Fitch Revises Daimler AG´s Outlook to Positive; Affirms IDR at 'BBB+'

(The following statement was released by the rating agency) Fitch Ratings-Barcelona-25 March 2021: Fitch Ratings has revised Daimler AG (DE:DAIGn)'s Outlook to Positive from Stable while affirming the auto manufacturer's Long-Term Issuer Default Rating (IDR) and senior unsecured notes at 'BBB+'. A full list of rating actions is provided below. The Outlook revision reflects Daimler's resilience during the pandemic and our expectations that profitability will improve further as the operating environment normalises and Daimler's updated product range and cost-saving actions yield positive results. We expect free cash flow (FCF) generation in the next 12-18 months to be burdened by the settlements and restructuring measures announced in 2020 but to increase to levels more commensurate with the 'A' rating category thereafter. Daimler's decision to spin off its heavy truck and bus (T&B) division and focus on the passenger car and van (C&V) business will be broadly neutral for the ratings. We believe that the loss of diversification will be offset by the car division's higher profitability and lower volatility. Key Rating Drivers Refocused Strategy: Daimler has presented a comprehensive plan to reposition its product portfolio on higher-end and more profitable models and to prioritise value over volume. The group also intends to accelerate its effort on electrification and vehicle software and enhance its customer relationships. Furthermore, Daimler aims to lower fixed costs by more than 20% by 2025, through a reduction in platforms, lower spending on conventional powertrains and streamlined industrial footprint. Truck Spin-off Credit Neutral: Daimler will lose some diversification benefits following the planned spin-off of its s (T&B) business by end-2021. Weaker demand or operational issues stressing earnings and cash flow at one division have often been offset by better results at the other. The car business is more capital-intensive and its profitability and cash generation have come under significant pressure since 2018 as Daimler invested heavily in the electrification of its passenger cars. However, it has also been more profitable than the T&B division and we expect a rebound in its profitability. The retained minority stake in T&B will also enable Daimler to benefit partially from the truck business' expected growth and future dividends. We also expect the two companies to maintain some relationship and possibly collaborate should they identify potential synergies. Net Cash Position Unaffected: The divested T&B majority stake will be distributed to Daimler's shareholders and will therefore not boost the group's financial structure but we expect Daimler to retain a healthy net cash position. Existing bonds issued or guaranteed by Daimler will remain at the group until maturity, but after the spin-off it will only issue debt to fund its remaining C&V business and will not guarantee T&B's debt. About EUR30 billion of asset receivables at Daimler Mobility relate to T&B. The majority will be acquired by Daimler T&B and will be deconsolidated at the spin-off. Cost Reduction Supporting Profitability: Daimler significantly streamlined its cost structure in 2020 as it cut material costs, R&D and other fixed costs including headcount. Industrial operating margin, including Fitch's adjustments for associate income and extraordinary items, declined only moderately in the pandemic to 4.7% in 2020, from 5.2% in 2019, although it remained lower than the high single digits posted before 2018. Daimler booked EUR1.6 billion in one-off costs in 2020, including EUR900 million to restructure the production network. We forecast a gradual recovery of the industrial operating margin to more than 7.5% from 2022 onwards, as Daimler benefits from its restructuring measures and the launch of more profitable models, in particular the new S-Class. Emission Payments: Daimler will pay a total of about EUR2.2 billion-EUR2.3 billion to settle civil and environmental claims related to emissions in the US, including a USD1.5 billion settlement with the US authorities and USD700 million to resolve a US consumer class action. We expect the bulk of these costs to be incurred over the next 12-18 months and mostly affect 2021 FCF. Total provisions of EUR4.6 billion