US CR Event AutoCWArticle2012

CreditWeek
The Global Authority On Credit Quality | September 26, 2012

Can The Ford, GM, & Chrysler
Resurgence Continue? (p. 50)
Global Truck Makers Face
Wavering Demand (p. 32)
Difcult Conditions Await
Europes Carmakers (p. 98)
As U.S. Auto ABS Recovers,
Do Risks Lie Ahead? (p. 74)
SPECIAL REPORT
THE AUTO INDUSTRY
Chasing Global Growth (p. 12)
CONTENTS
2 www.creditweek.com
September 26, 2012 | Volume 32, No. 36
The Global Auto Industry Holds Steady Amid
Economic Turbulence
By Beth Ann Bovino, New York
The past five years have been tumultuous for the global economyand
especially the auto sector. First came the worst recession since the Great
Depression of 1929, then an earthquake in Japan and floods in Thailand,
and now the eurozone debt crisis. However, subdued consumer
sentiment has not yet dented healthy growth in demand for the auto
industry in the U.S., but some other markets are growing more slowly.
CREDIT FAQ
18 The Global Auto Sector Faces Obstacles And
Opportunities As Regional Economic Outlooks Diverge
By Robert E. Schulz, CFA, New York
Wide variations in the economic health and prospects
of regional markets are making for a disparate outlook
for global automakers. Sales are rising in the U.S. and
likely will rise in China. Yet Europes economic woes
are contributing to weaker sales and pressure to cut
production capacity. Although Japans auto market has
rebounded from the effect of natural disasters, a
strong yen is making it tougher for Japanese makers
to compete on exports.
32 Can Global Heavy Truck Makers Downshift Fast
Enough To Ride Out Wavering Demand?
By Michael Andersson, Stockholm
The outlook for global heavy
truck markets is hazy due to
uncertainty over the global
economy. The slowdown in
the European heavy truck
market seems to be
worsening, in line with our
base-case scenario of a mild
recession in the eurozone in 2012.
A weak order intake in the U.S. and
increased economic uncertainty have made
the outlook for the North American truck
market similarly uncertain.
37 Life In The Slow Lane: Adjusting To The
Fall In Replacement Tire Demand
By Lawrence Orlowski, CFA, New York
As the world economy has slowed,
so has demand in the largest
segment of tire manufacturing: the
replacement industry. The
underlying reasons for this shift
in behavior include stubbornly high
unemployment, prevailing economic uncertainty, and
rising fuel prices. And theres not much hope that
demand will increase any time soon.
46 Global Rental Car Companies Have The
Resilience To Ride Out A Weaker Economy
By Betsy R. Snyder, CFA, New York
We dont expect the global slowdown in economic
growth to significantly hurt global rental car
companies earnings and cash flow or our ratings on
the sector. These companies have proven resilient to
past downturns and we expect them to respond
similarly this time around.
50 Can General Motors, Ford, And Chrysler Continue
Their Resurgence?
By Robert E. Schulz, CFA, New York
Even as economic uncertainty persists in the U.S.,
recession looms in Europe, Chinas economy slows, and
evolving intra-Latin America trade issues persist,
General Motors, Ford and Chrysler demonstrated
that they can maintain and move beyond their
improvements in credit quality from late 2009 to 2011.
12
SPECIAL REPORT
FEATURES
Standard & Poors Ratings Services CreditWeek | September 26, 2012 3
62 U.S. Auto Suppliers Could Largely Weather
Slowing Global Economic Growth
By Nishit K. Madlani, New York
Growing global economic
risks will likely slow
earnings growth among
U.S. auto suppliers this
year and into 2013, but
most should sidestep any
significant deterioration in
their credit quality.
71 U.S. Banks Affinity For Auto Loans Continues
74 The Recovery Continues For U.S. Auto ABS,
But What Risks Lie Ahead?
79 The U.S. Subprime Auto Loan ABS Market: Not Seen
Headed For A 1997-1998 Style Contraction
85 The U.S. Personal Lines Automobile Insurance
Sector Is On Credit Cruise Control Through 2013
88 How S&P Values The U.S. Auto Sector To Arrive At
Its Post-Default Recovery Ratings
93 The Aggregate Auto Sector Spread Tightened As
Sales Picked Up
CREDIT FAQ
95 How Sustainable Are Hyundai Motor And Kias
Gains In Market Share And Profitability?
98 Europes Speculative-Grade Volume Carmakers Are
Still Rolling, But Driving Conditions Are Becoming
More Precarious
SPECIAL REPORT FEATURES
T
he past five years have been tumultuous for the global
economyand especially the auto sector. First came the
worst recession since the Great Depression of 1929, then
an earthquake in Japan and floods in Thailand, and now the
eurozone debt crisis. However, subdued consumer sentiment has
not yet dented healthy growth in demand for the auto industry in
the U.S., but some other markets are growing more slowly, and
European sales are falling year over year.
The Global Auto Industry
Holds Steady Amid
Economic Turbulence
Overview
Despite the tepid U.S. economic recovery, we expect U.S. auto sales in 2012 to
rise to their highest level since 2008 as a result of consumers replacing their
aging vehicles, as well as better credit availability.
We expect the eurozone economies to remain depressed, and although the

severity and length of the downturn will vary by country, the overall trend will
be a continued decline in auto sales in 2012.
The auto markets in the emerging markets, particularly China and India, have huge
growth potential, but as demand is directly linked to overall economic activity, it
will decline if the economy weakens further, as we expect it will in 2012.
Although the Japanese economy has bounced back since the earthquake and
tsunami that hit in 2011auto sales climbed 46.3% in the first half of 2012we
expect it to slow in the second half of 2012 as domestic consumption loses
momentum once the government incentives end and global economic
uncertainty hurts its exports.
Auto sales growth has turned out to be
a bright spot in the U.S. in the past
year, benef i t i ng f rom demand as
drivers replace their aging cars and
trucks, which are now a record 10.8
years old, on average. In Japan, the
industry has bounced back from last
years production losses resulting from
the tsunami. The governments incen-
tive for fuel-efficient vehicles has also
given a boost to the countr ys auto
industry. Economic growth has slowed
in the emerging markets, especially in
China and India, primarily because of
these countri es ef for ts to contai n
inflation, as well as the impact of tepid
growth in the U.S. and the recession in
Europe. Although auto sales growth
rates in India and China have slipped
from their recent highs, they remain
strong relative to sales in some other
regi ons. Meanwhi l e, aut o sal es i n
Europe continued to drop in 2011 and
were down 7.1% through the first eight
months of 2012. The drop could be the
result of the simultaneous delever-
aging taking place in the public sector,
the household sector, and the banking
sector, which is holding back growth in
the region and hurting auto sales.
The U.S.: Making Its Way
Toward A Recovery
Light-vehicle sales in the U.S. were one
of the consistent bright spots in the
economy in 2011, rebounding to 12.5
million in 2011 from 11.8 million in
2010 and the depressed level of 10.6
million in 2009. Last years sales figures
could have been even higher if not for
the tsunami and earthquake in Japan
and flooding in Thailand. These disas-
ters forced not only Japanese
automakers, but also other companies
(to a much lesser extent), to curtail pro-
duction in virtually all of their assembly
plants around the world. These events
also disruptedand in some cases shut
down entirelyJapanese auto parts
suppliers, which hurt U.S. carmakers
(again, to a much lesser degree than the
Japanese automakers).
We believe that auto sales will
improve as the U.S. economy continues
its tepid recovery. In addition, pent-up
demand and better credit availability
should support year-over-year sales
growth for 2012.
We expect auto sales to reach 14.1
million units in 2012surpassing the
13 million-unit mark for the first time
since 2008. Nevertheless, we remain
watchful of potential weakening in the
recover y because of Europes eco-
nomi c t roubl es, sl ower growt h i n
Chi na, and the potenti al U. S. fi scal
showdowns late in 2012, which could
dampen fragile consumer sentiment
and, consequently, hurt auto sales.
The economic recovery in the U.S.
has cont i nued t o advance, al bei t
slowly, since the first half of this year.
Also, an increase in pent-up demand
and a falling unemployment rate have
benef i t ed U. S. aut o sal es, despi t e
higher gasoline prices (see char t 1).
These factors, along with stronger con-
sumer conf i dence, hel ped l i f t auto
sales. In addition, high used-car prices
and an agi ng U. S. motor f l eet have
boosted demand in the U.S.
Al l of t hi s was good news f or
automakers, especially those in the
U. S. , whi ch have restr uctured thei r
operations to be profitable at lower
vol umes. The Mi chi gan Three
General Motors, Ford, and Chrysler
gained market share at the expense of
the Japanese manufacturers and have
now posted strong operating perform-
ance for several quarters. As the U.S.
companies are focusing on producing
more attractive vehi cl es, they al so
reached a new and mutually beneficial
four-year labor agreement with the
Uni t ed Aut o Wor ker s i n 2011. By
offering newly hired workers rates that
are comparable to those that Asian
transplants in the U.S. pay, these com-
panies have taken another important
Passenger car sales in the eurozone continue to face
strong headwinds, and we dont expect a pickup in
demand this year.
step in narrowing the gap on manufac-
turing costs.
Europe: Still Heading Downhill
Passenger car sales in the eurozone
continue to face strong headwinds,
and as most economi es are weak-
eni ng, we dont expect a pi ckup i n
demand this year. Passenger car regis-
trations decreased in Europe for the
second consecutive year in 2011, by
1. 7%, af t er f al l i ng 5. 6% i n 2010,
according to the European Automobile
Manufacturers Assn. (see chart 2). The
number of registered passenger cars
in the region shrank to 13.1 million
f rom 13. 35 mi l l i on over t he same
period. Most of the significant markets
reported declines, with decreases of
2. 1% i n France, 4. 4% i n t he U. K. ,
10.9% in Italy, and 17.7% in Spain. In
contrast, car sales in Germany rose as
demand for new cars grew by 8.8%.
The eurozone economies continue
to face turbulence as growth stalled in
the first quarter and then dropped in
the second. Financial market condi-
ti ons al so worsened i n the second
quarter. The recent spike in risk pre-
miums for Italian and Spanish bonds
and concerns about the future of the
eurozone have caused capital to flow
out from countries in the southern rim,
such as Greece, Portugal, and Italy. In
the first six months of 2012, new pas-
senger vehicle registrations in the EU
fell 6.8% year over year, though we
saw wide variations by country. The
two largest marketsGermany and
t he U. K. were up, whi l e t he next
three largest markets (Spain, France,
and Italy) were all down.
