DBRS Downgrades DaimlerChrysler’s Long-Term Debt Rating to BBB (high), Confirms CP at R-1 (low)

DBRS has downgraded the long-term ratings (see below) of DaimlerChrysler AG (DaimlerChrysler or the Company) and related companies to BBB (high) from A (low), and the trends have been changed to Stable from Negative. Concurrently, DBRS has confirmed the commercial paper rating of these companies at R-1 (low) with a Stable trend. The downgrade of the long-term debt ratings reflects the Company’s weakened business profile caused by a sharp deterioration at the Chrysler Group (Chrysler). With an intensifying competitive environment and softening demand in the North American automotive market, it is unlikely that Chrysler would be able to overcome the structural problems affecting its operating performance and return to profitability in the near term. The confirmation of the commercial paper rating recognizes the above-average liquidity position at DaimlerChrysler. The Company’s industrial business continues to generate free cash flow, maintain above-average coverage ratios and is virtually debt free.

Since peaking in 2005, Chrysler’s operating performance has been impacted by a number of negative developments in the North American market.
(1) High gasoline prices have turned consumers away from the more profitable medium and large SUVs and pick-up trucks, which represent the strength of Chrysler’s product offerings. (2) Product cadence at Chrysler has been weaker than its major competition due to a trough in its new product cycle. The aging of its more popular models further worsens the situation.
(3) The use of high sales incentives to support sales has been costly but ineffective.
(4) An aging product lineup has led to a steady loss of market share and inventory buildup which necessitated a corrective action to cut production, worsening an already weak profit margin.
(5) Persistent high raw materials costs also pressure margins. Chrysler has reported a €1.1 billion operating loss for 2006.

The Company announced the ‘Recovery and Transformation Plan’ (Recovery) on February 14, 2007, aiming at a return to profitability by 2008 through a combination of revenue growth and cost reduction. The Company launched eight new models in late 2006 and will introduce eight new models in 2007 to strengthen its product offering. Chrysler also targets reduction in headcount (salary and hourly), production capacity, material and other production costs. However, the automotive market in North America is expected to soften in 2007 impacted by a weak housing market and high interest rates. In addition, new products from major competitors will further add to Chrysler’s challenge to regain lost market share. Chrysler is not expected to be profitable in 2007 despite these positive actions. Moreover, there are risks associated with executing the Recovery plan, especially regarding the consumer’s acceptance of Chrysler’s new products. The current contract with the United Auto Workers Union (UAW) will expire in September 2007. The Company has the additional challenge to secure concessions in the new contract from the UAW to narrow the labour cost gap with the Asian producers.

DBRS notes that DaimlerChrysler’s business profile has weakened given the recurring problems at Chrysler. Chrysler had made progress since the last restructuring program launched in 2001 but recent operating problems have reversed most of the gains. The latest setback has cast doubt on Chrysler’s ability to compete effectively in an increasingly competitive North American market as well as the Company’s strategy to compete in the mass market segments. The Company’s profitability has been at the low end of the A (low) rating range since a decline in profitability at the Mercedes Car Group (Mercedes) which was beset by quality problems and operating issues at the Smart brand. Although Mercedes has staged a solid recovery, problems at Chrysler have stalled the Company’s efforts to restore its profitability to historic levels in 2006. In 2007, Chrysler is expected to report a loss, albeit at a lower level. In addition, DBRS expects the contribution from the Company’s other businesses, the Truck Group (Truck) and the Financial Services Group (Finance) to decline. A change in emission regulations in the United States in 2007 is expected to lower industry demand for heavy trucks and Truck’s profit while margins at Finance would be pressured by high interest rates and worsening credit quality. Even though Mercedes is expected to maintain its improvement momentum, DBRS believes that the Company is unlikely to be able to strengthen its profitability profile to be compatible with an A (low) rating.

Nevertheless, the Company is expected to remain solidly profitable with a stronger contribution from Mercedes and still-respectable earnings at both Truck and Finance. Business diversity remains a key strength supporting the current rating. Moreover, the Company has a strong balance sheet, and the industrial business remains virtually debt free (with cash exceeding debt by €6.4 billion at the end of 2006). Although capital expenditures are expected to remain high in the next few years to support new product development and launches, DaimlerChrysler is expected to fund its spending internally and continue to generate free cash flow. This will bolster its already above-average liquidity. The Company has ample liquidity to fund its turnaround at Chrysler. The progress in executing Chrysler’s Recovery plan and, ultimately, the success of Chrysler’s recovery would have a major influence on any future rating actions.

Notes:
The long-term debts of DaimlerChrysler Canada Finance Inc. and DaimlerChrysler North American Holding Corporation are guaranteed by DaimlerChrysler AG. The commercial paper issued by DaimlerChrysler Canada Finance Inc. is supported by a keepwell agreement from DaimlerChrysler North America Holding Corporation.

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