at end-2020 related to various global litigation risks and regulatory proceedings point to further potential cash outflows beyond 2021 but we believe that pressure on FCF has been alleviated. Recovering FCF After 2021: We believe that FCF generated in 2020 was extraordinarily strong at more than 5% of sales, as cash-preservation measures taken during the pandemic were aided by an exceptional inflow of working capital and a cut in dividends. We expect the combination of working- capital reversal, rising capex and dividend increase to offset an improvement in funds from operations (FFO) in 2021. Emission settlements and restructuring-related outflows will further constrain FCF margin, which we forecast at around 0.5% in 2021. However, we expect it to improve to more than 2.5% thereafter due to better underlying profitability and capex moderation. Electrification Progress: A sharp increase in sales of electric and plug-in hybrid vehicles in 4Q20 enabled Daimler to meet its 2020 emission target. We expect the launch of additional electric models this year to help the group reach its 2021 target and lower the risk of a fine. However, we also believe that electric vehicle (EV) sales remain dependent on various factors outside of Daimler's control, including government subsidies, potential supply-chain issues and the development of a still limited charging network. ESG Factors: Daimler has an ESG Relevance Score of 4 for GHG Emissions & Air Quality as Daimler is facing stringent emission regulation, notably in Europe. Investments in lower emission are a key driver of the group's strategy and cash generation. Daimler has an ESG Relevance Score of 4 for Management Strategy, reflecting the various strategic decisions taken in recent years with regard to fuel emissions. Daimler has paid fines as a result of regulatory investigations ruling that its vehicles did not meet all legal requirements and will also pay more than EUR2 billion in the next 12-18 months to settle emission-related claims and class actions in the US. Derivation Summary Daimler is smaller and has a lower product diversification than large manufacturers, such as Toyota Motor Corporation (A+/Stable) and Volkswagen (DE:VOWG_p) AG (BBB+/Stable) but this is offset by its positioning in the premium segment. Its geographic diversification is broad and largely in line with peers'. Daimler's reputation is strong and brand value extremely high. Daimler's financial structure deteriorated between 2017 and 2019 and was more in line with that of the 'BBB' category. However, it recovered strongly in 2020. FFO net leverage deteriorated to about break-even in 2020, compared with a historically healthy net cash position but we expect an improvement from 2021 onwards and Daimler's leverage to return to levels in line with that of Volkswagen, Toyota and Honda Motor Co., Ltd (A/Stable). Among the highest-rated manufacturers, Daimler's net cash generation has been most volatile in the past decade and is weak for the rating category. Likewise, automotive operations' profitability has been lower and more volatile than that of close peers BMW and Volkswagen's Audi. However, we expect FCF to improve from 2022 onwards to levels in line with peers' and more commensurate with the 'A' rating category. The truck division's profitability compares adequately with that of other large global truck makers, including AB Volvo (BBB+/Stable). Key Assumptions Low double-digit sales increase for industrial operations in 2021, driven by continued recovery in demand in key markets. This will be further supported by new model introduction (notably S and C-class) in the car business and strong order book for the truck division. The C&V business will grow further in low-to mid-single digit from 2022 to 2024, driven by solid demand for luxury products. T&B spin-off at end-2021, leading to its deconsolidation. Operating margin recovery from 2021 (excluding exceptional items) due to the implementation of cost-cutting measures and a favourable product mix. Working-capital reversal in 2021 due to demand recovery, followed by broadly neutral movements thereafter. Exceptional cash outflows to cover settlement of legal and government proceedings and some restructuring costs of EUR2.6 billion in 2021 and EUR2 billion and 2022. Capex declining towards 6% of sales, in line with management's