In 2012, we expect austerity meas-
ures and the debt crisis to continue to
depress eurozone economies. Recession
set in for most eurozone economies in
the first half of 2012. We believe that
the severity and length of the down-
turn will vary by country, but that the
overal l t rend wi l l be a cont i nued
decl i ne i n aut o sal es i n 2012. We
expect eurozone GDP to contract by
0. 6% thi s year and to recover only
slightly in 2013, with growth of 0.4%.
Outside the zone, we forecast anemic
2
0
0
0
2
0
0
1
2
0
0
2
2
0
0
3
2
0
0
4
2
0
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5
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6
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0
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7
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8
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0
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9
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1
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e
2
0
1
3
f
2
0
1
4
f
0
2
4
6
8
10
12
(%)
0
2
4
6
8
10
12
14
16
18
20
(Mil.)
eEstimate. fForecast.
Standard & Poors 2012.
Sources: Global Insight and Standard & Poors forecasts.
Unemployment rate (left scale) Auto sales (right scale)
Chart 1 U.S. Auto Sales And The Unemployment Rate
2006 2007 2008 2009 2010 2011
8
9
10
11
12
13
14
15
(Mil.)
(10)
(8)
(6)
(4)
(2)
0
2
4
(%)
Source: European Automobile Manufacturers Association.
Change (right scale) New passenger car registrations (left scale)
Chart 2 New Passenger Vehicle Registrations In Europe
2006 2007 2008 2009 2010 2011
0
2
4
6
8
10
12
(Mil.)
(20)
(10)
0
10
20
30
40
50
60
(% change)
*Fiscal year.
Sources: Society of Indian Automobile Manufacturers, Japanese Automobile Manufacturers Assn., and Global Insight.
India % change (right scale) China % change (right scale) Japan % change (right scale)
India sales* (left scale) China sales (left scale) Japan sales (left scale)
Chart 3 Auto Sales In Asia
GDP growth i n the U. K. of 0. 3% i n
2012 and 1.0% in 2013.
The eurozone debt crisisnow in its
third yearhas sharply dented con-
sumer sentiment in the region. In fact,
the crisis is probably more severe and
deeper than ever, and it is threatening
the viability of the eurozone in its cur-
rent for m. Moreover, some of the
strongest European countries, especially
Germany, have started to feel the strain
tooGerman manufacturing output
contracted at its fastest pace in three
years. The unemployment rate in the
eurozone reached a record high of
11.3% in July. It averaged 7.8% in 2007.
Eurozone consumer sentiment dropped
to 89.9 in June, far below its long-term
threshold average of 100. Also, the
threat of implementing new austerity
plans further hampered the economies.
The slew of bleak data and political
leaderships failure to come up with a
long-term solution for the European
debt crisis have eroded consumer con-
f i dence. Mar ki t Economi cs, whi ch
computes the purchasing managers
indices (PMIs), noted that in second-
quarter 2012, the eurozone appeared
to be experiencing the strongest quar-
terly downturn i n three years. The
composite indices point to the euro-
zone economies having contracted by
about 0.6% in the second quarter. And
the big fear is that a disorderly default
on sovereign debt, such as Greece,
could turn into a bigger financial crisis
that would spread to larger economies,
l i ke Spai n and Italy. Moreover, the
fiscal stimulus measures that offset the
i mpact of t he recessi on i n 2009
(including offering payments for scrap-
ping older cars and buying new, low-
emission vehicles) wont be available
t hi s t i me around. The European
Central Bank (ECB) has undertaken
new monetary policies, including its
potentially unlimited bond-buying pro-
gram called outright monetary transac-
tions (OMT), in an effort to stabilize
secondary sovereign bond markets and
strengthen the viability of the euro-
zone. The OMT initiative is a major
move to consolidate states and is very
different than the ECBs earlier initia-
tives, but it has yet to be tested, so
risks remain.
Emerging Markets: On
A Roller Coaster Ride
After making significant progress fol-
lowing the 2008 financial crisis, the
recoveries in emerging economies, espe-
cially China and India, have slowed con-
siderably as policymakers try to curb
rising inf lation. Auto sales growth in
China dropped sharply to a meager 2%
in 2011 from its high of 46% in 2009,
and in India, it fell to 2.2% in 2011 from
26.9% the previous year.
Growth in these economies deceler-
ated sharply in 2011. Chinas economy
slowed to 9.2% in 2011 after expanding
10. 4% in 2010. Indias GDP growth
slumped to 6.5% from 2011 to 2012,
compared with an impressive 8.4% in
the previous fiscal year. The slowdown
resulted from tighter credit policies, a
weak recovery in the U.S., and the reces-
sion in Europe. The slowdown in exports
to EuropeAsias largest export
markethas hurt industrial activity in
the region, especially in China. We
expect economic growth to continue to
declineto 7.8% in China in 2012 and to
5.5% in India in 2012 to 2013.
Following the 2008 financial crisis,
emerging marketsChina in partic-
ularseemed to have the potential to
lead a recovery in global auto demand.
But Chinas economy is rapidly losing
traction, and a series of steps to ease
monetary policy in recent months does
not appear to be making much differ-
ence (see chart 3). In addition, Chinas
manufacturing PMIone of the early
i ndi cators of the state of the
economycontinues to signal weak-
ness, dropping to 47.6, the lowest level
since March 2009. In addition, major
The slowdown in exports to EuropeAsias largest
export markethas hurt industrial activity in the
region, especially in China.
Chinese cities like Beijing are increas-
ingly resorting to stricter standards of
emi ssi on and restri cti ons on the
number of passenger car registrations
per year to curb emissions and ease
traffic congestion, which have further
hampered auto sales. However, to stem
the drop in sales, the government has
initiated a package worth Chinese ren-
minbi (RMB) 6 billion (US$952 billion)
to provide subsidies on purchases of
fuel-efficient cars with engines of less
than 1.6 liters. In addition, the govern-
ment announced that it will spend $156
billion on building new subways, high-
ways, and other infrastructure projects,
which likely will support a resumption
of growth in the coming year.
Similarly, auto sales in India have
slowed considerably because of tighter
monetary policies. The Reserve Bank of
India has raised borrowing cost rates 13
times since March 2010 to cool inflation,
which has remained above 9%.
Moreover, a 21.1% increase in gas prices
since the beginning of 2012 has sharply
cut into consumer sentiment.
Nevertheless, the auto markets in
China and India have huge growth
potential given their large populations,
ongoing urbanization, and rising pur-
chasing power. But obstacles to auto
industry growth in the region remain.
Because demand is directly linked to
overall economic activity, it will decline
if the economy weakens further, as we
expect it will in 2012. Also, rising oil
prices and supply concerns stemming
from troubles in the Middle East could
cause inf lation to climb, which likely
would erode consumers income and, as
a result, demand for autos.
Japan: Recovering From
Natural Disasters
In March 2011, the earthquake and
tsunami that hit Japan created havoc
throughout the country and brought
the auto industry to a standstill. Plant
outages and power shortages jeopard-
ized Japans auto productionwhich
accounts for about 13% of worldwide
auto productionand manufacturing
of many critical components. The nat-
ural disaster struck a powerful blow to
the nati ons economy, tri ggeri ng a
0.7% contraction in real GDP for 2011
af ter a gai n of 4. 5% i n 2010. Thi s
resul t ed i n a 15. 1% decl i ne i n
Japanese auto sales in 2011 following
an increase of 7.5% in 2010. However,
the Japanese economy bounced back
in early 2012. The economy grew a
sol i d 4. 1%, pri mari l y because of
strong consumer spending, especially
on car purchases, which received a
boost from temporar y government
incentives. This led auto sales to soar
46.3% in the first half of 2012.
However, the Japanese auto market is
fairly saturated, and domestic demand is
unlikely to lead to a significant recovery
in 2012 once the government incentives
are rolled back. Japans growth depends
more on exports. It recorded a trade
deficit of more than $37 billion in the
first half of the year, and most of its auto
exports are to the U.S. and the EU, which
ran into economic turmoil in 2011. So in
2012, reconstruction spending will con-
tinue to support Japans economic
growth, while the slowdown in Europe
and China will hamper it. We expect
Japans economy to grow by 2% in 2012
and 1.4% in 2013.
Auto Sales Should Hold Up,
But Struggling Economies
Will Remain A Drag
Although we expect global auto sales
to remain steady in 2012, the looming
fi scal cl i f f i n the U. S. , i ntensi fyi ng
recessions in eurozone countries, and a
slowdown in emerging economies such
as China pose significant risks to the
global economy. Other issues include
i ncreasi ng geopol i ti cal ri sks i n the
Middle East, which could cause crude
oil prices to rise. We think these factors
could keep some potential car buyers
on the sidelines through 2012. CW
Analytical Contacts:
Beth Ann Bovino
New York (1) 212-438-1652
Kaustubh Pandey
CRISIL Global Analytical Center, an S&P affiliate
Mumbai
For more articles on this topic search RatingsDirect with keyword:
Auto Industry
SPECIAL REPORT | Q&A
FEATURES
W
ide variations in the economic health and prospects of
regional markets are making for a similarly disparate
outlook for global automakers. Sales are rising in the
highly competitive U.S. market, and we expect sales to be up in
China this year as well. At the same time, Europes economic
woes are contributing to weaker sales and pressure to cut
production capacity in the region. Japans auto market has
rebounded from the effect of natural disasters last year, although
a strong yen is making it tougher for Japanese makers to
compete on exports.
The Global Auto Sector
Faces Obstacles And
Opportunities As Regional
Economic Outlooks Diverge
Credit FAQ
Here, we provide insight into some of
the key issues for investors in the global
auto industry.
Q. What is Standard & Poors outlook for
credit quality in the global auto sector?
A. Standard & Poors Ratings Services
outlook for credit quality in the auto
sector is mixed: almost 40% of our out-
looks on the rated global automakers are
either positive or negative, ref lecting
individual companies geographic con-
centrations and significant variations in
our regional economic outlooks. The
rated global automakers are navigating a
variety of conditions, including weak or
recovering markets and global economic
uncertainty. Some have more exposure
than their competitors to declining mar-
kets or a cost base that they cant easily
restructure because of their location.
SPECIAL REPORT | Q&A FEATURES
2011 2012 2013
Units (000s) Units (%) Units (%) Units (%) Percent of the 2013 total
U.S.
