May 26, 2017 / 1:45 PM / in 2 months

Fitch Affirms Daimler AG at 'A-'; Outlook Stable

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(The following statement was released by the rating agency) LONDON/BARCELONA, May 26 (Fitch) Fitch Ratings has affirmed Daimler AG's Long-Term Issuer Default Rating (IDR) and senior unsecured notes at 'A-' and Short-Term IDR at 'F2'. The Outlook on the Long-Term IDR is Stable. A full list of rating actions is at the end of this release. The ratings reflect Daimler's strong business profile and robust credit metrics. The group maintains a net cash position and adjusted funds from operations (FFO) gross leverage remained low at 0.7x at end-2016. Daimler is currently facing headwinds in the trucks business, particularly in the US, but profitability in the core automotive division supports our expectations for group operating margin remaining around 9% over the rating horizon. The ratings also reflect the relatively weak and volatile free cash flow (FCF) compared to investment-grade peers. A sustained improvement towards 2.5% would be positive for the ratings. KEY RATING DRIVERS Large, Leading, Diversified Business: Daimler AG has wide geographical and business diversification. It has leading positions in the premium passenger-car segment with its Mercedes-Benz and smart brands (MBC division). Daimler Trucks (DT) is the world's largest heavy-truck manufacturer, ranking number one in Europe and North America, and second or third in several other countries/regions, including Brazil and Japan. The group also holds leading positions in the global van and bus markets. Weak Free Cash Flow: Fitch expects the group's operating margin to remain between 8.5%-9.0% in the foreseeable future. However, the free cash-flow (FCF) margin is weak for the rating category, around 1% on average since 2013, as cash from operations (CFO) is absorbed by high capex and generous dividends. Net cash flows have also been hindered by regular contributions to pensions and financial services (FS) operations. We expect FCF to be around 2% through 2019. Weak FCF remains a key rating constraint. Strong Car Business: We expect MBC's operating margins to remain solid, above 9% in the foreseeable future, despite moderate erosion after 2017. In particular, we believe profitability will remain supported by the robust product pipeline and favourable developments in China. This should offset renewed competition from close peers, risks related to the changing powertrain mix and high investments to meet increasingly stringent emission legislation and new mobility trends. We believe that Daimler's increasing efforts towards sustainable and future mobility trends put the group in a better competitive position. Resilient Truck Margins: DT's operating margin was back under pressure in 2016 but remained relatively solid at 5.9%, bearing in mind the significant drop in unit sales. We project a recovery of its operating margin to more than 6% in 2017 and towards 7% by 2019 thanks to a sales recovery, further efficiency and optimisation programmes. Diesel Exposure: An accelerating decline in diesel penetration in Europe would be negative for Daimler, similar to its German peers. Firstly, its fleet has a heavy bias to diesel in Europe (between 60% and 70%, compared with less than 50% for the overall car market in Europe) as diesel is critical to meet 2020 EU CO2 emission targets, for which concerns are growing. Missing targets could cost Daimler a few hundred million euros. Secondly, a rapid swing to other powertrains would be negative for used car prices and, in turn, residual values to which the group is exposed. Increasing sales of electric vehicles could partially lower the risk. Robust Credit Metrics: Key credit ratios have been supported by extraordinary cash inflows from divestments made between 2012 and 2014 and the low debt level. Metrics remain solid despite recurring and extraordinary cash outflows. Daimler has important headroom in its ratings, with funds from operations (FFO) gross adjusted leverage below 1x and a sustained net cash position at its industrial operations. DERIVATION SUMMARY Daimler's business and financial profiles are largely in line with peers at a similar rating level. The group has a weaker competitive position than large volume manufacturers but this is fully offset by its positioning in the premium segment. Daimler is among the top-three premium car manufacturers and has recovered in the past couple of years market shares lost to Volkswagen's Audi and to BMW following its recent product offensive and rejuvenated model line-up. Its image remains strong and its brand value extremely high. Business diversification is supported by the group's exposure to the heavy trucks and bus segments, despite the latter's greater cyclicality and volatility than the passenger car business. Synergies between the latter divisions and the passenger car business have typically been more limited than with the vans division but we expect that increased technological convergence in the fields of autonomous driving and electric mobility will provide more synergies between divisions in the