VW’s continuing performance momentum, in addition to further resolution regarding its integration activities with Porsche AG (Porsche). Following changes in tax legislation, the Company has been able to accelerate these efforts, with Porsche becoming fully consolidated in VW as of August 1, 2012, earlier than was previously anticipated. DBRS notes that these developments effectively enable the Company to expedite its integration activities with Porsche, as while Porsche and VW had previously cooperated in many areas, such activities were conducted on an arm’s-length basis. The addition of Porsche (along with the acquisition of motorcycle manufacturer Ducati) expands the Company’s portfolio to twelve brands, with Porsche not only being significantly profitable, but also contributing considerably to VW’s total presence in the premium vehicle segment, an area which generates materially higher margins while also typically being considerably more resilient to cyclical downturns vis-à-vis mass-market automotive brands.

The ratings continue to incorporate VW’s strong business profile as the world’s second-largest automotive manufacturer, with impressive product and geographic diversification. DBRS notes that the Company has been materially outperforming the automotive industry across all major geographic markets. Of particular note is the Company’s ongoing progress in China, which is the world’s largest automotive market and (notwithstanding some recent moderation) remains subject to material growth going forward. VW is the market leader (2011 share of 18.2%) in China, which is now also the Company’s largest sales market; (results from VW’s joint ventures in the region are accounted for using the equity method). The Company also enjoys a strong number two position in Brazil, which has emerged as the world’s fifth-largest automotive market.

VW has been progressively increasing its presence in North America, where the Company’s operations have benefited from the moderate recovery in the U.S. market, although strong competition and foreign exchange headwinds continue to undermine earnings performance. However, DBRS notes that the current Jetta and Passat models (both of which were designed specifically for the region) have generated considerably stronger sales vis-à-vis their predecessors, with forthcoming model introductions likely to further bolster future market share. This, along with higher localized production through the Company’s Chattanooga, Tennessee plant (whose capacity utilization is being progressively increased) should enable VW to generate profits in that market over the near- to medium-term.

VW remains heavily exposed to its native Western Europe, where the automotive industry has contracted significantly this year amid ongoing economic headwinds exacerbated by the region’s sovereign debt crisis. However, DBRS notes that the Company continues to perform much better in this continent than many of its peers, reflecting VW’s strong competitive position and its favourable country mix. VW’s two largest European markets, Germany (where the Company enjoys a leading market share of approximately 36%) and the U.K., have fared much better than other countries (particularly Southern European markets), with the automotive industry in Germany through the first eight months of 2012 contracting by only 1% year-over-year and the U.K. actually achieving moderate year-over-year growth. DBRS also observes that VW’s mass-market Volkswagen brand, in addition to being the region’s market share leader, is significantly stronger than its closest mass-market peers, and as a result commands greater pricing power. The Company’s European sales have also been bolstered through the efforts of its financial services division, which, as a result of lower funding costs attributable to its relatively stronger credit rating(s), is able to provide greater financial incentives toward the purchase of Volkswagen vehicles.

The acquisition of Porsche meaningfully improves the Company’s business profile. While the earnings impact in 2012 will be significantly muted, given Porsche’s consolidation for only the latter five months of the year (in addition to the amortization of the purchase price allocation associated with the transaction), DBRS expects Porsche to be a significant contributor to VW’s profitability from 2013 onward. Closer cooperation efforts and joint activities such as purchasing are estimated by the Company to result in annual synergies of approximately EUR 700 million. Moreover, VW was already well-represented in the premium segment, primarily by Audi (and, on a much smaller scale, by Lamborghini and Bentley). However, the addition of Porsche stands to significantly bolster VW’s presence in the premium segment, which DBRS projects will account for as much as half of the Company’s consolidated operating profit going forward.

DBRS acknowledges that the extensive outlays (which have totaled approximately EUR 14 billion from the start of 2011 through the first eight months of 2012) associated with the acquisitions/increased equity stakes in MAN, Ducati and Porsche have had moderate adverse effects on VW’s financial profile. However, DBRS notes that credit metrics persist at levels effectively exceeding the assigned ratings. While the outlays have significantly lowered the Company’s cash balances, DBRS notes that the automotive operations continue to have a net cash position (following the acquisition of the remaining 50.1% stake in Porsche). Moreover, the industrial segment’s liquidity position continues to be excellent, with DBRS estimating the gross liquidity of the automotive segment, post the Porsche acquisition, at approximately EUR 23 billion.

VW is also planning significant investments in line with its growth objectives of eventually becoming the world’s largest auto manufacturer, as well as the ongoing progression of the Company’s modular matrix strategy. Following the modular longitudinal matrix (MLB) and new small family (NSF) platforms, the Company late last year unveiled its modular transverse matrix (MQB), which was utilized in the recently launched seventh-generation Volkswagen Golf, and in the longer term is expected to serve as the underpinning for approximately half of the Company’s total vehicle volumes. While the Company’s plants are subject to significant modernization costs in order to accommodate the modular matrices, significantly lower vehicle development costs are expected going forward, as well as increases in VW’s ability to design and produce niche models in the future, both of which should serve to bolster margins over the medium to long term.

With its strong presence in emerging markets, VW is very well-positioned to benefit from the projected growth of the global automotive industry. Should the Company’s performance momentum persist amid ongoing headwinds in Europe and its financial profile continue to readily absorb VW’s significant investments, this would likely result in an upgrade of the ratings over the next twelve to eighteen months.

Notes:
All figures are in Euros unless otherwise noted.
The ratings of Volkswagen Canada Inc. and VW Credit Canada Inc. are based on a guarantee of Volkswagen AG.

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