General Motors 2,504 19.6 2,642 18.3 2,832 18.7
Ford 2,120 16.6 2,257 15.6 2,385 15.7
Toyota 1,645 12.9 2,100 14.5 2,174 14.3
Fiat-Chrysler 1,369 10.7 1,643 11.4 1,669 11.0
Total Industry U.S. 12,748 14,459 15,174 Top 4 account for about 60%
Western Europe
Volkswagen 3,172 22.1 3,009 22.4 2,910 21.5
PSA 1,951 13.6 1,745 13.0 1,790 13.3
Renault-Nissan 1,945 13.5 1,632 12.1 1,666 12.3
Ford 1,208 8.4 1,168 8.7 1,182 8.7
General Motors 1,188 8.3 1,177 8.7 1,156 8.6
Total Industry Western Europe 14,375 13,453 13,510 Top 5 account for 64%
Eastern Europe
Renault-Nissan 1,186 25.4 1,180 24.4 1,272 24.5
Volkswagen 572 12.3 655 13.6 697 13.4
General Motors 485 10.4 488 10.1 485 9.3
Hyundai 448 9.6 496 10.3 453 8.7
Total Industry Eastern Europe 4,663 4,828 5,198 Top 4 account for 56%
China
Volkswagen 2,327 12.9 2,532 13.0 2,759 12.3
SAIC 1,396 7.8 1,508 7.7 1,806 8.1
Chinese Manufacturers 1,325 7.4 1,454 7.5 1,758 7.9
General Motors 1,301 7.2 1,405 7.2 1,529 6.8
Hyundai 1,247 6.9 1,343 6.9 1,552 6.9
Total Industry China 18,000 19,472 22,342 Top 5 account for 42%
Brazil
Fiat-Chrysler 781 22.2 790 22.9 798 21.2
Volkswagen 707 20.1 704 20.4 706 18.7
General Motors 643 18.3 615 17.8 674 17.9
Ford 312 8.9 327 9.5 341 9.1
Total Industry Brazil 3,515 3,449 3,766 Top 4 account for 67%
Source: LMC Automotive Ltd.
Table 1 | Top-Selling OEM BrandsLight Vehicle For Key Regions
Accordingly, results in 2012 have
varied across regions and companies. In
Europe, for example, losses have been
the norm among volume automakers,
while luxury makers remain largely prof-
itable. We expect this variability to con-
tinue, and as such, some Europe-based
volume automakers have experienced
negative rating actions this year, while
the Korean automakers and some luxury
makers, along with U.S. automaker Ford
Motor Co. (BB+/Positive/), have seen
positive rating actions. We believe most
investment-grade automakers have room
within their ratings to weather some ero-
sion in performance, while most specula-
tive-grade automakers have less room in
their ratings for underperformance.
Standard & Poors base-case outlook
continues to forecast considerable
regional differences in auto sales for
2012, and we believe the underlying fun-
damentals driving these differences
including economic and political uncer-
tainty in Europe, slowing economic
growth in China and Brazil, and fiscal
uncertainty in the U.S.could persist
into 2013. The mix of regional expo-
sures is a key aspect of automakers
credit quality and is unlikely to change
significantly over the next year or so
because of their established manufac-
turing and sales footprints. Table 1 illus-
trates the variety of regional exposures
among the global automakers.
Q. What are some of the major develop-
ments Standard & Poors is watching?
A. Higher sales and stiff competition in the
U.S. Competition in the U.S. market is
not abating, even as sales continue to
recover. The U.S. automakers halted the
trend of declining shares several years
ago, and their competitive position has
improved in many of their traditionally
weaker segments, such as small cars. At
the same time, Korea-based Hyundai
Motor Co. (BBB+/Stable/) and its Kia
Motors subsidiary have gained share
over the past few years, and in 2012 the
Japanese automakers have recovered
from 2011 inventory shortages: Toyota
Motor Corp.s (AA-/Negative/A-1+)
sales were up 46% year-over-year in
August 2012. Still, the Japanese
automakers share remains below its
peak. Nonetheless, we view the U.S. auto
market as highly competitive.
But beyond the established (and
reestablished) players, were also watching
how Volkswagen AG (A-/Positive/A-2)
executes its plan to gain share in the U.S.
Volkswagen is underrepresented in the
U.S. market relative to its share elsewhere
in the world. However, the company has
made inroads: Its market share has grown
steadily over the past few years, to 3.8% of
the U.S. passenger car market at the end
of June 2012 from 2.4% in 2008.
Following the opening of a new plant in
Chattanooga, Tenn., in 2010 (with 2,500
employees and a current capacity of
150,000 vehicles), the U.S.-made Passat
has been the focus of the companys
efforts to gain share in the U.S. The Jetta,
Touareg, Tiguan, and new Beetle models,
manufactured in Puebla, Mexico, as well
as the Audi Q5 and Q7 models, added up
to some 440,000 vehicle deliveries for
Volkswagen in the U.S. in 2011, a 23%
year-on-year increase.
Volkswagen targets sales of 800,000
vehicles annually in the U.S. by 2018 (and 1
million units for North America altogether)
as part of the companys strategy 2018
multiyear plan. Its U.S. 2018 target would
represent roughly 5.7% of our estimated
2012 U.S. industry sales. But even allowing
for a higher level of industry sales in 2018,
Volkswagens plans to raise share in the
U.S. market, and its potential effect on
other volume makers, should not be
underestimated.
In Europe, fierce competition and weaker
sal es make f or a tough market.
Metric For a potential upgrade Actual*
Adjusted debt/EBITDA 2.5x 3.6x
Automotive-related FOCF to adjusted debt
(excluding voluntary pension contributions) 15% 6.5%
Automotive EBIT profit margins Mid-single-digit area for total automotive and 5.1%
high-single-digit area for North America
Prospects for sustained liquidity at the automotive parent More than $30 billion $38.5 billion
*Leverage and cash flow ratios as of 2011. Margins and liquidity as of June 30, 2012. FOCFFree operating cash flow.
Table 3 | General Motors Co.Quantitative Metrics For A Potential Upgrade
Metric For a potential upgrade Actual*
Adjusted debt/EBITDA 2.5x 3.5x
Automotive-related FOCF to adjusted debt (excluding voluntary
pension contributions) 15% 12%
Automotive EBIT profit margins Mid-single-digit area for total automotive and 4.9% total
high-single-digit area for North America
Prospects for sustained liquidity at the automotive parent More than $30 billion $33.9 billion
*Leverage and cash flow ratios as of 2011. Margins and liquidity as of June 30, 2012. FOCFFree operating cash flow.
Table 2 | Ford Motor Co.Quantitative Metrics For A Potential Upgrade
Competition has become fiercer than
ever in the depressed European car
market, and all manufacturers are strug-
gling to preserve market share while con-
sidering how to cut excess production
capacity. General Motors (GM;
BB+/Stable/) Opel unit and Ford are
among the losers in share so far: Each
currently holds an 8% share of the EU
passenger car market, down from some
Toyota Motor Corp. Honda Motor Co. Ltd. BMW AG Volkswagen AG Daimler AG
AA-/Negative/A-1+ A+/Stable/A-1 A/Stable/A-1 A-/Positive/A-2 A-/Stable/A-2
The ability to extend or protect retail market share in key markets by offering high-quality products desired by customers
Toyota successfully reversed Honda is the third-largest BMW is among the global With a share of 12.3% in the The group boasts leading
declining market share in automaker in Japan, leaders worldwide in the global auto market on positions in the niche, but
the U.S. after massive recalls following Toyota and Nissan, luxury car segment. The Dec. 31, 2011, VW is the highly profitable, premium
and supply chain disruptions in terms of revenues in group has solid positions global leading auto maker in segment through its reputed
following the earthquake that fiscal-year March 2012. With in Europe and the U.S. terms of market share. The Mercedes Benz brand. In
severely challenged the 9.8% market share during group enjoys sizable market addition, it has significant
company. In Japan, Toyota the first eight months of shares in most of the markets positions in trucks/vans/
continues to enjoy dominant 2012, the company has an in which it competes, buses, as well as in the small
share. Toyota also maintains established position in the including leading positions city car segments. Daimler
very strong position in U.S. In the Japanese in China, Brazil, and most sales volumes reached
Association of Southeast domestic market, Honda European countries. Recently, record levels in 2011 on the
Asian Nations countries. has the second-largest share the group has consistently back of double-digit growth
of 14.6% (including mini- gained market share in China, in emerging markets.
vehicles) in the first seven North America, and in
months of 2012. several European countries.
Frequency of model replacement; ability to meet shifts, often rapid, in consumer preferences and perceptions
We believe Toyota has Hondas robust positions in The group has a solid track- Thanks to its multibrand Daimler reported an overall
proven its ability to anticipate global auto and motorcycle record of successfully portfolio, products offered good model turnover in the
and meet shifting consumer markets reflect the strong launching new brands and are wide and cover all premium segment and
preference reflected in its competitiveness of Hondas products with a reputation market segments with a demonstrated a good
track record in keeping a products. Hondas multiple for high quality. For example, clear focus on new products capacity to meet customers
strong lineup of fuel-efficient global core models (Civic, BMW introduced the MINI development. To support its taste in emerging markets.
cars. Toyota also has Accord, Fit, and CR-V) are brand and enlarged the global growth strategy,
demonstrated its outstanding of particular strengths that BMW family of products Volkswagen plans to
ability to create and develop contribute greatly to the with the inclusion of SUV increase the number of
a hybrid vehicle segment. companys performance models. The new challenge model launches per year to
despite increasing compet- is the BMWi brand, created about 40 from 30.
ition from other automakers. for the sustainable mobility.
The first model will be
launched in 2013.
Ability to limit sales incentives because of brand loyalty and success in differentiating product on the basis of quality, style, or other consumer-driven measures
Toyotas incentive spending Honda has a proven track In line with the characteristics Despite its large exposure to The group benefits from
has consistently been below record in its reputation for of the premium segment, the European volume market, high brand loyalty and
the industry average. We quality, technology, and BMW benefits from high Volkswagen continues to higher margins in the
believe Toyota will likely design of its products in pricing and higher margins gain market share and to premium segment. High
continue to refrain from many global auto and than its peers in the command a premium price pricing for Mercedes Benz
aggressive incentives, which motorcycle markets. volume market. on its volume brands, has recently been supported
should help sustain its key supported by its high brand by a high share of large-
models strong residual value. recognition with customers. cylinder and luxury cars sold
Successful growth of the in 2011, notably in the
groups premium (Audi) and Chinese market.
entry (Skoda) brands in the
recent past is also a
supportive factor.
