Robert Streda Cathy Cheng +1 416 597 7397 +1 416 597 538 [email protected] [email protected] RATING REPORT Volkswagen AG Ratings Debt Rating Action Rating Trend Volkswagen AG – Issuer Rating A (low) Upgraded/Trend Change Stable VW Credit Canada Inc. – Senior Unsecured Debt * A (low) Upgraded/Trend Change Stable VW Credit Canada Inc. – Commercial Paper * R-1 (low) Upgraded/Trend Change Stable * Guaranteed by Volkswagen AG. Rating Update On October 25, 2019, DBRS Limited (DBRS Morningstar) upgrad- notes that VW’s corporate governance assessment continues to ed the Issuer Rating of Volkswagen AG (VW or the Company) adversely affect the Company’s ratings. to A (low) from BBB (high). Concurrently, DBRS Morningstar upgraded VW Credit Canada, Inc.’s Senior Unsecured Debt rat- DBRS Morningstar notes that VW has proven resilient to the ing and its Commercial Paper rating to A (low) and R-1 (low), Diesel Issue, with the Company’s global sales performance in respectively, from BBB (high) and R-2 (high), respectively. DBRS 2018 and through the first half of 2019 (H1 2019) continuing to Morningstar also changed the trend on all ratings to Stable from moderately outpace that of the overall industry. Financial per- Positive. The ratings incorporate VW’s solid business risk assess- formance over this period has also remained solid, with VW’s ment as an automotive original equipment manufacturer (OEM) Automotive business generating sound operating margins of 7.1% of substantial scale with a highly diversified brand portfolio. and 7.0% (trailing 12-month periods; both figures as calculated Moreover, the ratings upgrades recognize VW’s ongoing solid by DBRS Morningstar) in 2018 and H1 2019, respectively. DBRS operating performance despite sizeable challenges and cash out- Morningstar observes further that Company’s relative perfor- flows stemming from its diesel issue (the Diesel Issue), which, ap- mance in H1 2019 has readily exceeded that of many of its im- proximately four years following its initial onset, appears to have mediate peers that have reported markedly weaker earnings this been largely addressed by the Company, although there remain year in line with declining sales volumes, higher raw material numerous outstanding (primarily civil) actions across various costs and increasing investment requirements. Finally, VW’s per- jurisdictions. Notwithstanding the upgrade, DBRS Morningstar formance in China (accounted for using the equity method and Continued on P.2 Financial Information 12 mos. to 6 mos. to June 30 June 30 For the year ended December 31 (EUR millions) 2019 2018 2019 2018 2017 2016 2015 2014 Revenue 1 106,126 101,715 205,478 201,067 195,817 186,016 183,936 177,538 Net income before non-recurring items 7,485 7,466 13,834 13,812 13,163 9,794 8,896 10,847 Adjusted Interest coverage – EBITDA 1 17.4 16.4 24.5 22.7 18.4 16.5 13.0 13.8 Adjusted DEBT / EBITDA 0.8 0.6 0.9 0.9 0.6 0.6 0.8 0.8 Adjusted % gross debt in capital structure 1 20.7% 16.3% 20.7% 20.8% 16.1% 15.8% 19.5% 18.9% Note: Certain figures in this and in subsequent tables are subject to adjustments made by DBRS Morningstar. 1 Excludes financial services division. Issuer Description VW is the largest auto manufacturer in Europe and ranks first globally (according to 2018 data). The Company has a portfolio of 12 brands that, among others, includes Volkswagen, Volkswagen Commercial Vehicles, Porsche, Audi, Skoda, SEAT, Bentley, Lamborghini and Bugatti. VW’s Truck and Bus business, Traton, features the Scania and MAN brands. VW also has a sizable financial services business, and operates VW Credit Canada, Inc., its wholly owned subsidiary. October 31, 2019 1 Rating Report | Volkswagen AG Rating Update (CONTINUED) thus not included in the above-cited operating-margin figures) DBRS Morningstar notes further that the Company maintains has also remained robust, notwithstanding the ongoing contrac- several additional options to further bolster its liquidity position, tion of the Chinese market. including the sale of further equity stakes of its Truck and Bus business, Traton SE (Traton), and other potential divestitures of DBRS Morningstar recognizes that VW, like all of its automotive non-core assets. peers, will face meaningful industry headwinds over the next several years amid moderating global sales growth and sizeable Consistent with the Stable trend, the ratings are expected to re- investment requirements, in line with the increasing electrifi- main constant over the near to medium term. DBRS Morningstar cation of its product portfolio (to meet tightening environmen- notes that VW’s financial risk assessment provides some cush- tal regulations, notably in Europe and China). The Company is ion against unexpected challenges at the current ratings levels. also targeting additional investments into new mobility busi- Conversely, additional rating upgrades are not anticipated over nesses. (Regarding the Diesel Issue, while associated cash out- the similar time horizon given the slowing growth