DBRS Upgrades Volkswagen to “A” from A (low), Stable Trend

DBRS has today upgraded the long-term ratings of Volkswagen AG (VW or the Company), including its Issuer Rating to “A” from A (low). The short-term ratings remain confirmed at R-1 (low). The trend on all ratings is Stable. DBRS notes that the long-term ratings were previously on a Positive trend (assigned on October 5, 2012), with the ratings upgrade reflecting VW’s improving business profile given the Company’s additional progress with respect to the ongoing integration of acquired entities Porsche AG (Porsche) and MAN SE (MAN). Moreover, while VW’s results through the first half of 2013 were somewhat weaker year-over-year, DBRS notes that the Company’s financial profile remains commensurate with the newly assigned ratings; this despite VW having incurred substantial financial outlays in recent years in connection with the Company’s long-term growth objectives. With the addition of Porsche, VW has further bolstered its already strong position in the premium automotive segment; an area which generates materially higher margins vis à vis mass-market brands while also typically being considerably more resilient to cyclical downturns. In the commercial vehicles business, VW is also progressing further in its growth strategy with the conclusion of the control and profit and loss transfer agreement between VW and MAN; ratified by the latter’s shareholders at their annual meeting on June 6, 2013. Through the above, DBRS notes that any residual uncertainties regarding the Company’s eventual integration of Porsche and MAN have been effectively removed, thereby removing considerable distraction from VW’s senior management team.

The ratings incorporate VW’s strong business profile as the world’s third-largest automotive manufacturer, with impressive product and geographic diversification. DBRS recognizes that the Company’s financial performance through the first half of 2013 is weaker year-over-year. However, this is primarily a reflection of challenging market conditions, particularly in Europe (and to a lesser degree in South America). Moreover, the softer results in Europe this year are also significantly a function of VW’s country mix, with industry volumes in the Company’s native German market declining 8.1% year-over-year; (in contrast to 2012 when Germany proved resistant to the European downturn with its automotive industry sustaining growth).

The above notwithstanding, DBRS notes that the Company has continued to outperform its automotive peers in Germany and Europe and achieve ongoing market share gains, with such outperformance persisting 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 (2012 share of 20.8 %) 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.

The addition of Porsche meaningfully improves the Company’s business profile. With Porsche being consolidated as of August 2012, VW’s financial performance will benefit from its inclusion for the full 2013 year, with DBRS expecting Porsche to be a significant contributor to VW’s profitability in forthcoming years. Porsche’s integration into the Company’s operations is expected to result in significant synergies, which are projected by the Company at roughly EUR 400 million in 2013 and in the medium term could amount to approximately EUR 1 billion annually. Moreover, while the Company was already well-represented in the premium segment, primarily by Audi (and, on a much smaller scale, by Lamborghini and Bentley), the addition of Porsche stands to further bolster VW’s presence in this segment, which is expected to account for more than half of the Company’s consolidated operating profit going forward.

The inclusion of Porsche also bolsters VW’s presence in North America, which has been subject to additional focus of the Company in line with the completion of its assembly plant in Chattanooga, Tennessee in May 2011. VW’s current Passat and Jetta models (sold in North America) are designed specifically for that market, with the Company’s North American operations benefiting from the ongoing recovery of the region’s automotive industry. However, the earnings performance was impeded by challenges that, among other items, include strong competition in addition to foreign exchange headwinds. However, VW’s progressively growing sales, increased localized production (as a function of additional capacity at the Chattanooga plant) as well as the inclusion of Porsche (which complements Audi’s solid market position) should enable VW’s North American operations to revert to sustainable profitability from 2013 onward.

VW remains significantly exposed to its native Western Europe, where extremely challenging conditions persist in the automotive industry. DBRS notes, however, that the Company’s dependence on Europe has nonetheless considerably lessened in recent years in line with VW’s strong growth in the Asia-Pacific region, which accounted for approximately 38% of VW’s total deliveries through the first half of this year (as opposed to only 17% in all of 2007).

DBRS recognizes that VW, in line with its ongoing growth objectives, has in recent years made substantial equity investments/acquisitions, with such transactions totalling in excess of EUR 16 billion since the beginning of 2011. However, DBRS also notes that the Company has through this process maintained its financial discipline, with VW from time to time executing capital increases/mandatory convertible note issuances so as not deviate from its historically conservative financial policy. This approach, in combination with the consistently strong cash flow generation of the Company, has resulted in credit metrics that are well commensurate with the newly assigned ratings.

The Stable trend on the ratings incorporates DBRS’s expectation that VW will maintain its strong financial and business profiles, with the Company’s competitive position being reinforced by its very solid representation in the premium automotive segment along with its strong presence in emerging markets, which are expected to represent the majority of the global automotive industry’s growth going forward.

Notes:
All figures are in euros unless otherwise noted.

The related regulatory disclosures pursuant to the National Instrument 25-101 Designated Rating Organizations are hereby incorporated by reference and can be found by clicking on the link to the right under Related Research or by contacting us at info@dbrs.com.

This rating is endorsed by DBRS Ratings Limited for use in the European Union.

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