Ability to generate consistent profits in key portions of the product lineup (retail and fleet) under most volume scenarios,
along with prospects for breakeven results or better during a significant market slump
Toyota has a strong ability to Honda shows a return to a The BMW auto division Volkswagen reported an Since a steep decline in
consistently reduce costs steady growth path, which reported 11.8% EBIT margin operating profit for its auto 2009, Daimler has gradually
through improving operating the company had to give up at year-end 2011, which is division of 6.9% in 2011, which improved its profitability on
efficiency and other temporarily in fiscal 2011 among the highest in the is well above the average of the back of improving
measures. Nevertheless, the because of natural disasters. auto sector. We do not European peers in the volume pricing and increasing unit
extremely strong yen against Hondas global unit sales of expect this level to be market. The group is profitable sales. In 2011 the groups
major currencies continues automobiles have shown a sustainable, but we believe in most of its segment/ operating margin in the auto
to weigh on Toyotas steady recovery and the that EBIT margin of 8% to geography combinations and division reached 9%, which
profitability given its figure has improved to 10% through-the-cycle its premium segment (Audi is well above the European
relatively large yen exposure. about 1 million units in would be commensurate and now Porsche, will average, reflecting the
recent quarters. with the current rating. represent some 50% of group groups large share of profit
earnings going forward) generated in the higher-
reports measures as strong margin premium market.
as BMWs. Exceptions are
operations in the U.S. and Seat.
Table 4 | Key Credit Factor Peer Comparisons For Companies Rated AA- To A-
10% back in 2008 (according to ACEA,
the European Automobile Manufacturers
Association). Manufacturers with the
most exposure to southern Europe
namely Fiat SpA (BB-/Stable/B), Peugeot
S.A. (BB/Negative/B), Renault S.A.
(BB+/Stable/B), and the Japanese manu-
facturersalso experienced significant
declines during the first half of 2012. As
in the U.S., the Hyundai-Kia group is
gaining in Europe: Its share of the EU
market has almost doubled since 2008,
rising to 6% at the end of June 2012 from
3.4 % in 2008 (its U.S. share was 9% for
the eight months ended August 2012,
according to Wards AutoInfoBank). More
surprisingly, Volkswagen has also been
able to boost or maintain its market share
in several European countries while main-
taining a disciplined premium pricing
strategy across the continent. The com-
panys share of the EU passenger car
market has steadily improved since 2009
and stood at 23.3% at the end of June
2012, up from 20.6% in 2008.
Automakers str uggle to cut excess
assembly capacity in Europe. Ebbing
demand and excess production capacity
amid the eurozone crisis have battered
the European volume automakers,
leading to a discounting race among
these companies, along with operating
losses and cash use. According to ACEA
data, total EU new-car sales totaled about
7.4 million vehicles at the end of June,
down 7.3% year-on-year (compared with
14.9 million vehicles in full-year 2011).
The overall decline to date masks con-
trasts between countries, however.
During the first half of 2012, car sales in
Germany and the U.K. remained broadly
f lat (with upticks of 0.6% and 1.3%,
respectively), and most of the declines
were concentrated in southern Europe,
primarily Italy (with a 20.6% drop),
France (down 13.3%), and Spain (down
11.3%). Combined, those five countries
represent about three-quarters of the
overall EU auto market.
Our base-case outlook for full-year
2012 foresees no significant improve-
ment in demand in the European market.
In light of the weakening economies and
the austerity plans that several European
countries are adopting, we assume no
significant turnaround during the second
half of the year.
We now expect the Western European
market to decline roughly 6.5% to about
13.4 million vehicles in 2012, followed
by potential anemic growth of about
0.4% next year. Volume declines have
resulted in fierce pricing competition
and rendered some volume makers
unable to break even in their core auto-
motive operations.
In that context, the need to reduce
production capacity has returned to the
forefront of the industrys concerns.
Peugeot in France, Fiat in Italy, and also
Opel in Germany have all been vocal
about the need for a concerted effort to
shut down some capacity across Europe,
as the U.S. automakers did before and
during the 2008 to 2009 financial crisis.
Ford has stated that the industry needs
to match capacity to demand, although it
has not yet commented on the timing of
any actions within Ford.
Estimates of excess capacity in
Europe vary depending on the study
and, as in the U.S., forecasts of the real-
istic levels of future sales vary as well.
With the big volume automakers
reporting capacity utilization rates below
80% for their main European operations,
we think excess capacity of at least 20%
is a safe estimate. The German manufac-
turers, however, have hardly suffered
from the depressed market so farif
anything, they have strengthened their
market shares. Much of this resilience
reflects their line-up of luxury products,
strong historical market share in the
better-performing German market, and
still-solid exports to China and other
regions. Not surprisingly, they have been
lukewarm about any concerted effort to
support capacity reductions under the
umbrella of the EU direction.
In our view, reducing capacity in Europe
is therefore likely to be a piecemeal
(country- and company-specific), costly, and
politically tough process whereby capacity
will be shut down case-by-case, primarily
following individual carmakers initiatives.
As such, we assume the timing, execution,
and benefit of any actions will be uneven.
Struggling Peugeot announced a restruc-
turing plan in July that will lead to a net
reduction of 8,000 jobs, primarily in France,
and the closure of its plant in Aulnay (with a
140,000-unit capacity) outside Paris.
Peugeot will also cut capacity at its Brittany-
based Rennes plant in the near future. Two
other manufacturers are undertaking similar
plans: General Motors has changed senior
management at its Opel/Vauxhall division
and earmarked the 130,000-unit Bochum
plant for closure, and Fiat shut down its
Termini Imerese plant last year.
Altogether, we estimate the current
planned reduction in European capacity to
be less than 600,000 vehicles, or less than
5% of current European production. Ford
has not announced how it will deal with its
overcapacity, but with the prospect of sev-
eral more years of weak vehicle sales in
Europe, we believe the company will act
with increasing decisiveness and commit-
ment to restructure its European opera-
tions to become profitable.
At the cur rent pace of planned
capacity reductions, we think it will take
well into 2013, if not longer, to restore
healthy supply and demand in the
European mass marketeven if the
sales outlook for 2013 improved unex-
pectedly. If sales in Europe do not
recover, as they have in North America,
then excess capacity will persist longer.
Q. What impact would a hard landing
for Chinas economy have on global
automakers?
Reducing capacity in Europe is therefore likely to be
a piecemealcostly, and politically tough process
whereby capacity will be shut down case-by-case
A. With Chinas dominance in the global
economy increasing, any domestic eco-
nomic setbackincluding slower-than-
anticipated growthcould reverberate
throughout the world. Our base-case
scenario for China calls for 8% economic
growth, while our hard landing sce-
nario (to which we assign a one-in-10
chance of occurring) calls for 5% eco-
nomic growth.
We think automakers and auto compo-
nent manufacturers in the U.S., Europe,
and Asia (outside China) would face lim-
ited credit risk from a hard economic
landing in China lasting one year or less,
despite some companies significant sales
exposure to the worlds largest auto
market. Ratings on some speculative-
grade auto component manufacturers in
Asia may be more vulnerable, however.
And if our hard landing scenario lasted
two years, some investment-grade and
strong speculative-grade companies in the
auto sector could also be at risk of down-
grades. (For more details on our views see
The Credit Overhang: Implications For The
Global Automotive Sector Of A Hard Landing
In China, published May 29, 2012, on
RatingsDirect, on the Global Credit Portal.)
Q. What would it take for Ford and GM
to achieve investment-grade ratings?
Toyota Motor Corp. Honda Motor Co. Ltd. BMW AG Volkswagen AG Daimler AG
AA-/Negative/A-1+ A+/Stable/A-1 A/Stable/A-1 A-/Positive/A-2 A-/Stable/A-2
Production capacity utilization across the companys manufacturing footprint, in light of typically high industry operating leverage
Not disclosed, but a strong Hondas disclosures on BMW has achieved high Disclosures on capacity Daimler boasts very high
rebound in production from capacity utilization are limited. labor productivity in utilization are scarce, but capacity utilization rates when
supply chain disruptions However, the significant Germany, where the bulk of this has not been a drag on compared with European
indicates a return to high increase in Hondas autombile its manufacturing facilities is VWs earnings profile, unlike peers. The group reported
capacity utilization. production in recent quarters located, through high southern European players. plant utilization rates of 95%
supports its capacity operating rates for plants and The ability to command a in early 2011 for its Mercedes
utilization at a high level. an innovative labor price premium may offset Benz division.
Hondas flexible manu- agreement that provides dips in capacity utilization.
facturing system, relative to flexible work schedules and The launch of the new
its peers, may also support the deployment of workers modular toolkit strategy may
its productivity and efficiency. among production facilities. also play a role in terms of
cost-efficiency.
The extent of brand, geographic, and product line diversification
We believe Toyotas Although Honda has achieved BMWs revenues are well- With nine brands and Daimlers revenues are
diversity is one of the best some product diversification diversified by region, and several models marketed in geographically well diversified,
among global peers, in in its Acura brand in the North the U.S., Germany, and all segments, and large and and Europe and North
terms geographic and American automobile market, China are the largest three wide commercial vehicle America represent the groups
product line. Toyota also it uses the Honda brand in single markets. The coverage, VWs product largest single markets. The
has the premium Lexus other regions in automobile, enlargement of its product offering is unmatched truck and van division
brand. Moreover, Hino, motorcycle, and other range has positively reduced among European carmakers. supports product diversity. We
commercial vehicle maker, products. In terms of the groups dependence on The group has recently expect auto markets in
and Daihatsu, mini-vehicle geographic diversification, the Series 3 models. increased its exposure to the developing economies to
maker, are consolidated North America has been the premium segment through support growth and
subsidiaries of Toyota. companys largest market, the consolidation of Porsche profitability in the
with Asia catching up in and has augmented its medium term.
recent years in sales and presence in the truck
profit contribution to the segment through the
company. Strengths in hybrid acquisition of MAN in 2011.
and other fuel-efficient In terms of geographic
technologies are other key diversification, VW enjoys a
factors that support Hondas strong position in Asia and a
product diversity and strong growing penetration in
competitive position. North America.