strategy of selective investment policy and projects prioritisation. Dividends in line with group's pay-out ratio of 40%. No share buy-backs and no major M&A activity over the next four years. RATING SENSITIVITIES Factors that could, individually or collectively, lead to positive rating action/upgrade: - FCF margin recovering to more than 1.5% (2020: 5.4%, 2021E: 0.4%, 2022E: 2.3%). - Group operating margins sustainably above 6% (2020: 5%, 2021E: 6.7%, 2022E: 7.4%). Factors that could, individually or collectively, lead to negative rating action/downgrade: - Increasing risk of deteriorating liquidity. - Group operating margins remaining below 4%. - FCF margin remaining below 0.5%. - FFO gross leverage above 2.0x (2020: 1.3x, 2021E: 0.7x, 2022E: 0.8x) and FFO net leverage above 1.0x (2020: -0.4x, 2021E: -0.1x, 2022E: -0.3x). Best/Worst Case Rating Scenario International scale credit ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579. Liquidity and Debt Structure Healthy Liquidity: Daimler's liquidity is supported by EUR20.3 billion of cash and equivalents and EUR5.5 billion of marketable debt securities, excluding Fitch's adjustment for operational and restricted cash (EUR3.2 billion). In addition, the group has EUR19.8 billion of undrawn credit facilities consisting of a EUR11 billion revolving credit facility due in 2025 and a EUR6 billion loan facility agreement at end-March 2021. Summary of Financial Adjustments Fitch adjusts leverage metrics for financial services operations. Fitch calculates a target debt-to-equity ratio of 5x for Daimler's financial services operations, below the actual ratio of 10x at end-2020. This leads to an adjustment of Daimler's financial debt of EUR11.4 billion at end-2020 to bring its debt-to-equity down to 5x. REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING The principal sources of information used in the analysis are described in the Applicable Criteria. ESG Considerations Daimler has an ESG Relevance Score of 4 for GHG Emissions & Air Quality as it is facing stringent emission regulation, notably in Europe. This has a negative impact on the credit profile and is relevant to the rating in conjunction with other factors. Daimler has an ESG Relevance Score of 4 for Management Strategy, reflecting the various strategic decisions taken in recent years with regard to fuel emissions that resulted in regulatory fines and settlements. This has a negative impact on the credit profile and is relevant to the rating in conjunction with other factors. Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg Daimler Finance North America LLC ----guaranteed; Long Term Rating; Affirmed; BBB+ ----guaranteed; Short Term Rating; Affirmed; F1 Mercedes-Benz Finance Co., Ltd. ----guaranteed; Long Term Rating; Affirmed; BBB+ ----guaranteed; Short Term Rating; Affirmed; F1 Daimler International Finance BV ----guaranteed; Long Term Rating; Affirmed; BBB+ ----guaranteed; Short Term Rating; Affirmed; F1 Daimler Mexico, S.A. de C.V. ----guaranteed; Long Term Rating; Affirmed; BBB+ ----guaranteed; Short Term Rating; Affirmed; F1 Daimler AG; Long Term Issuer Default Rating; Affirmed; BBB+; Rating Outlook Positive ; Short Term Issuer Default Rating; Affirmed; F1 ----senior unsecured; Long Term Rating; Affirmed; BBB+ ----senior unsecured; Short Term Rating; Affirmed; F1 Mercedes-Benz Australia/Pacific Pty. Ltd. ----guaranteed; Long Term Rating; Affirmed; BBB+ ----guaranteed; Short Term Rating; Affirmed; F1 Daimler Canada Finance Inc. ----guaranteed; Long Term Rating; Affirmed; BBB+ Mercedes-Benz Finansman Turk Anonim Sirketi ----guaranteed; Long Term Rating; Affirmed; BBB+ ----guaranteed; Short Term Rating; Affirmed; F1 Contacts: Primary Rating Analyst Emmanuel Bulle, Senior Director +34 93 323 8411 Fitch Ratings Ireland Spanish Branch, Sucursal en España Av. Diagonal 601 Barcelona 08028 Secondary Rating Analyst Michele Giagheddu, Associate Director +49 69 768076 156 Committee Chairperson Paul Lund, Senior Director +44 20 3530 1244 Media Relations: Adrian Simpson, London, Tel: +44 20 3530 1010, Email: adrian.simpson@thefitchgroup.com Additional information is available on www.fitchratings.com Applicable Model Numbers in parentheses accompanying applicable model(s) contain hyperlinks to criteria providing description of model(s). 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