Fitch Ratings has today downgraded Swedish-based AB Volvo's (Volvo) Long-term Issuer Default Rating (IDR) and senior unsecured debt rating to 'BBB-' from 'BBB', respectively. Fitch has simultaneously affirmed Volvo's Short-term IDR at 'F3'. The Outlook on the Long-term IDR is Negative.

The downgrade reflects a significant deterioration in Volvo's FY09 financial profile as result of a severe downturn in its key end markets, particularly heavy trucks sales, which declined 32% y-o-y, and construction equipment sales which fell 37% y-o-y. Volvo's reported full year 2009 results, released on 5 February 2010, showed that although the company has cut costs and unwound working capital over the past six months, this has not been enough to prevent sizable negative free cash flow (FCF) generation in FY09 (SEK15.5bn). Similarly, FY09 saw a larger-than-expected rise in gross debt levels to SEK79bn, compared with SEK47bn at FYE08, at the core Industrial Operations.

"The impact of the current downturn will have a long-lasting impact on Volvo's financial profile," says Ewan Macaulay, a Director in Fitch's Industrials team. "Although the agency expects conditions in the heavy truck market to rebound during 2010, the scale of deterioration in 2009 means it may take Volvo a number of years to significantly repair its balance sheet."

FCF at the Industrial Operations has now been negative for three consecutive years, and based on its internal forecasts, Fitch believes that 2010 and 2011 may see further negative FCF, even with a moderate improvement in end-market conditions. Such a cash-flow profile is not, in Fitch's view, consistent with a strong investment grade rating. The agency also forecasts that Volvo's credit metrics are likely to remain weak in 2010, with leverage (adjusted net debt/EBITDAR) at the Industrial Operations exceeding 3.5x and the funds from operations (FFO) fixed charge cover below 4x.

Fitch expects sales at Volvo's heavy-truck division (64% of group sales) to continue stabilising during 2010 as industrial production and freight rates slowly recover. A quarter-on-quarter 19% increase in orders at Volvo's heavy truck division in Q409 indicates that a trough in market conditions has probably already been reached. However, a swift and strong recovery in demand is not foreseen due to sluggish macroeconomic conditions, especially in Europe which is Volvo's main market. An overhang of relatively new second-hand trucks in Europe, and constrained credit availability is also likely to dampen a demand recovery. Fitch expects Volvo's Industrial Operations sales to improve modestly by 5%-10% in 2010, although absolute sales will likely remain well below 2008's peak. Other key divisions, notably construction equipment, are also expected to remain weak in 2010.

Volvo's prospects for repairing its financial profile may also be restricted by its historically generous stance towards its shareholders. Although dividends in 2010 have been suspended, dividend payout levels have historically been high compared to peers, and a resumption of such a strategy in 2011 remains possible. Furthermore, Volvo's existing shareholder structure could limit fund raising efforts. The company's largest shareholder is Renault SA ('BB'/Negative) with a 22% holding. Renault has its own financial constraints, which reduces the prospects of a Volvo rights issue as Renault would likely be unable to participate.

The Outlook on Volvo's Long-term IDR is Negative. Although Volvo's high operating leverage means that a moderate improvement in market conditions will likely see metrics improve in 2010-2011, Volvo's financial profile has been significantly weakened as a result of the current economic downturn. Therefore a significant improvement in performance will be needed to bring its financial profile back in line with that of an investment grade profile. A further downgrade of Volvo's ratings may be avoided if the company can demonstrate an ability to stem its negative FCF and quickly repair its credit metrics during 2010/2011. Nevertheless, there remains some risk that market conditions and/or Volvo's cost-cutting efforts could disappoint in 2010, leaving its metrics weak. Under such a scenario, a ratings downgrade is likely, as reflected in the Negative Outlook. A weakening in liquidity could also add extra downward pressure on the ratings.

Volvo's ratings continue to be supported by its strong market position as the world's second-largest truck-maker, its broad diversification in terms of geography and business line, and the company's increasing exposure to high growth emerging markets.

Volvo's liquidity remains adequate as of FYE09. On a group basis, short-term liquidity needs (mainly short term debt of SEK52bn) are covered 2.1x by sources of liquidity including unrestricted cash of SEK14bn, marketable securities of SEK17bn, committed undrawn facilities of SEK33bn and short-term customer finance receivables of SEK42bn.

In rating this issuer, Fitch used the master criteria 'Corporate Rating Methodology', dated 24 November, 2009. Applicable criteria are available at www.fitchratings.com.

Fitch POLSKA SA

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