The scale, profitability, and funding efficiency of vehicle finance capabilities, through a captive unit or partnerships because of significant
reliance on financing availability for the vehicle distribution and sales process
Toyota has extensive Honda has 100%-owned BMW Financial services is Volkswagen owns 100% of Daimler incorporates a 100%
captive finance operations captive operations in the U.S. the fully integrated captive Volkswagen Financial owned financial services
globally. Toyota manages and Japan. In the U.S., Honda finance division of the group. Services AG and its division, which manages the
its captive finance operates captive finance It is ultimately 100% owned subsidiary Volkswagen Bank captive finance operations of
operations in a conservative operations through American by BMW AG and operates GmbH, the captive finance the group.
manner and maintains Honda Finance Corp. (AHFC). globally through various arms of the group.
strong asset quality. AHFC is a wholly owned locally registered Performance of the captive
subsidiary of American Honda banking operations. is in line with but hardly
Motor Co. Inc. (AHMC), which better than the group average.
is a wholly owned subsidiary
of Honda.
Table 4 | Key Credit Factor Peer Comparisons For Companies Rated AA- To A- (continued)
A. Our BB+ ratings on Ford Motor Co.
and GM are the highest weve assigned
to either company since May 2005, and
a one-notch upgrade would bring both
companies back to investment-grade.
We revised our outlook on Ford to posi-
tive in August 2012 but have stated that
an upgrade to investment-grade isnt
likely to occur until late 2013 at the ear-
liest. Our outlook on GM is currently
stable, so we dont see a one in three or
greater chance of an upgrade in the next
year. In the longer term, a restructuring
of its European operations for a return to
profitability, along with the evolution of
its U.S. Treasury ownership and long-
term capital structure, would be factors
for any eventual upgrade.
The U.S. light-vehicle market is recov-
ering, notwithstanding a cautious U.S.
economic outlook (including the so-
called fiscal cliff of early 2013), and both
companies have been generating profits
and cash flow in their North American
operations since late in 2009. However,
we would also look for sustainable prof-
itability in key markets outside of North
America to support an investment-grade
rating for either company. While other
factors could also support a higher rating
(see tables 2 and 3), sustainable, geo-
graphically diverse profitability is a char-
acteristic we often associate with invest-
ment-grade global companies. One
reason we view diverse sources of
profits as an important credit factor is
that we anticipate the return, at some
point, of cyclicality (and volatility) in
sales and production in North America.
For Ford, beyond regaining control
over its ability to be profitable in Europe,
we will look for the following when con-
sidering an upgrade:
The company sustains debt to

EBITDA of about 2.5x;
Pretax automotive profit to reach the

mid-single digits overall and the high-
single digits for North America;
Hyundai Motor Co. and Kia Motors Corp. Nissan Motor Co. Ltd.
BBB+/Stable/ BBB+/Stable/A-2
HMC and Kias structural improvement in their product quality, such as fuel Nissan has been gaining market share in the U.S. and China in the past
efficiency and design, has led to a gain in their share in major markets such several years. In China, Nissans sales performance is remarkable despite its
as the U.S. and China over the past three years. Although the improved late entry, thanks to its strong lineup of fuel-efficient small cars, and strong
quality is unlikely to suddenly deteriorate over the next one to two years, distribution network leveraging on its local partner.
their market share is likely to moderate from the peak in 2011 because of
their planned modest increase of production capacity.
HMC and Kia served consumer preference and perceptions well, especially We believe that Nissan has demonstrated an ability to keep its product
since the weak economy in 2009. During that time, they focused on the lineup refreshed and that it is committed to actively introduce new models.
small and medium car segment by launching several models whose fuel Nissan plans to launch 51 new models in its midterm business plan through
efficiencies are good and sales prices are competitive. As a result, they fiscal 2016.
continued to gain market share during the period.
HMC and Kia are offering the fewest sales incentives in the U.S. among the Nissans solid profitability generation despite limited success in its premium
automakers based on their much-improved brand as a result of better Infiniti brand reflects its ability to limit sales incentives because of its
product quality measures. success in maintaining a strong product lineup.
HMC and Kia have generated an elite profit margin among global Nissan has demonstrated stronger resilience to an external environment
automakers in the past three years during the ups and downs of the global than Toyota and Honda in the past few years. Nissan has been profitable in
auto industry cycle. Still, both companies lack more long-term track records all the geographic segments, including Japan, for the past two years.
to generate consistent profits.
HMC and Kia have maintained more than 100% utilization rates in most It is not disclosed, but we believe Nissans robust sales performance and
countries in which they have manufacturing facilities over the past three solid automotive profit margins in the past three years indicate high capacity
years because of their good sales. Still, their Korean manufacturing facilities utilization overall.
often undergo halts in manufacturing because of labor union strikes.
HMC and Kia have limited brand diversification without any subbrand such Nissan has good diversity in both geographic and product line. Nissan has
as a premium brand. However, their geographic sales and production better balance than most peers between sales and production in most
diversification are good across the major markets such as U.S., China, regions. Nissan is further diversifying its brand by adding new brands
Europe, and India. Venucia in China and Datsun in emerging markets.
The scale, profitability, and funding efficiency of vehicle finance capabilities, through a captive unit or partnerships
because of significant reliance on financing availability for the vehicle distribution and sales process
HMC and Kia own the majority share of Hyundai Capital Services Inc. and Nissan operates captive finance operations and has maintained healthy
fully own Hyundai Capital America, which serve HMC and Kias vehicle asset quality. While Nissan uses Renaults captive finance operations in
financing in Korea and the U.S., respectively. Still, HMC and Kias vehicle certain countries, Nissan provides financial services to Renault customers in
financing capabilities are relatively weak, albeit improving, given the small some countries.
size of capital of the captive finance subsidiaries. HMC and Kia are likely to
increase the capital of the two captive finance subsidiaries given the parents
strong financials and form partnerships to develop vehicle financing
capabilities in the regions other than Korea and the U.S.
Table 5 | Key Credit Factor Peer Comparisons For Companies Rated BBB+
Liquidity at the automotive parent

remains above $30 billion;
Automotive-related operating free

cash flow totals about 15% of debt;
The company successfully manages

the evolving competitive structure of
the global auto industry, including
continuing to develop and produce
Ford Motor Co. Renault S.A. General Motors Co. Tata Motors Ltd. Peugeot S.A.
BB+/Positive/ BB+/Stable/B BB+/Stable/ BB/Positive/ BB/Negative/B
The ability to extend or protect retail market share in key markets by offering high quality products desired by customers
Fords traction with the Renault boasts a solid GMs U.S. light vehicle share Tata Motors commercial Peugeot is the second-
consumer because it avoided market position in the small (excluding legacy brands) vehicle operations are largest player in Europe after
bankruptcy has helped its and midsize auto segments, has been fairly stable. Two expected to maintain Volkswagen in terms of
retail share since mid-2009, and in the entry segment of the top 10 selling vehicles dominant 60% market share market share. In Europe, the
but this effect is likely through Dacia. Selective for the first eight months of in the Indian heavy and light group has recently suffered
moderating by now. Two of expansion in emerging 2012 were GMs. commercial vehicle market some market share loss,
the top 10 selling vehicles countries (Mediterranean despite increasing driving down its share of the
for the first eight months of countries, Latin America, competition. Jaguar Land European auto market to
2012 were Fords. and Russia) has been Rover, Tata Motors largest 12% at the end of first-half
sustained while fierce subsidiary, has slightly 2012 from 14.2% in 2010.
competition has slightly improved its small market Outside Europe, Peugeot has
eroded the groups market share in the luxury car heavily invested in China,
share in Europe. Its alliance market through its new and Russia, and Latin America,
with Nissan is beneficial to refreshed launches. with moderate success in
Renault in terms of joint R&D terms of volume gains, and
spending, market coverage, so far no positive impact
and model launches. whatsoever on earnings.
We believe that Ford has Renault has demonstrated a We believe that GMs ability We believe Jaguar Land There has been positive
demonstrated an ability to sound overall capacity to to keep its product line up Rover still has to make product mix evolutions in
keep its product line up anticipate market trends. fresh has improved, and it is significant investments to recent years, with Peugeots
refreshed, and that it is The group has gradually committed to bolstering its refresh its product lineup product offer gradually
committed to bolstering its reduced its reliance on the car lineup while lessening its and launch new products. We moving upmarket. Recently
car lineup to lessen its Megane and Clio models, reliance on light trucks. view the companys Evoque announced restructuring
reliance on light trucks. The adding new model families model as a step toward the plans may hurt Peugeots
Ford Fusion and Escape to its offerings. The value- company developing new market positions in the
have been top 10 selling offer models sold under the models to meet changing coming quarters.
vehicles during the past year. Dacia brand, e.g. the Logan- consumer preference. In our
Sandero family and the view, Tata Motors broad
Duster family, have been commercial vehicle portfolio
particularly successful. is well equipped to meet
customer demands, though
its passenger vehicle
segment is behind the curve
in this aspect.
Ford has been able to Intense price competition in GM has focused on keeping The incentive levels for Sales in Europe continue to
remain disciplined about the European volume incentives under control Jaguar Land Rover be depressed by the intense
incentive spending because market continues to hamper and believes it is on track to significantly fell in fiscal price competition from
of past cost reductions and sales and profitability. meeting this goal. A lower 2012 because of excess European peers and
a renewed ability to keep its cost base is a significant demand and supply increasingly by Asian
product lineup renewed. factor in meeting this goal. constraints. Jaguar and Land competitors. The ability to
Rover are established niche retain any premium pricing
brands. Tata Motors India on any model will likely
business incentive structure be tested in the
is in line with the industry coming quarters.
average, in our view.
Ford has been profitable in So far Renault has reported We believe GM can be Jaguar Land Rover has After a rebound in 2010 and
North America since the low but stable profits in profitable at its current U.S. improved its efficiency of first-half 2011, Peugeot has
third quarter of 2009, and most regions and segments, industry sales volumes of operations over the past been generating losses from
we believe the company with above-average earnings about 12 million unitsfar two yearswhich should its core automotive
can remain profitable at from its captive finance lower than before 2009. result in more stable profits, operations, largely as a result
current U.S. industry sales operations. We expect also supported by good of its strong dependence on
volumesabout 12 million declining sales in Europe to demand. Tata Motors Indias the highly competitive and
unitswhich are far lower weigh on the groups overall operations are cost- mature European volume
than before 2009. profitability in the competitive and the company market. The group, so far,
coming quarters. has generated profits even has failed to translate higher
during the global revenues outside its
economic downturn. historical markets into profits.
