OREANDA-NEWS. Fitch Ratings has affirmed AB Volvo's (Volvo) Long-term Issuer Default Rating (IDR) and senior unsecured rating at 'BBB' and Volvo Treasury AB's senior unsecured rating at 'BBB'. The Outlook on the IDR is Stable. Fitch has also affirmed Volvo Treasury AB's EUR900m 5.5 year non-call and EUR600m 8.25 year non-call subordinated fixed to reset capital securities at 'BB+' .The securities are unconditionally and irrevocably guaranteed by Volvo.

The affirmation reflects the recovery in key credit metrics to levels more commensurate with the ratings after a period of weakness. Profitability has been boosted by increased revenue and the restructuring programme launched in 2013. We also expect free cash flow to become positive again in 2015 and for the foreseeable future and funds from operations (FFO) adjusted net leverage to decline sustainably below 1.5x.

However, we believe that part of the decline in financial debt and leverage has come from disposals and extraordinary items and not only from operating improvements. In addition, Volvo's operating margins, in particular at its truck division, remain below its main peers, reflecting the different product lines but also a structural difference in cost bases. These factors constrain the ratings.

KEY RATING DRIVERS
'BBB' Business Profile
The ratings are supported by Volvo's geographic and business diversification as a full-line truck maker, its leading market positions in major markets and growing exposure to high-growth emerging markets. The group's services business (26% of sales at end 2014) provides fairly stable income and mitigates the inherent volatility of its end-markets

Leverage Commensurate with Ratings
Fitch believes earnings and funds from operations have reached a trough and will be supported by improved demand in Volvo's core truck operations and self-help measures that focus on reducing costs and investments. In addition to a strengthened operational profile, Volvo's hybrid issue improved the company's maturity profile and leverage metrics at end-2014 to a level that provides additional headroom for weak market conditions in emerging markets.

Fitch forecasts adjusted FFO net leverage to remain around 1.1x-1.3x in the medium term, with additional room for improvement depending on Volvo's non-core business disposal strategy.

Disposals Offset Acquisitions
Volvo's M&A approach of funding acquisitions via disposal proceeds is credit-positive. The SEK8.9bn proceeds from the sale of Volvo Rents and its commercial real estate business offset a SEK6bn increase in net debt from a 45% stake purchase in DFCV and the SEK1bn Terex acquisition at the beginning of 2014. As witnessed by the sale of Eicher, Volvo's basic segment brand in India, for SEK4.5bn in 2015, disposals remain a part of Volvo's strategy towards improving internal efficiency and operating margins.

Muted Growth Forecasts
Volvo's operating performance has been better than Fitch's expectations in 2015, with industrial revenues increasing to SEK302bn for the 12 months ending in September from SEK276bn in 2014. Limited organic growth of 1% because of increasingly difficult market conditions in emerging markets was boosted by the depreciation of the Swedish krona vs other currencies.

However, the current order intake has weakened and Fitch expects the pickup in fleet demand in North America and Europe to be stressed in 2016 and we project muted revenue growth until 2017.

Recognised Credit Losses
Volvo reported significant contingent liabilities of SEK14.5bn at end-September 2015, including SEK6.6bn of credit guarantees mainly related to construction equipment sales in China. Writedowns related to credit losses have increased since 2H14 and Fitch believes that continuous adverse market conditions in China could lead to further cancellations and credit losses. A material deterioration of financial metrics from accelerating credit losses could put pressure on ratings.

KEY ASSUMPTIONS
Fitch's key assumptions within the rating case for Volvo include:
- Slowdown in North America in 2016
- Stressed demand in China and South America until end 2017
- No significant acquisitions
- CAPEX returning to normalised levels after 2017

RATING SENSITIVITIES
Positive: Future developments that may, individually or collectively, lead to positive rating action include:
-Structural improvement and reduced cyclicality of group operating margin (FY14: 3%), particularly at its truck division
-FFO margin (post capitalised R&D) of more than 8% (FY14: 5.1%)
-FFO adjusted net leverage of less than 1x (FYE14: 1.9x)

Negative: Future developments that may, individually or collectively, lead to negative rating action include:
- Negative EBIT margins for at least two years
-FFO margin (post capitalised R&D) of less than 4%
-Persistent negative FCF, actual or expected (FY14: SEK-0.4bn)
-FFO adjusted net leverage of more than 2x
-Significant weakening in liquidity

These credit metrics refer to industrial operations on a sustained basis.

LIQUIDITY
Sound Liquidity
Liquidity at Volvo's industrial operations is sound, with liquidity sources at end-3Q15 comprising SEK14.9bn of cash and SEK32.7bn of non-current undrawn committed credit facilities. This compares with SEK44.8bn of debt maturing in 2016. Liquidity was further supported by an issue of EUR1.5bn (around SEK14bn) subordinated fixed-to-reset capital securities in December 2014. The group's policy is to maintain sufficient liquidity to cover 12-18 months in case of no access to capital markets.