DBRS Confirms AB Volvo at BBB (high), Trend Changed to Stable from Negative

DBRS Limited (DBRS) has today confirmed the long- and short-term ratings AB Volvo (Volvo or the Company) and Volvo Treasury Canada Inc. (Volvo Treasury Canada) at BBB (high) R-2 (high), respectively, with the trend being changed to Stable from Negative. Following these rating actions, DBRS has discontinued all ratings of Volvo Treasury Canada as well as the Senior Unsecured and Short-Term Debt ratings of Volvo. The rating reflects the Company’s solid business profile as Volvo is firmly entrenched among the world’s largest truck manufacturers and is the third-largest global player in construction equipment. The Company’s rating was previously on a Negative trend (as of August 2014) amid weaker-than-expected earnings improvement and negative free cash flow generation (significantly attributable to substantial working capital absorption). The trend change to Stable reflects the Company’s stronger earnings and free cash flow generation over the past 12-month period as global industry conditions in Volvo’s core truck segment continue to improve in aggregate (notwithstanding substantial disparities across certain regional markets); moreover, the Company’s ongoing cost-reduction efforts have further benefited margins. Additionally, Volvo’s financial risk profile has been moderately bolstered by the Company’s EUR 1.5 billion hybrid bond issuance in Q4 2014, with credit metrics now being well commensurate with the assigned rating.

Volvo’s moderately higher profitability (after adjusting for unusual items) in 2014 was essentially a function of improved performance of the core truck segment that achieved firmer pricing and mix (and associated stronger margins) amid effectively flat volumes, reflecting solid market acceptance of the Company’s extensive product renewal. Earnings were further strengthened by increased aftermarket services and ongoing cost-reduction activities. The stronger truck results more than offset ongoing weak performance of the construction equipment segment, which was adversely affected primarily by substantial contraction in China (while construction activity across other regional markets were mixed).

Through H1 2015, the Company’s earnings momentum persisted, with profitability considerably higher vis-à-vis H1 2014. Results of the truck segment continued to trend positively given volume gains in North America and Europe that more than offset declines across other regional markets, most notably in South America. Profitability was further supported by materially favourable foreign currency effects. While results of the construction equipment business remained weak, DBRS nonetheless observes that segment earnings improved (despite an ongoing contraction in volumes) as a function of not only foreign exchange tailwinds, but also continued cost-reduction activities and favourable product mix in line with the Company’s increased focus on larger, higher-margin equipment.

DBRS further notes that Volvo’s financial risk profile has benefitted from the Company’s Q4 2014 issuance of a hybrid bond (not rated by DBRS) in the total amount of EUR 1.5 billion. Pursuant to “DBRS Criteria: Preferred Share and Hybrid Criteria for Corporate Issuers,” DBRS has assigned an equity treatment of 25% to the hybrid bond issue. This, in combination with the above-cited improvement in earnings performance, has rendered Volvo’s credit metrics to levels consistent with the ratings.

Going forward, DBRS anticipates moderately firmer earnings and cash flow generation from the Company. While the results of the construction equipment segment will likely remain undermined by continued challenging conditions primarily across emerging markets (mainly China), this is expected to be more than offset by the truck segment’s estimated profits, which are assumed to benefit from higher volumes and firmer pricing. Moreover, with the Company’s investments (associated with its extensive product renewal) having essentially peaked, capital expenditures are projected to remain roughly equivalent with 2014 levels. This, combined with ongoing efficiencies in research and development spending as well as anticipated lower inventory levels (positively affecting working capital requirements), should further support earnings and free cash flow generation. However, in the event that market headwinds escalate to such a degree that Volvo’s earnings are adversely affected, causing a recurrence of negative free cash flow generation (unanticipated by DBRS), this could result in negative rating implications.

Notes:
All amounts are in SEK unless otherwise specified.

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 Industry, which can be found on our website under Methodologies.