Table 6 | Key Credit Factor Peer Comparisons For Companies Rated BB+ To BB
products that appeal to U. S. con-
sumers, and faces reasonable
prospects for profitability in devel-
oping markets, such as China; and
Ford Credit continues to be profitable

and demonstrates underwriting stan-
dards consistent with an investment-
grade rating.
For both companies, the challenges to
profitability outside of North America are
substantial. In Europe, the combination of
excess assembly capacity and recession-
like economic conditions are leading to
losses for almost all the volume
automakers there. We assume losses in
Ford and GMs European operations are
likely for at least a part of 2013, if not the
entire year (which contributes to our view
that a Ford upgrade isnt likely until at
least late 2013, assuming visibility into
2014). In Latin America, especially Brazil,
trade restrictions and capacity additions
are creating challenges in the large
automakers established footprints. In
China, we assume sales will grow in the
upper single-digits this year. However,
Fords market share there is modest,
although the company is investing to
expand capacity. Ford China reported
that sales in the country were up 8% for
the first eight months of 2012, to 368,513,
compared with about 1.5 million in the
U.S. for the same period. So the develop-
ment of sales in China sufficient to signifi-
cantly benefit Fords profit diversity will
be a matter of time and execution. GMs
presence in China remains strong.
Q. Could the French and Italian
automakers fall into the B category?
A. Following the downgrades of Fiat
SpA and Peugeot during the first part of
2012, some investors are wondering to
what extent further downgrades are pos-
sible, and at what point we would con-
sider the B category appropriate for the
three southern European volume
makers, namely Peugeot, Fiat, and
Renault. Fiat and Renault currently have
stable outlooks, so a downgrade in the
next year is not part of our current base
case. The negative outlook on Peugeot
indicates a one in three chance of a
downgrade over the next year.
In our view, these companies size and
diversification, their solid presence in sev-
eral markets outside Europe, and their
substantial share of the European car
market (which, though depressed, is still
bigger than the U.S. market) are anchor
points for their business risk profiles,
which we currently assess as fair. All
three companies also benefit from some
market positions outside Europe (e.g., in
Latin America for Fiat and the
Mediterranean countries for Renault),
harbor a fairly wide and well-accepted
product range, have good prospects for
compliance with tightening emission stan-
dards, and are all partners in wider
alliances to various degrees (Fiat through
majority-owned Chrysler, Renault through
43%-held Nissan and a more limited
working agreement with Daimler, and
Peugeot through GMs recent subscription
of a 7% equity stake in the company).
Profitability is the key issue for all
three players. Peugeot is currently the
worst performer, with a negative 3.7%
operating margin in its core automotive
operations for the first half of 2012.
Renault and Fiat are currently breaking
even, but non-European operations are
supporting Fiat. A more pronounced
upturn in European profitability will
prove challenging, in our view, given
that Ger man competi tors remai n
unwilling to take part in any concerted
capacity reduction.
Still, all three players are facing this
new round of crisis with relatively
healthy balance sheets, adequate liq-
uidity, and long debt maturity profiles. So
far, we think these companies have con-
tinuing access to the capital markets and
bank funding, even if the cost of such
access has risen.
The ability to generate positive free
cash flow from operations (FOCF) is the
key differentiator among the three com-
panies. Renault is the clear leader in this
regard, generating positive FOCF in
2011 and likely to do so again this year.
FOCF was negative for Fiat last year and
is likely to break even at best this year,
while Peugeots FOCF was significantly
negative in 2011 and is likely to be even
worse in 2012; moreover, there is no sign
of a return to break-even cash flow for
Peugeot in 2013.
Our current ratings assume that both
Fiat and Peugeots FOCF will turn posi-
tive by 2014 at the latest. If we conclude
that such a turnaround is out of reach,
we would consider downgrades to the
B category.
Q. What are the biggest challenges
facing the Japanese automakers in their
recovery?
A. Japanese automakers have been
trying to turn their businesses around in
fiscal 2012, as they did in fiscal 2011 to
recover from the effect of the Great East
Japan Earthquake and tsunami.
However, these companies face a
number of obstacles, including the yens
appreciation, a potential global economic
slowdown, and intensifying competition.
Despite the strong yen, profits for
Japans auto industry have rebounded
since the beginning of 2012 due to a rapid
recovery in production and sales. We
think profits for Japans auto industry will
likely continue to recover in step with
improvements in the business environ-
ment. We expect global vehicle sales to
rise overall in 2012 but that economic
conditions will vary by region. We expect
demand in North America to continue to
rebound and assume slower but still posi-
tive growth in emerging markets, such as
China. We see demand in Europe
We think profits for Japans auto industry will likely
continue to recover in step with improvements in the
business environment.
declining more significantly in 2012 than
in 2011. In the U.S.the biggest profit
source for many Japanese automakers
light-vehicle sales increased almost 15%
year-on-year during the first eight months
of 2012. Strong performance in the U.S.,
where Toyota and Honda Motor Co. Ltd.
(A+/Stable/A-1) regained market share,
drove the recovery in profitability for the
quarter ended June.
On the other hand, the strong yen con-
tinues to weigh heavily on Japanese
automakers earnings and undermines
their global competitiveness. Although
the rated Japanese automakers have
generally enjoyed a significant rebound
in production and sales in recent months
and a recovery in profit margins, their
resilience to the strong yen varies based
upon how much production capacity
they have outside of Japan. We believe
the ability to achieve stronger profits
through increased sales volumes despite
unfavorable exchange rates will be a key
factor for Japanese automakers credit
quality. In our view, Toyota is likely to
retain its strong financial standing, but
the ratings may come under further pres-
sure if the company is unable to boost
profits sustainably.
Q. How sustainable is Hyundai-Kias
track record of share gains and solid
financial performance?
Ford Motor Co. Renault S.A. General Motors Co. Tata Motors Ltd. Peugeot S.A.
BB+/Positive/ BB+/Stable/B BB+/Stable/ BB/Positive/ BB/Negative/B
It is not disclosed, but Fords With a global capacity It is not disclosed, but we Jaguar Land Rovers During first-half 2012,
N.A. profitability indicates to utilization rate of about believe GM is high in the U.S. capacity utilization has Peugeot reported a European
us that utilization should be 87% in 2011 (only about (based upon profits) and too significantly improved over capacity utilization rate of
more than 80%. With losses 64% in Europe), Renault low in Europe (based on the past two years, and the 76%, a historical low.
in Europe, we assume compares positively with losses). We assume some company is facing supply
capacity utilization is far direct peers in the European actions will eventually occur constraints on some of its
too low. volume market. Renault in Europe. assembly lines. Tata Motors
has moved faster in moving Indias operations have
production out of high- traditionally maintained
cost Western Europe healthy capacity utilization,
(e.g. to Romania, Turkey, though it occasionally cuts
Brazil, or Morocco). production to manage
retail and wholesale
inventory levels.
Fords geographic diversity Renault has been able to GMs diversity of sales and Tata Motors geographic The group has average brand
is not as good as GMs achieve some product product is the best among diversity is lower than most and geographic
because its presence in Asia diversification through its the U.S. automakers and at global peers. Tata Motors diversification. The group has
and South America is more three brands: Renault, Dacia, least as strong as the other Indias sales are almost two brands: Peugeot and
limited. Its product diversity and Renault Samsung large global volume entirely in the domestic Citroen, which target the
is equivalent in the key Motors. In terms of automakers. But losses in market, though with a wide same market segments.
North American market. geographic diversity, Renault Europe and weakness in product range across most Geographic diversification is
Its ability to return to is still reliant on Western South America reduce segments. Jaguar Land too limited, with 73% of the
profitability in Europe could Europe, accounting for the benefits of Rover has moderate groups revenues generated in
be somewhat better than approximately 58% of its geographic diversity. geographic diversity but Europe. Some benefits stem
GMs, although this remains unit sales and 70% of its weak product diversification. from the consolidation of
to be determined. revenues in 2011. Faurecia (auto parts) and
BPF, the fully owned captive
finance subsidiary.
The scale, profitability, and funding efficiency of vehicle finance capabilities, through a captive unit or partnerships because of
significant reliance on financing availability for the vehicle distribution and sales process
Ford has maintained full Renault owns 100% of RCI GM operates a captive but Tata Motors commercial Peugeot owns 100% of BPF,
ownership of traditional Banque, which provides still fairly small scale unit vehicle operations are well which provides financing for
captive finance unit Ford financing for Renault dealers though its growing. GM supported by its captive PSA dealers and retail
Motors Credit LLC. It plans and retail customers in continues to use Ally and finance subsidiary. Because customers in PSAs major auto
to increase leverage of Renaults and some of others for various financings, of good resale value, Tata markets. BPF represents a
captive as its ability Nissans major markets. RCI wholesale, and retail but commercial vehicles also substantial, relatively stable
to diversify funding Banque provides Renault seems to be increasingly have diverse third-party source of earnings and cash
channels increases. with a substantial, relatively committed to expanding GM financiers providing vehicle flow for PSA.
stable source of earnings and Financial to other aspects of finance to customers. Jaguar
cash flow not directly tied to auto finance beyond Land Rover doesnt have
the auto industry cyclicality. subprime auto. captive finance operations
and is reliant on third-
party funding.
Table 6 | Key Credit Factor Peer Comparisons For Companies Rated BB+ To BB (continued)
A. As we expected after our upgrades in
March 2012, Hyundai and its Kia sub-
sidiary have maintained sound financial
risk profiles, owing in large part to their
good market positions (9% U.S. share, up
from to 5.1% in 2008) and solid profitability.
Still, we see some challenges emerging that
could hamper further improvement. For
example, the companies are likely to fall
short of our prior expectation of around a
9% combined share of the global auto
market in 2012 (versus 8.7% in 2011 and
8.1% in 2010). The companies also face
hurdles to further improvements in prof-
itability, such as various cost increases,
including for labor and utilities; weak
domestic demand for vehicles; and rising
sales of imported cars in Koreas market.
Nonetheless, we believe the compa-
nies solid progress will support stable rat-
ings this year. (For more information, see
Credit FAQ: How Sustainable Are Hyundai
Motor And Kias Gains In Market Share And
Profitability? published Sept. 17, 2012.)
