oSweden-headquartered global truck maker AB Volvo's operating performance has continued to improve in 2021 and is likely to outperform our earlier expectations.
oDespite headwinds from the global chip shortage and increasing raw material prices, we expect AB Volvo's adjusted EBITDA margins will be in the 12%-13% range in 2021, up from 9% in 2020, indicating solid prospects, profitability, and cash flow this year with demand for new trucks supported by increased e-commerce and freight rates.
oWe believe truck demand will also remain healthy over 2022-2023, and that AB Volvo will continue to build a track record of stable operating performance.
oWe have revised our outlook on AB Volvo to positive from stable and affirmed our 'A-/A-2' long- and short-term issuer credit and issue ratings on the company and its debt.
oThe positive outlook indicates that we could raise the ratings on AB Volvo by one notch, if its operating metrics remain stable, alongside a strong balance sheet and credit ratios.
STOCKHOLM (S&P Global Ratings) --S&P Global Ratings today took the rating actions listed above.
The outlook revision reflects our expectations that AB Volvo will continue to demonstrate stable operating margins through the cycle.
Over the past five years, AB Volvo has demonstrated increased operating stability, which compares favorably with that of most sector peers. If we perceive this trend will continue, this could lead to a one-notch upgrade. We expect the group's EBITDA will increase to about Swedish krona (SEK) 45 billion-SEK50 billion in 2021, from about SEK29 billion in 2020, with an EBITDA margin of about 12%-13%, up from 9% last year. We see this as a strong achievement. In turn, we believe AB Volvo's operating performance will be in the top range of the peer group, including Scania, Paccar, and Daimler Trucks, and acknowledge the company is building a track record of stable performance. Notably, margins have been stable and above our expectations over the past five years. In 2021, margins have withstood pressure both from the semiconductor shortage and general raw material prices. Although this demonstrates continued strong management skills by AB Volvo, it also indicates the current robust truck market. The strong freight market, with increased transportation volumes driven partly by higher e-commerce and freight rates, has implied that fleet owners are keener to order new trucks, both to renew and expand their fleets. We therefore expect AB Volvo's performance this year to be stronger than we previously forecast, and have updated our base case. Still, we are mindful of margin development for 2022 and 2023 and that it could become difficult to keep passing on increasing raw material prices to customers, especially if truck demand softens. That said, the industry wide semiconductor shortage implies postponed truck deliveries, which could mean continued strong truck demand in 2022 and 2023.
AB Volvo is preparing for the energy transition, relying both on batteries and fuel cells.
The transition to alternative powertrains could pressure margins and free operating cash flow (FOCF). Like Daimler and in contrast with TRATON, AB Volvo is developing alternative powertrain technologies for its trucks, both powered with batteries and hydrogen. AB Volvo has launched serial production of electrical trucks and has already received large orders, which demonstrates that customers are increasingly interested in electrical powertrains. AB Volvo's electric truck delivery numbers are still relatively low, totaling 227 as of third-quarter 2021, but increasing and compare favorably with those of peers. At year-end 2020 in Europe, only 0.4% of trucks on the road were battery-powered, according to ACEA. Although we anticipate zero-emission truck penetration will be marginal for 2022-2023 compared to the total conventional truck units sold, we expect that Volvo will continue to invest in these new technologies and remain a leader in the transition. However, we acknowledge that this will be an increasing focus area where all participants are likely to need to increase research and development (R&D) spending in the next few years, ultimately affecting profitability. In our view, the risks related to industry transition, such as electrification and automation, are increasing for the overall sector, which could meaningfully affect profitability and cash flow in the coming years. In our base case, we assume adjusted capital expenditure (capex) of SEK8 billion-SEK 9 billion in 2021 (after capitalized development costs of about SEK2.5 billion-SEK3 billion). FOCF to sales will therefore be about 4%-5%, or SEK15 billion-SEK20 billion. This should support AB Volvo's ambitions to run its industrial operation in a net cash position.
We expect AB Volvo's credit-friendly financial policies and conservative leverage to continue to provide a cushion during downturns, like in 2020.
Since 2016, management has adopted a policy of running the industrial business with no financial debt (excluding pensions and leases), which provides a strong cushion against the cyclicality of capital-intensive industry. AB Volvo's wide geographical product diversification further supports this expectation, since it is also a leading provider of construction machinery and engines to boats and off-road machinery, which reduces exposure to the volatile heavy truck industry. We note that the group cancelled its dividend payments in 2020, which supports its ambitions, but acknowledge sizable dividend payments on occasion that will lead to negative discretionary cash flow (DCF). For example, in 2021 AB Volvo paid out the SEK19 billion of proceeds it received for the sale of UD truck earlier in the year in addition to the ordinary dividend. Therefore, the total dividend for the year will be material, at about SEK49 billion. However, we don't expect that this will lead to any adjusted debt that is not temporary. We expect management will continue to comply with its policy thanks to the group's strong cash flow. Leverage at AB Volvo's captive operations is typically 9x-10x, which is in the same range as European peers. That said, it is significantly higher than U.S. peer Paccar, which had a leverage of about 3x-4x at year end 2020.
The positive outlook indicates that we could raise our rating on AB Volvo within the next 24 months, if we perceive the company will continue to deliver strong operating results and a very conservative financial policy
An upgrade could materialize if AB Volvo's strong operating and cash flow performance continue. This will translate into our adjusted EBITDA margin being sustainably in the 10%-13% band and AB Volvo's industrial business being in an adjusted net cash position under any market circumstances. In our view, such performance implies that the group will manage the investments needed to comply with future carbon dioxide legislation during the coming years. Rating upside could also be supported if leverage at AB Volvo's captive operations significantly reduces, approaching the leader in the peer group.
We could revise the outlook to stable if AB Volvo's EBITDA margin drops below 10% or if DCF to debt is negative for a prolonged period during a down cycle.
Related Criteria
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oGeneral Criteria: Group Rating Methodology, July 1, 2019
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oCriteria | Corporates | General: Reflecting Subordination Risk In Corporate Issue Ratings, March 28, 2018
oGeneral Criteria: Methodology For Linking Long-Term And Short-Term Ratings, April 7, 2017
oCriteria | Corporates | General: Methodology: The Impact Of Captive Finance Operations On Nonfinancial Corporate Issuers, Dec. 14, 2015
oCriteria | Corporates | General: Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, Dec. 16, 2014
oGeneral Criteria: Methodology: Industry Risk, Nov. 19, 2013
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oCriteria | Corporates | General: Corporate Methodology, Nov. 19, 2013
oGeneral Criteria: Methodology: Management And Governance Credit Factors For Corporate Entities, Nov. 13, 2012
oGeneral Criteria: Principles Of Credit Ratings, Feb. 16, 2011
oGeneral Criteria: Stand-Alone Credit Profiles: One Component Of A Rating, Oct. 1, 2010
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