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Fitch Revises Volkswagen's Outlook to Stable; Affirms at 'BBB+'
June 27, 2017 / 4:07 PM / 6 months ago

Fitch Revises Volkswagen's Outlook to Stable; Affirms at 'BBB+'

(The following statement was released by the rating agency) LONDON/BARCELONA, June 27 (Fitch) Fitch Ratings has affirmed Volkswagen AG's Long-Term Issuer Default Rating (IDR) at 'BBB+' and Short-Term IDR at 'F2'. The Outlook on the Long-Term IDR has been revised to Stable from Negative. A full list of rating actions is at the end of this commentary. The rating action reflects the greater clarity about the operational and financial effect of the diesel issue. Fitch acknowledges that risks of further legal actions have not disappeared but believes that these risks have become manageable at the current rating level and incorporated in the ratings. In particular, we believe that the group could accommodate several billion euros in additional fines and/or recall and repair costs and still sustain its current ratings. In addition, the group has demonstrated a strong resilience since the start of the emissions crisis in late 2015 and we expect only a limited impact on credit metrics at the exit point by 2019-2020, when the bulk of cash outflows will have hit free cash flow (FCF) and net debt. Fitch believes that all car manufacturers now face financial and operational risks related to emission legislation, regulators' investigations and customers' complaints. These risks and their rating impact will be treated on a case-by-case basis as they emerge, including for Volkswagen. Therefore, a sudden acceleration of current legal actions or the emergence of major new litigation leading to an actual or potential breach of Fitch's negative rating sensitivities, will put renewed pressure on the ratings. In particular, legal actions engulfing the profitable Audi brand could be negative for the ratings. KEY RATING DRIVERS Greater Clarity on Diesel Issue: Investigations and legal actions are reaching an end in the US where the emission crisis started and we have gained more clarity about the total cost of this issue which will be between EUR20-25 billion. Investigations are, however, not over in other countries and we believe that risks of further class actions and legal cases will remain acute in the coming 12-18 months. In particular, a key risk is if investigations engulf Audi and severely impact this brand, which is a core cash generator for the group. Nonetheless, we gain comfort from the group's track record in managing the crisis in the US and its ability to absorb the substantial costs already levied. Firstly, the cash outflows will be spread over several years and will be partly offset by Volkswagen's solid underlying cash generation. Secondly, the effect on the group's reputation and brands has been quite limited outside the US and sales have not fallen as significantly as was expected when the scandal erupted. Thirdly, Volkswagen's financial flexibility remains adequate to accommodate further cash outflows without breaching our debt-related negative rating sensitivities. Emissions Crisis Hit Profitability: Volkswagen's industrial operating margin, before exceptional items related to the diesel issue, increased to 5.8% in 2016 from 5.3% in 2015, excluding the robust double-digit margins from Chinese joint ventures. However, the group booked a further EUR6.4 billion of provisions for the emissions crisis in 2016 on top of the EUR16.2 billion provisions taken in 2015. Furthermore, the core Volkswagen brand's profitability declined further to 1.8% in 2016 from 4.0% in 2011, highlighting the relentless challenges in streamlining the cost structure. Fitch expects a recovery in the industrial operating margin before extraordinary charges to more than 7% through 2019 as the company continues to restructure and reaps the benefit of several new models. We also believe that the majority of costs related to the emissions crisis have been accounted for, significantly decreasing the financial uncertainty linked to the diesel issue. FCF to Suffer: The FCF margin declined further to 0.7% in 2016, but we project a substantial effect from the emissions crisis in 2017-2019 as provisions taken in 2015 and 2016 will convert into cash outflows. We assume the total cost of the emissions crisis to amount to just less than EUR25 billion. The group has already reached several agreements worth an equivalent of EUR22 billion with various US parties to settle criminal, civil and environmental claims. Nonetheless, lawsuits and claims remain open in several countries and could entail further cash outflows. Governance Below Peers': Key areas of corporate governance weakness include a 20% blocking minority in voting resolutions, potential conflicts of interest on the part of some board members, and lack of independence and diversity at the supervisory board level. The emissions crisis has also highlighted serious internal control issues. We acknowledge the measures taken by the new management to strengthen corporate governance as well as the progress made in reshuffling management and reporting lines, but we also believe that their implementation and an overhaul of the company's culture may take time and meet resistance. Strong Business Profile: The ratings are supported by the group's unparalleled product portfolio in the auto and heavy-truck segments. They also reflect Volkswagen's broad diversification, leading market shares and an unrivalled potential for cost savings and economies of scale. The group is also refocusing its strategy on sustained mobility, including electric vehicles, and on new sector trends such as autonomous vehicles, car sharing and ride hailing. DERIVATION SUMMARY Weak corporate governance remains a rating constraint following the downgrade to 'BBB+', but the ratings are supported by