Q. How do the rated automakers com-
pare on selected key credit factors?
A. We compared similarly rated compa-
nies using a number of key credit factors
Jaguar Land Rover PLC Fiat SpA Chrysler Group LLC Mitsubishi Motors Corp. Aston Martin Holdings (UK) Ltd.
BB-/Positive/ BB-/Stable/B B+/Stable/ B+/Stable/ B+/Negative/
JLR is made of two The group lags somewhat Chryslers light vehicle share Although Mitsubishi Motor Aston Martin is a leader in
companies, Jaguar and Land behind its direct competitors is more heavily weighted to Corp. (MMC) has limited the niche segment for
Rover, and both compete in in terms of market share in light trucks, so the presence in the major high-end luxury sports cars.
the auto premium segment. Europe (8% of the European companys share is more vehicle markets, it has With sales volumes of about
Land Rover (LR) has a strong market). This weakness is exposed as gas prices relatively good positions in 4,000 units, market shares
technological recognition in partially mitigated by the fluctuate. One of the top 10 ASEAN countries with the relative to other players are
the off-road passenger cars. groups leading position in selling vehicles for the first strong Mitsubishi brand. not meaningful.
Brazil (20% market share) eight months of 2012 MMC is one of the first
and by its expansion in the was Chryslers. mass producers of electric
U.S. following the June 2011 vehicles, but it appears to
consolidation of Chrysler. take time for the market to
meaningfully expand given
various challenges.
JLR has a limited range of Managements decision to Chryslers product line under Because of its limited size The company has a proven
products when compared limit investments in new Fiats direction is evolving, and resources, MMC track record for designing
with its largest peers. modelsalthough beneficial but its ability to lessen its concentrates its business high-end and bespoke luxury
Historically, the average life for cash flow in the near reliance on light trucks and resources in emerging sports cars that sets the
of its LR products is higher termmay undermine the improve its standing with markets and environmental company somewhat apart
than average. The group has groups model diversity and consumers is still a work in initiatives. Although MMC from other premium makers.
an ambitious model growth competitive position in the progress, in our view. has been active in
plan and the first new longer term. There has been introducing global small
product, the Range Rover limited success for Chryslers models and expanding SUV
Evoque, has been well revamped products in lineup in emerging markets,
received across Europe. Europe so far. it has decided to discontinue
Rebranding of Jaguar is region-specific models in the
taking more time. U.S. and Europe.
JLR benefits from a very While fast-declining in Chrysler reports that We believe MMCs ability to Aston Martin has strong
specific positioning of its Europe and Italy (a market average transaction prices limit incentive is high in brand recognition and high
LR products: it is able to that experienced a double- have been fairly stable since ASEAN countries because of premium pricing policy. It
impose a premium price on digit fall during the first half first-quarter 2011 and that its strong market position nevertheless suffers from
most of its models. Jaguar of 2012), consolidated average incentives have with strong brand strong positioning and
is perceived as a luxury revenues are supported by been fairly stable as well. recognition. However, in the growing market shares of
brand but the brand appeal Chryslers robust performance U.S. or other established German brands in the
is not yet as strong as it in the U.S. and sustained flows markets, MMCs weak sports cars segment.
could be. from Latin America, Fiats presence and limited product
luxury segment (Ferrari), and pipeline likely limit
auto parts. such ability.
JLR is taking advantage of Although loss-making in Chrysler has reduced its MMC has been unprofitable Aston Martin maintained
the positive momentum in Europe, consolidated fixed costs significantly and in North America and positive operating profit
global demand for premium earnings are supported by has reported profitability in Europe where it suffers from (EBIT) in 2009 when volume
cars and its new products. Chryslers recently robust North America since the excess capacity and a strong dropped 48%. Since then,
Unit sales are increasing, operating performance in the first quarter of 2011. yen. On the other hand, operating profitability
and it has maintained its U.S. and sustained flow of Although we believe the MMC has been consistently deteriorated despite
reported EBITDA in fiscal earnings from Latin America, company can remain profitable in Asia and posted improving volumes. A cost
2011 and first-half 2012 at Fiats luxury segment profitableat U.S. industry double-digit EBIT margin in reduction program initiated
about 15%. (Ferrari), and auto parts. sales volumes about 12 the past two years. in late 2011 may start
Excess capacity remains an million unitsits track bearing some fruit in 2012.
ongoing issue for Fiats record is limited,
European operations. but growing.
Table 7 | Key Credit Factor Peer Comparisons For Companies Rated BB- And Below
(KCF) to provide investors insight into
each companys relative positioning (see
tables 4 through 7). The KCFs we selected
are each an input we analyze in deter-
mining a companys business risk profile.
Specifically, we compared:
AA or A category BMW, Toyota,

Honda, Daimler, and Volkswagen;
BBB categor y Hyundai-Kia and

Nissan;
BB+ or BB rated Ford, GM,

Peugeot, Renault, and Tata; and
BB- and lower-rated Aston Martin,

Chrysler, Fiat, Jaguar, and Mitsubishi.
Q. What is the relationship between your
ratings on Fiat and Chr ysler? When
could these ratings converge?
A. Although Fiat has a majority own-
ership stake in Chrysler, and we ana-
lyze some aspects of the companies on
a consolidated basis, we do not cur-
rently al i gn our rati ngs on the two
companies. The financing agreements
are separate, there is still a substantial
minority stake, and the operational
i nt egrat i on i s a wor k i n progress.
However, we dont expect the one-
notch gap between BB- rated Fiat and
B+ rated Chrysler to increase, and the
rat i ngs coul d wel l equal i ze. For
example, in addition to a performance-
driven upgrade or downgrade of one
or the other company, the ratings could
converge because of further opera-
tional and ownership integration, even
if Fiat were to maintain less than a
100% ownership stake in Chrysler.
We consider Fiats core operations
and Chryslers when determining Fiats
business risk profile, which we continue
Jaguar Land Rover PLC Fiat SpA Chrysler Group LLC Mitsubishi Motors Corp. Aston Martin Holdings (UK) Ltd.
BB-/Positive/ BB-/Stable/B B+/Stable/ B+/Stable/ B+/Negative/
JLR has three plants in the Fiat reported very low Its not disclosed, but a focus MMC has signed a principal The company has a low
U.K. The capacity utilization capacity utilization rates of the Chrysler agreement agreement to sell its degree of vertical integration
has been very high since across its manufacturing with Fiat is to improve manufacturing subsidiary in with major components
2011, and the company is plants. Reported plant manufacturing utilization the Netherlands, a decision (e.g., engine) sourced from
investing to enlarge it in utilization in Italy was as low rates. Given profit margins, we believe should help outside suppliers.
line with the expected as 50% in 2011. Brazil and we believe utilization is address excess capacity and
sales growth. the U.S. reported 92% and solidly above breakeven. restore profitability in
114% utilization rates, Europe. Still, MMC
respectively. The group continues to carry excess
seems focused on improving production capacity in the
capacity utilization rates. U.S. MMC plans to raise
utilization at the U.S. plant
through increasing exports
to markets outside the U.S.
JLRs exposure to Europe is Fiat benefits from a Chryslers diversity is the MMC has fair geographic Revenues mostly focused on
42% (including 20% in the moderate geographic and most limited of the U.S. diversity in terms of Europe, the U.K., and U.S.,
U.K.) and to North America brand diversification. The automakers in our view. unit sales, but it has and emerging markets,
it is 19%. In 2011 and 2012 agreement with Chrysler The majority of sales are in disproportionately high notably China, represent a
Chinas weight on total sales further supports the overall North America, and there is reliance on earnings from low percentage of sales.
increased to 17% from 12%, group diversity both in more dependence on light vehicles sold in Asia. Product diversity is limited to
and the rest of the world terms of geography and trucks, although the a few models.
increased to 19% from 16.5%. segment, with the American company held a large share
The model diversification brand supporting its strong of the minivan market.
comes mainly from its two position in the light trucks
different brands, LR (which and minivan markets.
includes Range Rover)
and Jaguar.
The scale, profitability, and funding efficiency of vehicle finance capabilities, through a captive unit or partnerships
because of significant reliance on financing availability for the vehicle distribution and sales process
JLR does not have its own Nonconsolidated and There is no captive Chrysler MMC operates small-scale Aston Martin does not
captive finance company. It 50%-owned FGA is not finance unit since its former captive finance operations in provide captive finance
has some agreements with significantly adding to parent sold the sister captive certain countries. MMC services. The company has
external partners to address business diversity. finance unit to Toronto significantly scaled back in place a wholesale facility
financing needs. Dominion Bank. It is wholly captive finance operations in line to provide funding to
reliant on third-party finance the U.S. in mid-2000s. its dealers.
sources for retail and
wholesale financing.
Table 7 | Key Credit Factor Peer Comparisons For Companies Rated BB- And Below (continued)
to assess as fair. Fiat benefits from
the diversi ty that Chr ysl ers North
American market position provides and
Chryslers recently strong earnings, as
well as joint purchasing power and
shared capital investments. With Fiats
EMEA operations generating losses,
the companys recent 4.5% reported
consol i dated tradi ng margi n was
largely attributable to Chryslers supe-
rior performance during the first half of
2012 and the resilience of Fiats Latin
American operations.
But we analyze Fiat and Chrysler
t oget her because of Chr ysl er s
strategic importance to Fiat and our
expectation that its ownership per-
centage wi l l conti nue to ri se (i t i s
currently 58.5%). On the other hand,
the integration of Chrysler resulted
i n a 3. 9 bi l l i on addi ti on to Fi ats
financial debt at year-end 2011 and
added subst ant i al pensi on obl i ga-
tions to Standard & Poors adjusted
debt f i gur es f or t he company.
Chr ysler also continues to work on
renewing its product line, which has
contributed to the increase in Fiats
consolidated capital expenditures to
some 7.5 billion this year from 5.5
bi l l i on i n 2011 (Chr ysl er f unds i ts
own capi tal spendi ng) . So f ar, the
sale of Chrysler-based products has
had a limited ef fect on Fiats situa-
tion in Europe.
Constraints on the movement of cash
between Chrysler and parent Fiat cause
us to assess the liquidity positions of the
two entities independently. Moreover,
we dont believe there are any cross-
defaults in the Chrysler debt to a Fiat
default, but we understand that a
Chrysler default would cause a cross-
default in the Fiat debt agreements.
