oValeo SA's earnings, cash flows, and leverage will be severely hit by the impact of the COVID-19 pandemic on global auto production volumes in 2020.
oWe foresee a significant cash burn for Valeo this year, and given the slow pace of market recovery, we expect Valeo's free cash flow to remain subdued in the next two years and that cash contributions to its joint-venture Valeo Siemens eAutomotive (VSeA) will further limit its ability to reduce debt.
oWe are therefore lowering our long-term issuer credit rating and unsecured issue-level rating on Valeo and its debt to 'BB+'. We are also lowering our short-term rating to 'B'.
oThe stable outlook reflects our expectation that Valeo's revenue will recover faster than its industry from the trough in 2020, supporting an improvement in free operating cash flow (FOCF) to debt toward 10% and funds from operations (FFO) to debt well above 20% in 2021.
PARIS (S&P Global Ratings) --S&P Global Ratings today took the rating actions listed above.
The demand for cars has plummeted in the first half of 2020 due to the extensive lockdowns imposed by governments to combat the spread of the COVID-19 pandemic. Overall, for the full year 2020, we project auto unit sales will decrease by about 20%-25% in Europe, by about 21% in the U.S., and by about 10% in China. We assume auto production volumes will follow similar trends. For Valeo, we think this will lead to a drop in sales of 17%-18% in 2020, reflecting its large exposure to Europe and North America, which accounted for 67% of 2019 sales. We estimate the sales decline will cause a drop in S&P Global Ratings-adjusted EBITDA margin to 5%-6%, down from 9.2% in 2019, resulting from the company's high level of fixed costs. In our view, this will translate into negative FOCF of EUR450 million-EUR550 million in 2020, also taking into account an outflow in working capital of about EUR250 million for the full year. In the first half 2020, Valeo's working capital increased by EUR574 million due to the sharp decrease in sales. Our FOCF estimate for the full year assumes a reversal in working capital of about EUR320 million in the second half, supported by our expectation of sales recovery. The company's intention to reduce capital expenditures (capex) will not prevent FOCF from turning negative in 2020. The steep downturn will further cause our adjusted FFO to debt to fall well below 15% in 2020 and remain below the level of about 31% observed in 2019 in 2021. We see mild recovery prospects for the auto sector in 2021, especially in Europe, where we expect real GDP to grow by only 5.2%, after a contraction of 6.7% in 2020. In our base case scenario, we assume Valeo will outpace market growth thanks to its product portfolio, which should benefit from the electrification of car models and from the increasing interest in connected and automated cars. For instance, the company's comfort and driving assistance products (such as cameras and radars) are becoming mainstream on new car models; driving a higher content per car for Valeo. In addition, the company is well-placed to support carmakers' needs to meet the more stringent CO2 emissions limit from 2020, for example, with products like 48V systems (e-motors and DC/DC converters) used for mild hybrid cars. In 2021, we assume these factors will help Valeo increase sales by more than 15%, and restore its EBITDA margin to 9%-10%, supported by higher volumes and efficiency gains. We also assume limited ramp-up costs because the start of production for new contracts will mostly be related to the second generation of parts that Valeo already manufactures. That said, at this level, Valeo will still lag peers such as Aptiv, Autoliv, and Borgwarner in terms of profitability, and its EBITDA margins will be more comparable with Faurecia, Lear Corp., and ZF Friedrichshafen. Moreover, despite a rebound in Valeo's cash flows next year, our forecast for its FOCF to debt of 8%-10% in 2021 is weaker than what we project for peers such as Lear and Aptiv. In response to the pandemic, Valeo's board of directors slashed the dividend per share to EUR0.20, corresponding to a payment of about EUR50 million in 2020, down from about EUR297 million (EUR1.25 per share) in 2019. We believe this measure will not be enough to prevent a build-up of debt in the near-term. This is also because of an expected cash contribution of about EUR200 million-EUR250 million to VSeA, Valeo's joint-venture with Siemens in the area of high voltage components for electrified cars, which will continue to delay leverage reduction. At year-end 2020, we expect that Valeo's debt will increase to about EUR5.1 billion-EUR5.3 billion compared with EUR4.5 billion in 2019.
oHealth and safety
The stable outlook reflects our expectation that Valeo will outperform its industry during the expected market recovery thanks to its focus on innovative products. This should enable Valeo to increase revenue by at least 15% and increase EBITDA margins back toward 10% in 2021. We think this will translate into FFO to debt above 25% and FOCF to debt strengthening toward 10% next year. In addition, we think Valeo will proactively refinance upcoming debt maturities so as to ensure continued adequate liquidity.
We could lower our ratings on Valeo if we expected its FOCF to debt to remain materially below 10% in the next 12-18 months, in addition to FFO to debt not recovering to above 20%.
We could raise the rating if Valeo continued to show significantly faster topline growth than its industry, combined with EBITDA margins above our base case and FOCF to debt improving sustainably above 10%. In addition, this would require FFO to debt of more than 30%, supported by a conservative financial policy. Alternatively, we could raise our rating on Valeo if its FFO to debt sustainably exceeded 30% and its FOCF to debt increased toward 15%.
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