the group's solid business profile and resilient financial profile. Volkswagen is the largest car manufacturer in Europe and is competing head-to-head with Toyota as the largest group globally. Its scale enables an industrial strategy of platform consolidation and a massive potential for synergies across its broad brand portfolio. However, the group's structure has not yet enabled these potential synergies to fully accrue to operating profit. Volkswagen is the most diversified auto manufacturer in the world along with Toyota, with substantial product and geographic exposure as well as production diversification. The group's individual brands have a lower value than other premium manufacturers, such as BMW and Daimler's Mercedes, or other large and recognised global manufacturers including Honda and Toyota, but it owns several brands with strong image. Profitability took a major hit in 2015 and 2016 from exceptional items related to the emissions crisis. Excluding such costs, the group's earnings remain solid in spite of the weak performance of the core Volkswagen brand. The operating margin is lower than for premium manufacturers such as BMW, Daimler and JLR, but compares favourably with other volume manufacturers. Profitability was more resilient than other European groups' during the 2008-2009 crisis. FCF generation is extremely robust, in line with the highest-rated manufacturers, but will suffer from outflows related to the emissions scandal over the next few years, particularly in 2017-2019. Likewise, cash outflows related to the emissions scandal will take their toll on leverage in 2017-2019. However, following the downgrade to the 'BBB' category, leverage is now low for the ratings. KEY ASSUMPTIONS Fitch's key assumptions within our rating case for the issuer include: - industrial operations' revenue increasing in the low to mid-single digits in 2017-2019; - industrial operating margin rebounding to more than 7% in 2017, excluding exceptional items, and remaining between 7%-7.5% through 2109, driven notably by a rebound of the Volkswagen PC division to more than 4% and a moderate recovery at Audi of between 8.5%-9% by 2019; - further exceptional charges of about EUR1 billion in 2017, related to the emissions crisis. Total cash outflows of EUR24 billion spread over 2017 (EUR16 billion) to 2019; - capex to fall moderately to around EUR18 billion in 2017-2018 and increase to more than EUR20 billion in 2019; - neutral working-capital movement on average over 2017-2019, including a large inflow in 2017, partially reversing the 2016 substantial outflow; - dividend payment reinitiated in 2017 increasing to more than EUR3 billion by 2019. RATING SENSITIVITIES Future Developments That May, Individually or Collectively, Lead to Positive Rating Action - Tighter corporate governance practices - Evidence that core brands have not been impaired by the emission test crisis Future Developments That May, Individually or Collectively, Lead to Negative Rating Action - Further material reputational damage to the group and its brands - Further substantial negative findings as a result of ongoing investigations - Operating margins remaining below 3% (for industrial operations) and 4% (at group level) (industrial: 2016: 6.6%, 2017E: 7.3%, 2018E: 7.1% -- group: 2016: 3.3%, 2017E: 6.9%, 2018E: 7.2%) - Significant deterioration in key credit metrics, including FFO adjusted gross and net leverage above 2x and 1.5x, respectively, (gross: 2016: 1.1x, 2017E: 0.9x, 2018E: 0.9x ; net: 2016: -0.1x, 2017E: 0.2x, 2018E: 0.1x) - Cash from operations on adjusted debt below 50% (2016: 99%, 2017E: 131%, 2018E: 127%) LIQUIDITY Sufficient Liquidity: We expect liquidity to remain healthy despite the substantial upcoming cash drains. It is supported by EUR23 billion in cash and securities at end-2016 after Fitch's adjustments for operational and non-readily available cash and an unused EUR5 billion credit line maturing in 2020. In addition, syndicated credit lines worth a total of EUR2.4 billion at other group companies were available at end-2016. Group companies had also arranged bilateral, confirmed credit lines with national and international banks in various countries for a total of EUR8.5 billion, of which EUR2.6 billion was drawn down. FULL LIST OF RATING ACTIONS Volkswagen AG -- Long-Term IDR affirmed at 'BBB+', Outlook revised to Stable from Negative -- Senior unsecured notes affirmed at 'BBB+' -- Short-Term IDR affirmed at 'F2' Volkswagen International Finance NV -- Senior unsecured notes affirmed at 'BBB+' -- Subordinated notes affirmed at 'BBB-' Contact: Principal Analyst Thomas Corcoran Associate Director +44 20 3530 1231 Supervisory Analyst Emmanuel Bulle Senior Director +34 9 3323 8411 Fitch Ratings Espana S.A.U. Av. Diagonal 601 08028 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 EUR12.0 billion debt adjustment in 2016 - Diesel related special items classified as non-recurring - Fitch adjusts the debt deconsolidated to Volkswagen's financial services business so that debt to equity at the financial services business does not exceed 6x. For 2016 this results in approximately EUR1.0 billion of debt being reallocated to the industrial business. - Fitch has treated EUR3.7 billion (equivalent to 2% of sales) as restricted for working capital and operating needs. Media Relations: Adrian Simpson, London, Tel: 203 530, Email: adrian.simpson@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 Applicable Criteria Criteria for Rating Non-Financial Corporates (pub. 10 Mar 2017) here Non-Financial Corporates Hybrids Treatment and Notching Criteria (pub. 27 Apr 2017) here Additional Disclosures Dodd-Frank Rating Information Disclosure Form here Solicitation Status here#solicitation Endorsement Policy here ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. 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