S&P Raises L-T/S-T Ratings on Volkswagen AG (VLKAY) to 'A/A-1'

Standard & Poor's Ratings Services said today that it raised to 'A/A-1' from 'A-/A-2' its long- and short-term corporate credit ratings on Germany-based auto manufacturer Volkswagen AG (OTCBB: VLKAY) (VW). The outlook is stable. We also raised our long- and short-term ratings on the company's debt to 'A' and 'A-1' from 'A-' and 'A-2'.

In addition, we raised to 'A/A-1' from 'A-/A-2' the long- and short-term ratings on Volkswagen's "core" subsidiaries, captive finance entity Volkswagen Financial Services AG (VW FS) and its subsidiary Volkswagen Bank GmbH. We also raised to 'A' from 'A-' the long-term rating on finance subsidiary Volkswagen Group Services SA and the long-term issuer credit and financial strength ratings on captive insurer Volkswagen Insurance Co. Ltd.

The outlook on all these entities is stable. We regard these entities as "core" under our group rating methodology, and as such the ratings and outlook are at the same level as the parent Volkswagen AG.

The upgrade reflects our expectation that VW's leverage metrics will steadily strengthen during 2015 and 2016, supported by gradual profitability improvements and positive free operating cash flow (FOCF) in the auto division. We anticipate that metrics will be resilient to continued challenging macroeconomic conditions in certain regions, competitive end-markets, and VW's significant capital expenditures (capex). We do not expect the company to make further material debt-financed acquisitions.

The VW group has leading market positions in passenger cars and trucks, with broad product and geographic diversity in Europe, the Americas, and Asia. The group has well-known brands covering volume, premium, and luxury segments. In addition, we expect the company's spending on modernizing and extending its product range to support the business over the next few years. These strengths are partly offset by the group's significant exposure to generally cyclical demand, high capital intensity, and price competition in end-markets. This includes the low-margin, mass-market volume segment, which accounts for a significant portion of VW's vehicle sales. Our business risk profile assessment remains "strong."

For 2014 and 2015, we forecast that auto demand in Europe and Asia-Pacific–-VW's most important regions for volume sales--will continue to grow. We recognize that there are some risks, such as the ongoing quite weak macroeconomic conditions in Europe and Latin America, and the impact of political risks on car demand in Russia. Chinese authorities are conducting an investigation into pricing in the auto sector, but we assume that this will not affect VW in a meaningful way.

The group's leverage is moderate, supported by significant operating cash flow in its auto division. We anticipate that this will fund the group's large capex, which is planned at about €84 billion during 2014-2018 (excluding Chinese joint ventures). VW has considerable liquidity resources and a financial policy that maintains a balanced funding mix, in our view. We continue to assess VW's financial risk profile as "modest."

For 2014, we forecast that the auto operations will continue to generate positive FOCF, supported by gradual improvements in profitability. Coupled with an absence of material debt-financed acquisitions, we forecast that leverage will steadily strengthen.

Under our criteria, a combination of "strong" business risk and "modest" financial risk profiles results in an anchor of 'a+' or 'a'. We use the lower anchor of 'a' for VW, reflecting the constraints to VW's business risk profile from the significant portion of vehicle sales it derives from the volume segment. We no longer apply a one-notch downward adjustment for our comparable ratings analysis, as we now consider that VW's leverage metrics will be toward the middle of the range for a "modest" financial risk profile over the next two years.

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