S&P: Outlook On Sweden-Based Truck Maker Volvo Revised To Positive; 'BBB/A-2' Ratings Affirmed
We also affirmed our ratings on Volvo's debt.
The outlook revision and rating affirmation reflect our expectation that Volvo's credit ratios will remain robust for the ratings, supported by improved profitability, despite periods of weak demand.
Although we anticipate that Volvo will remain exposed to swings in demand, challenging macroeconomic conditions in certain regions, and working capital patterns, we acknowledge that the company has strengthened its financial position further over the past 12 months, despite a relatively soft truck market. In the first half of 2016, truck deliveries declined 5% compared with the same period in 2015, and only the European market experienced volume growth. In the U. S. market--Volvo's second largest--volumes reduced by 33%.
Despite this, Volvo has been able to improve its profitability and credit ratios in this market, which we view as positive. We project that the group's operating margin will remain above 6% for 2016, following the efficiency program that Volvo completed in 2015. Lower selling and administrative expenses, more efficient production, and lower material costs are the main factors that we believe will improve Volvo's profitability compared with peers'. The S&P Global Ratings-adjusted ratios of funds from operations (FFO) to debt and debt to EBITDA are strong, at about 70% and 1.1x respectively, thanks largely to lower debt than in previous years. We now forecast adjusted debt at about Swedish krona (SEK) 27 billion to SEK32 billion (about $3.0 billion-$3.7 billion) at year-end 2016, compared with SEK43 billion at year-end 2013.
We forecast adjusted FFO to debt at 60%-75% and adjusted debt to EBITDA at about 1.0x-1.5x over the coming two years. This will however also depend on working capital (including intrayear), which has historically been very volatile. Due to large working capital movements and dividend payments, other ratios such as free operating cash flow (FOCF) to debt and discretionary cash continue to weigh on our overall assessment. The company's net debt has reduced over the past few years, but the financial policy, stated as net debt to equity below 35%, remains unchanged. We therefore cannot fully rule out possible debt increases in the future; implying that Volvo's credit-protection ratios could decline.
Our assessment of Volvo's business risk profile as satisfactory reflects the group's strong position as the second largest manufacturer of heavy duty engines worldwide, behind Germany-based Daimler, and its solid geographic presence. We view Volvo's geographic diversity as strong and on par with that of market leader Daimler. Volvo also has an up-to-date product line, after investing heavily in fuel-efficient engine and emissions technology over the past few years. These strengths are partly offset by the group's significant exposure to cyclical demand, high capital intensity, and price competition in its end markets.
The positive outlook indicates the possibility of an upgrade over the next 12 to 24 months if, as we expect, Volvo's profitability and financial position remain at least at current levels, and the company continues to demonstrate the capacity to withstand weaker market conditions.
We could raise the ratings if Volvo's credit metrics appear sustainable, stabilizing at the current levels despite periods of soft demand. A track record of FFO to debt at about 60% and FOCF to debt at about 25% could lead to a one-notch upgrade.
We could revise the outlook to stable if Volvo's operating margin did not remain above 6% over 2017, or if adjusted FFO to debt did not stay above 45%. Moreover, we would consider a downgrade in the event of more generous shareholder payouts than we anticipate in our base case.