DBRS Confirms Volkswagen at A (low)

Dominion Bond Rating Service (DBRS) has today confirmed the Issuer Rating of Volkswagen AG (VW or the Company), the Senior Unsecured Debt of VW Credit Canada, Inc., and the Issuer Rating of Volkswagen Canada Inc. at A (low), all with Stable trends. DBRS is also confirming the Commercial Paper ratings of VW Credit Canada, Inc. and Volkswagen Canada Inc. at R-1 (low), with Stable trends.

The credit profile for VW remains acceptable for the ratings. The Company has strengthened its leadership position in Western Europe and its core German market over the past year, with favourable earnings growth despite highly competitive industry conditions. The Company has also substantially increased its net cash position (industrial operations) to more than EUR 8 billion (at September 30, 2006) from free cash flow and asset sales, which adds financial flexibility.

Over the near to medium term, DBRS expects VW to continue the trend of earnings growth that was established at the end of 2004. Significant efficiency improvements, mainly lower product costs/overhead (“ForMotion plus” plan), new car/light truck models and continued expansion in higher growth/lower-cost emerging markets are expected to be key drivers. Cost reduction is of particular importance given the expectation for flat/modestly slowing industry volumes and increased competition. Furthermore, VW’s financial services division is expected to remain a stable and measurable source of earnings.

DBRS notes, despite the recent improvement, VW’s industrial operating margins remain weak at less than 3%. DBRS expects profitability to increase to levels considered more appropriate for the rating, led by the automotive segment, but several challenges remain. The Company continues to face earnings pressure from the relative strength of the euro and high/rising commodity prices. VW’s unionized labour force in Germany remains high-cost, and further concessions will be difficult to achieve. In North America, VW is highly dependent on the success of new models being introduced in the U.S. (i.e. repositioned Jetta, new compact SUVs, etc.) to return to profitability. Losses have been generated in North America since 2002, and positive earnings are likely required for VW to meet its consolidated pre-tax profit target of EUR 5.1 billion in 2008. In China, a rebound in equity income could prove challenging as a result of intense competition despite modest improvements related to recent restructuring initiatives.

DBRS also notes that VW is expected to continue to generate favourable free cash flow, driven mainly from capex that remains lower than pre-2005 levels and well below depreciation. Free cash flow, combined with a large net cash position, provides significant financial flexibility. VW is expected to maintain a conservative balance sheet, with strong and improving coverage ratios. DBRS also notes that a decision is expected shortly regarding the potential sale of VW’s 18.7% economic interest in Scania AB (Scania) to MAN Aktiengesellschaft (MAN), which has submitted a takeover bid for Scania. A potential sale would be modestly positive to VW’s financial profile but would not warrant a rating action.

Note:
The ratings of Volkswagen Canada Inc. and VW Credit Canada, Inc. are guaranteed by Volkswagen AG.
Issuer Ratings apply to all general senior unsecured obligations of the issuer in question.

The full report providing additional analytical detail is available by clicking on the link under Related Research at the right of the screen or by contacting us at info@dbrs.com.

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