AB Volvo Upgraded To 'A-' On Forecast Strong Credit Metrics; Outlook Stable


  • Positive performance trends and debt reduction at Sweden-based truck manufacturer Volvo have resulted in improved credit metrics, and we forecast that industrial operations will be in a net cash position at year-end 2019.
  • We anticipate that cash flow, after capital expenditure and about SEK20 billion (about €2 billion) of shareholder distributions, will be about SEK8 billion-SEK12 billion in 2019, supporting a further modest strengthening of credit metrics over the year.
  • Given this strong financial position, and our expectations of a supportive industry environment in 2019, we anticipate Volvo will better withstand tougher market conditions.
  • We are therefore raising our issuer credit rating on Volvo to 'A-' from 'BBB+', and affirming the short-term ratings at 'A-2' and 'K-1'.
  • The stable outlook reflects our view that Volvo's industrial operations will maintain EBITDA margins above 11% over the cycle as well as a strong balance sheet supported by positive discretionary cash flow (DCF). This translates in FFO to debt well in excess of 60% and net debt to EBITDA well below 1.5x.
MILAN (S&P Global Ratings) April 16, 2019—S&P Global Ratings said today that it took the rating actions listed above.
The upgrade reflects our expectation that Volvo's good operating performance will continue to propel a modest strengthening of the company's balance sheet over 2019. We therefore expect Volvo will have flexibility to withstand softer market conditions, with low or no financial debt. Furthermore, we perceive management as committed to its financial target to operate its industrial division on a debt-free basis. This means we expect management to reduce dividends when needed, so that the industrial division will remain virtually debt free. Despite the high dividend outflow in 2019 of SEK20 billion, including a SEK10 billion extraordinary dividend, we still forecast the company will generate positive cash flow after capital expenditure (capex) and shareholder distributions.
In contrast to our previous expectations, we now believe market fundamentals will remain supportive for most of 2019, although a weakening is possible toward the second half of the year, and in 2020, especially in the U.S. This follows a strong 2018, during which Volvo delivered 226,490 trucks, up 12% over 2017, the second-highest rise since the 2008 financial crisis (238,000 units were delivered 2011). However, we acknowledge the softer order intake in the final quarter of the year (to 59,535 from 69,597 the previous quarter), and assume in our base case a softer market from 2020, with a 5%-10% revenue decrease during the year. This is also because we perceive the heavy truck manufacturing industry as highly volatile. We anticipate the financial performance for 2019 will be supported by profitability of about 12.5%-13.5%, roughly the same level as in 2018 (13.1%). We think this will result in adjusted EBITDA around SEK50 billion-SEK55 billion, compared with about SEK50 billion in 2018 (in our adjusted EBITDA we add back a SEK7 billion provision that relates to a nonperforming emissions-control component, which we see as debt and utilized over the coming five years). For 2020, as we expect less supportive market conditions, especially in North America, we expect margins will weaken to about 11.5%-12.5%.
Nevertheless, we believe that Volvo's profitability and the volatility of its cash flow ratios will be more stable than in the past. This partly derives from the increased share of services, which are more stable and recurrent. In 2018, services represented more than 20% of industrial sales. In 2018, services grew by 11% to SEK58.2 billion from SEK52.6 billion in 2017. As margins are significantly higher in the service and parts business, this trend should support group margins in the next downcycle we believe. We expect this trend to gradually continue.
About 1 million Volvo trucks with an age below 9 years are on the roads, up 16% over the past three years. This should also support increasing service and parts revenue over the coming years. During 2013-2015, the company also undertook a wide restructuring program, which we believe explains at least half of the margin increase since 2015, when EBITDA margin stood at 9.3%. In 2018, Volvo's EBITDA margin (13.1%) was higher than peers': Scania (12.3%), Paccar (12.0%), and Daimler (10%). That said, we believe that Volvo has a limited track record of maintaining stable margins over the cycle, compared with peers. Adjusted profitability ratios have, however, been affected by Volvo's large research and development (R&D) spending. In 2018, Volvo's total investment (R&D and capex) to sales was about 6.1%, compared with Scania's 5.7% and Paccar's 3.6%. We perceive this investment supports Volvo's market position, with many new important truck launches over the past few years. This included new models such as the FH series in Europe, Volvo VNR, Volvo VNL, and Mack Granite, Mack Pinnacle and re-entry of the long-haul segment with the Mack Anthem in the U.S., and UD Quon in Japan, which have required large investments. We also believe Volvo is ahead of many peers with regards to trends such as electrification and automation, which increasingly will be drivers of revenue and profitability. For example, Volvo will start selling electric refuse trucks in Europe in 2019, and it has manufactured autonomous and electric machines that are already running as pilot in some quarries.
Thanks to the company's strong cash flow, we expect a net cash position (including our debt adjustments) from the end of 2019. We calculate Volvo's adjusted debt at year-end 2018 to be SEK6.9 billion, comprising SEK25 billion gross debt reported under the industrial operations, SEK11 billion for pensions, SEK7 billion from the provision on degradation of emission control. We then deduct SEK7.7 billion for the hybrids since we assign them intermediate equity content, and SEK36 million in freely available cash. We also exclude from reported gross debt the financial services division. Financial services' debt stood at SEK110.5 billion on Dec. 31, 2018. Reported debt to equity in the captive finance operations is around 9x, and we expect it to remain well below 12x. We expect finance receivables in the captive finance division will continue to broadly match debt. On Dec. 31, 2018, the group had captive finance receivables and operating lease assets of about SEK127 billion. We regard the asset quality of the receivables (which are primarily vehicle-financing term loans) as excellent, based on annual net losses well below 1% in recent years.
We bear in mind that group could be exposed to increasing litigation risks for collusive behavior, for which the EU issued a SEK6.1 billion fine to the group, which Volvo paid in 2016. At this stage, we don't make any further adjustment for this, given the absence of provisions.
The stable outlook reflects our view that Volvo will maintain EBITDA margins above 11% as well as a strong balance sheet, supported by positive DCF over the cycle. This translates in FFO to debt in excess of 60% and net debt to EBITDA well below 1.5x also during softer period of the cycle. Our view is supported the net cash position of Volvo's industrial operations over 2019 and 2020.
Negative rating pressure could emerge if Volvo's EBITDA margin deteriorated below 10% or if its discretionary cash flow to debt turned negative for a prolonged period. This could follow a market downturn causing greater volatility in free operating cash flow generation than we currently expect, or in the event of more generous shareholder payouts than we anticipate in our base case.
We see limited rating upside at this stage, given the company's exposure to a volatile market. That said, we could consider a positive rating action in the longer term if Volvo were able show stable EBITDA margins over the cycle and consistently robust FOCF
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