prospects and flows will persist, these are anticipated to be of a substantially cost headwinds facing the industry, with the Company’s corpo- lesser magnitude going forward.) However, DBRS Morningstar rate governance issues also serving to constrain further positive estimates that VW’s liquidity position will remain robust amid rating actions. such headwinds given its consistent free cash flow generation. Rating Considerations Strengths 4. Financial services earnings smooth profitability VW’s financial services business has provided a stable and mean- 1. Size provides economies of scale ingful source of earnings, with annual operating profit totalling VW is the largest automobile manufacturer in the world and the EUR 2.8 billion in 2018. Financial services earnings help to re- leader in Europe. VW has the size and critical mass to attain the duce the volatility of earnings associated with the Company’s economies of scale necessary to be cost-competitive. Automotive operations. 2. Above-average financial strength Challenges The Company has above-average credit metrics and a strong li- quidity position. The Company’s Automotive operations (exclud- 1. Diesel Issue ing financial services) had a net cash position of EUR 9.4 billion VW faces challenges as the Company attempts to recover from (as calculated by DBRS Morningstar) as at June 30, 2019 (exclud- the Diesel Issue, which initially spanned 482,000 thousand ing the impact of International Financial Reporting Standards vehicles in the United States, only to quickly increase to ap- (IFRS) 16 Leases, which was adopted as of January 1, 2019, and proximately 11 million worldwide. DBRS Morningstar notes negatively affected the Automotive operations’ reported debt by that related provisions incurred by the Company have totalled approximately EUR 5.1 billion). EUR 30 billion as of H1 2019. While this likely represents the ma- jority of such charges, DBRS Morningstar notes that there may 3. Market leader in Western Europe; yet be additional increases pending further developments, litiga- globally diversified tion and regulatory sanctions. Notwithstanding the Diesel Issue and amid ongoing competition across markets worldwide, the Company’s competitive position 2. Corporate governance challenges in terms of market share has held essentially firm. VW’s world- VW’s corporate governance framework is considered to be sub- wide market share in 2018 increased slightly to 12.3% compared optimal as indicated by the following characteristics: with 12.0% in 2017. In North America, the Company’s share de- 1. VW’s Supervisory Board is composed primarily of share- creased slightly and remained low at 4.6% (compared with 4.7% holders and worker representatives, with only a nominal in 2017). In Western Europe, VW’s market share remained con- proportion of independent members; stant (at a level of 22.0% in 2018), with the Company remaining the region’s market leader by a sizable margin. Moreover, VW’s 2. The Diesel Issue highlighted the lack of oversight and ac- market position remained solid in Central and Eastern Europe, countability from VW’s Management Board; and notwithstanding a moderate decline in market share in 2018 to 3. External investors have very little voting rights as the ma- 21.2% (compared with 22.0% in 2017). jority of voting shares are held by a small group of share- October 31, 2019 2 Rating Report | Volkswagen AG Rating Considerations (CONTINUED) holders (as of year-end 2018, Porsche Automobil Hold- source of production for the Company (the country having ac- ing SE, Stuttgart owns 52.2% of voting shares (53.1% as of counted for approximately 20.9% of VW Group production in March 2019), State of Lower Saxony owns 20.0% and Qa- H1 2019). VW is seeking to improve its productivity through tar Holding owns 17.0%). Overall, the challenges in VW’s greater application of modular architectures, which will make it easier to build a wider variety of cars in future factories. Moreover, corporate governance have resulted in a downward adjust- VW’s existing labour agreement cites specific objectives of the ment of the Company’s ratings. Volkswagen brand and the German production facilities, target- ing savings and efficiency improvements and projected declines 3. Earnings volatility from cyclical automotive in headcount (primarily through attrition taking into consider- industry conditions ation the demographic curve of its labour force). VW’s operating performance is largely dependent on automotive business conditions, which fluctuate generally in line with eco- 5. Modest U.S. presence nomic cycles. VW has a modest presence in the United States, which is among the largest automotive markets in the world. Moreover, the 4. Significant production in Germany Diesel Issue (which originated in the United States) continues DBRS Morningstar notes that Germany, a relatively high-cost to represent an ongoing headwind for future sales growth in jurisdiction, continues to represent a material (albeit declining) that country.