DBRS Confirms AB Volvo at BBB (high), Changes Trend to Positive from Stable

DBRS Limited (DBRS) confirmed the Issuer Rating of AB Volvo (Volvo or the Company) at BBB (high). The confirmation reflects Volvo’s sound business risk assessment, as the Company is one of the world’s largest truck manufacturers and is the third-largest global player in construction equipment. The trend on the rating has been changed to Positive from Stable, in recognition of the Company’s stronger financial performance in recent periods, which has exceeded DBRS’s expectations. Moreover, the improved and sustained operating performance coupled with a stronger balance sheet (resulting from non-core asset sales in addition to the Company’s prior issuance of a hybrid EUR 1.5 billion bond with equity-like features) has caused Volvo’s credit metrics and financial risk assessment (FRA) to be above levels commensurate with the current rating.

While Volvo’s earnings in 2015 through H1 2016 were already significantly stronger relative to the previous two years, DBRS was uncertain as to whether the improvement was sustainable, as the Company appeared to face meaningful headwinds in its core Truck segment (in line with an expected contraction in North American industry volumes and concern in Europe following last year’s Brexit vote), with Construction Equipment (CE) conditions, in aggregate, remaining rather lackluster. However, Volvo’s Truck earnings have proven resilient and continued to increase through H1 2017 despite the anticipated decline in unit sales and revenues. Additionally, CE’s profitability has grown markedly this year in line with higher construction activity across most major markets, notably China (albeit from weak levels).

DBRS notes that Volvo’s improved performance significantly reflects its extensive restructuring and cost-reduction measures (collectively, the Efficiency Program) that were substantially completed by year-end 2015 and included a sizable reduction in support and overhead costs as well as the optimization of the Company’s sales and service channels. Notable positive results from the Efficiency Program include a 40% decrease in Truck break-even production volumes in North America. In addition to a leaner cost structure, Volvo’s earnings have benefited from concerted product renewal in both the Truck and CE segments. Finally, the Company’s ongoing efforts to grow its services business (which typically generates higher margins relative to equipment sales while also being more resilient to cyclical downturns) are also expected to benefit future profitability.

In line with the above, DBRS notes that Volvo recently publicly disclosed new financial targets for the Company that include attaining a consolidated operating margin of 10% through a business cycle (i.e., including the earnings of Volvo Financial Services), with the balance sheet of the industrial operations under normal conditions having no net financial indebtedness (i.e., excluding pension liabilities and taking cash balances and intercompany lending activities into account). While DBRS views Volvo’s operating margin target as somewhat aggressive, the Company’s new balance sheet target highlights a more conservative financial policy that should support current credit metrics going forward.

Volvo continues to face challenging conditions across some of its markets; although unlikely, a sudden and pronounced decline in Truck volumes could negatively affect earnings. However, DBRS recognizes the Company’s materially stronger FRA and, assuming Volvo’s recent operating performance remains on track, anticipates upgrading the Company’s rating within Q1 2018.

Notes:
All amounts are in Swedish krona 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.

The principal methodologies are Rating Companies in the Automotive Manufacturing Industry (October 2016), Rating Companies in the Industrial Products Industry (February 2017), DBRS Criteria: Preferred Share and Hybrid Security Criteria for Corporate Issuers (December 2016) and Global Methodology for Rating Finance Companies – Appendix A (October 2016), which can be found on dbrs.com under Methodologies.

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

The rated entity or its related entities did participate in the rating process. DBRS did not have access to the accounts and other relevant internal documents of the rated entity or its related entities.

This rating was not initiated at the request of the rated entity.

DBRS will publish a full report shortly that will provide additional analytical detail on this rating action. If you are interested in receiving this report, contact us at info@dbrs.com.