medium term. The group's financial profile is robust for the ratings. Automotive operations' profitability has been lower and more volatile than those of its close peers BMW and Audi, but it has strengthened continuously in the past few years. The truck division's profitability also compares adequately with other large global truck makers. However, amongst the highest-rated manufacturers, Daimler's net cash generation has been the most volatile in the past decade and is weak for the rating category, in part due to extraordinary contributions to pensions and regular contributions to its financial services operations. Nonetheless, net leverage has been consistently negative since 2010 and compares favourably with other similarly rated peers. No country-ceiling, parent/subsidiary or operating environment aspects impact the rating KEY ASSUMPTIONS Fitch's key assumptions within our rating case for the issuer include: - industrial operations' revenue growth of around 4% in 2017 declining to between 1%-2% in 2018 and 2019; - industrial operating margin improving to more than 9% in 2017 as a result of the strong MBC's product line-up but declining modestly to just below 9% by 2019; - capex to increase to around EUR9.5 billion in 2017 and maintained around 6.5% of sales in 2018-2019; - around neutral working capital movements; - dividends increasing to EUR3.7 billion in 2017 and rising further towards EUR4.0 billion by 2018. RATING SENSITIVITIES Future Developments That May, Individually or Collectively, Lead to Positive Rating Action - FCF margin remaining above 2.5% (2016: 0.2%, 2017E: 2.0%, 2018E: 2.2%) - The ability to meet the group's target for MBC operating margin of 10% through the cycle (2016: 9.1%, 2017E: 9.6%, 2018E: 9.4%) - DT operating margin approaching 8% through the cycle, (2016: 5.9%, 2017E: 6.2%, 2018E: 6.6%), with a minimum of 3% Future Developments That May, Individually or Collectively, Lead to Negative Rating Action - Operating margins remaining below 2% (industrial)/3% (group), (industrial: 2016: 7.9%, 2017E: 9.4%, 2018E: 9.1% -- group: 2016: 8.4%, 2017E: 9.2%, 2018E: 9.0%) - Material negative FCF (actual or expected) for more than three years, coming from weak underlying performance, or shareholder-friendly actions - Gross adjusted leverage above 2x (2016: 0.7x, 2017E: 0.7x, 2018E: 0.7x) and net adjusted leverage above 1x (2016: -0.3x, 2017E: -0.3x, 2018E: -0.5x). LIQUIDITY Healthy Liquidity: The group has historically reported a strong net cash position. Gross cash and marketable securities from the industrial business were EUR14.2 billion at end-2016, including Fitch's adjustments for restricted and not readily available cash. It more than covered total financing liabilities of EUR10.9 billion including adjustments for operating leases and financial services capitalisation. FULL LIST OF RATING ACTIONS Daimler AG: Long-term IDR affirmed at 'A-'; Outlook Stable Senior unsecured debt affirmed at 'A-' Short-Term IDR affirmed at 'F2' Commercial paper affirmed at 'F2' Guaranteed notes affirmed at 'A-' and 'F2' The guaranteed long-term and short-term debt of the following issuers has been affirmed at 'A-'/'F2': Mercedes-Benz Australia/Pacific Pty. Ltd. Daimler International Finance BV Mercedes-Benz Japan Co. Ltd. Daimler Canada Finance Inc. Daimler Finance North America LLC Mercedes-Benz Finansman Turk A.S. Mercedes-Benz South Africa (Pty) Ltd. Daimler Mexico S.A. de C.V. Contact: Principal Analyst Thomas Corcoran Associate Director +44 20 3530 1231 Supervisory Analyst Emmanuel Bulle Senior Director +34 93 323 84 11 Fitch Ratings Espana. S.A.U. 85 Paseo de Gracia 08018 Barcelona Committee Chairperson Paul Lund Senior Director +44 20 3530 1244 Summary of Financial Statement Adjustments - Fitch adds an 8x multiple of lease payments to debt, resulting in a EUR4.3 billion debt adjustment in 2016. - Fitch has treated EUR3.3 billion (equivalent to 2.5% of sales) as restricted for working capital and operating needs. - Fitch adjusts the debt deconsolidated to Daimler's financial services business so that debt to equity at the FS business does not exceed 6x. For 2016 this results in approximately EUR8.1 billion of debt being allocated to the industrial business. - A EUR1.0 billion fine resulting from European Commission antitrust proceedings related to the truck industry was classified by Fitch as non-operating and non-recurring. - Fitch has also changed its treatment of extraordinary pension contributions to Daimler's German pension schemes. These contributions are now considered investing rather than operating cash flows, resulting in a an uplift to FFO margin of 2.2pp and 0.8pp for 2014 and 2015, respectively, compared to those published previously. FCF remains unchanged. Media Relations: Peter Fitzpatrick, London, Tel: +44 20 3530 1103, Email: peter.fitzpatrick@fitchratings.com. Additional information is available on www.fitchratings.com. For regulatory purposes in various jurisdictions, the supervisory analyst named above is deemed to be the primary analyst for this issuer; the principal analyst is deemed to be the secondary. 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