Q. Given your positive outlook on
Volkswagen, what would bring about an
upgrade to A from A-?
A. Our positive outlook on Volkswagen
indicates the possibility of an upgrade over
the coming two years. Specifically, we
would look for the groups profit measures
to remain strong in the face of tough
macroeconomic conditions and for its
credit ratios to remain at the higher end of
the modest category despite our
assumption of high capital expenditures.
Credit ratios that we would consider
commensurate with an A rating would
be adjusted funds from operations to
debt close to 60% and debt to EBITDA
below 1.5x. Our base-case scenario for
2012 and 2013 assumes that VW may
slightly outperform those levels. An
upgrade would also require the company
to sustain operating margins above 6%
despite periods of soft demand, while at
the same time reducing its dependence
on the European market.
When deciding on a future upgrade,
we will also review several other factors
that could affect VWs credit quality.
These include future acquisition risk,
particularly with respect to VWs invest-
ment in the truck business; improve-
ments in profitability for the companys
currently lackluster Seat S.A. and North
American operations; clarity on the com-
panys somewhat complex corporate
governance; and the status of pending
litigation related to Porsche. (For more
i nf or mati on, see Research Update:
Volkswagen AG Outlook To Positive On
Porsche Integration And Strong Operating
Performance; Ratings Affirmed At A-/A-2,
published Aug. 27, 2012.)
Q. How much credit do you give for
geographic diver sity in your rating
assessments?
A. Geographic diversity is one of the
key credit factors that we review for
automakers as part of our competitive
position assessment. This has become
ever more important in an increasingly
global market in which all significant
pl ayers are competi ng agai nst one
another on al l five conti nents, and
where technical requirements (if not
local tastes about design) are becoming
more uniform. We view Volkswagens
diversity, for instance, as a key anchor
point in our assessment of its business
risk profile as strong.
Moreover, beyond sheer volumes,
we vi ew an aut omakers abi l i t y t o
garner sustainable earnings outside its
home market as key i n our assess-
ment of geographic diversification.
Peugeots cur rent inability to make
profits outside Europe, for instance, is a
drag on our assessment of its business
risk profile (which we assess as fair).
Similarly, we view Renaults losses in
Europe or even VWs inability so far
to generate a profit in North America
( excl udi ng Audi ) as negat i ves f or
those companies business risk pro-
files. GM and Fords losses in Europe
similarly detract from their business
ri sk prof i l es, and we not e t hat
improving diversity of profitability is
key for Ford if we are to consider an
upgrade. A rated Dai ml er AG and
BMW AG provi de exampl es of the
benef i t s of di ver si t y: bot h l uxur y
aut omaker s are prof i t abl e i n t he
important markets of Europe, North
America, and China. CW
We view an automakers ability to garner
sustainable earnings outside its home market as key
in our assessment of geographic diversification.
Robert E. Schulz, CFA
New York (1) 212-438-7808
Eric Tanguy
Paris (33) 1-4420-6715
Osamu Kobayashi
Tokyo (81) 3-4550-8494
Sangyun Han
Hong Kong (852) 2533-3526
Chizuko Satsukawa
Tokyo (81) 3-4550-8694
Auto Sector
SPECIAL REPORT
FEATURES
T
he outlook for the global heavy truck markets is looking
increasingly hazy in the second half of 2012 and into 2013,
due to uncertainty over the global economy. In Standard &
Poors Ratings Services view, it wont be until the new order
intake in the fourth quarter of this year that we will get the first
indication of what the market will look like in 2013.
Can Global Heavy Truck
Makers Downshift Fast
Enough To Ride Out
Wavering Demand?
Overview
Continued economic uncertainty globally has led to declining credit metrics for
heavy truck makers.
Nonetheless, we dont expect any major ratings changes through the end of the
year.
Cutting production, costs, and inventories has helped truck makers, but further
adjustments could be difficult to make over the next 12 to 18 months, especially
if economic conditions worsen significantly.
Average industry profitability declined by
more than 100 basis points in the first half
of 2012, compared with full-year 2011,
when profit margins were close to their
2007 to 2008 peaks (see chart 1). Average
profitability is now slightly less than 7%,
compared with slightly more than 8% in
2011. Although the industry doesnt see
this as an alarming decline, truck makers
are concerned about the trend.
Demand for heavy trucks closely corre-
lates to GDP growth. At the moment, the
slowdown in the European heavy truck
market seems to be worsening, in line
with our economists base-case scenario
of a mild recession in the European
Economic and Monetary Union (EMU or
eurozone) in 2012. We anticipate that new
registrations of European heavy trucks of
more than 16 tons will be at the lower end
of the range of our previous forecast of
215,000 to 240,000 registrations in 2012,
compared with 243,000 in 2011.
However, even if Europe were to
suffer a double-dip recession this year,
we wouldnt anticipate as severe a slump
in the demand for trucks as during the
global recession of 2008 and 2009, which
decimated the markets. Unlike then, the
market is not currently overheated, order
inventories are manageable, and truck
makers have leaner cost structures and
stronger balance sheets to withstand a
moderate slide in demand. However, it
remains to be seen whether this will hold
true in 2013 in the face of increased
uncertainty about the economy.
In contrast to Europe, the U.S. market
has performed strongly in the past 18
months. This reflects high demand for
replacement trucks following a four-year
downturn, during which time the
average truck age reached record-highs.
It also ref lects stabilization in the
economy following the global financial
crisis of 2008 and 2009. The U.S. market
peaked earlier than the European
market, in 2006, compared with 2008 in
Europe, and therefore the average truck
age continues to be lower in Europe than
in North America.
However, a surprisingly weak order
intake in the U.S. in the second quarter of
2012, and increased economic uncer-
tainty have made the outlook for the
North American truck market similarly
uncertain. The sudden drop in order
intake could signal a degree of overpro-
duction. Therefore potential inventory
build-up in the coming 6 to 18 months
could preclude a continued rebound in
demand. For instance, freight transporta-
tion researcher FTR Associates predicts
that the production rate of North
American Class 8 trucks will increase by
only 3.4% in 2012, and decline by as
much as 11% in 2013. Freight growth,
trucking companies profits, and used
truck prices will be key to how produc-
tion volumes trend.
Reflecting the turbulence in the global
economy, the credit metrics of the invest-
ment-grade truck makers we rate (those
rated BBB- or higher; see table) have
declined from strong levels in 2011. As long
as the current slowdown remains moderate,
we do not envisage any major rating
changes for the remainder of 2012 thanks
to truck makers increased cost flexibility,
their ability to make rapid adjustments to
production volumes, and solid finances.
One possible exception is Navistar
International Corp. (B/Negative/), which
is facing unique issues. However, the overall
picture could worsen significantly if a more
severe downturn materializes.
European Outlook: The Market
Decline Could Steepen
Several factors, including rapid produc-
tion cuts and leaner cost structures, have
mitigated the 2012 slowdown in the
European truck market. However, we
foresee a few scenarios that could
increase the severity of this slowdown.
2003 2004 2005 2006 2007 2008 2009 2010 2011 1H2012
(%)
(10)
(5)
0
5
10
15
20
1HFirst half.
Scania Volvo IVECO Daimler MAN PACCAR Industry average
Chart 1 EBIT Margins In Commercial Vehicles Division Of
Investment-Grade Truck Makers
3
Q
2
0
0
6
1
Q
2
0
0
7
3
Q
2
0
0
7
1
Q
2
0
0
8
3
Q
2
0
0
8
1
Q
2
0
0
9
3
Q
2
0
0
9
1
Q
2
0
1
0
3
Q
2
0
1
0
1
Q
2
0
1
1
3
Q
2
0
1
1
1
Q
2
0
1
2
0
20,000
40,000
60,000
80,000
100,000
120,000
140,000
160,000
180,000
(Units)
*Order intake for European truck business of Scania, Volvo, Daimler, and MAN.
Chart 2 European Order Intake Of Truck Makers*
A potential lack of credit
for truck purchases
Funding could dry up for smaller truck
buyers and transportation companies if
weaker economic conditions or a tougher
regulatory framework for banks lead to
more cautious lending in 2012 and 2013.
Constrained lending is already reducing
the number of new orders for trucks.
Without bank lending, the presence of
captive finance companies (which provide
finance to customers buying their parent
companies products) will be important,
but they too need access to wholesale
funding channels.
A possible severe double-dip
recession in Europe
Demand for trucks is closely aligned
with economic growth. Therefore a
second severe recession (a so-called
double-dip) this year could cause truck
demand to fall below our base-case
assumption of 215,000 to 240,000 new
registrations. That said, we believe that
truck makers are better prepared for a
second recession than they were for the
previous recession in 2008 and 2009
because they have leaner cost structures
and stronger balance sheets.
Longer-term weakness in the
Brazilian market
The large and profitable Brazilian market is
a significant one for Europes truck makers.
For example, Brazil represented 21% of
the total sales of Swedish truck and bus
maker Scania (publ.) AB (Scania;
A-/Positive/A-2) in the first half of 2012,
while Germany-based diversified industrial
group MAN SE (A-/Positive/A-2) reported
17% of its total sales in Brazil, and 28% of
its operating profit in Latin America.
However, the Brazilian macroeconomic
environment has worsened in 2012, due
to a global slowdown in combination with
the introduction of new emissions legisla-
tion at the start of 2012. These factors
have put pressure on the truck market,
which was booming as late as 2011.
Although the Brazilian government con-
tinues to support demand through dif-
ferent incentive schemes, there are wor-
ries in the market that Brazil will
experience a longer downturn following 2
to 3 years of growth, like Europe in 2009
following the 2006 to 2008 boom.
The following factors have mitigated
the current slowdown in the European
truck market:
Rapid production cuts
Truck makers cut production in the fourth
quarter of 2012, and continue to fine-tune
their volumes to mirror a shrinking order
intake and limit margin deterioration.
However, a more competitive environ-
ment can quickly hamper margins. MANs
second-quarter financial results reflected
this tendency: Its operating profit margin
was 1.8% in the first half of 2012, com-
pared with 6.4% in the first half of 2011,
following a reduction in demand and what
we suspect to be tougher pricing pressure
in its home market of Germany.
The European truck market looks
healthier than it did before the 2009
industry downturn
The European truck market seems to us
to be maintaining a good balance
between order intake and the number of
vehicles delivered in 2012, compared
with the situation before the global finan-
cial crisis of 2008 and 2009 (see chart 2).
In our view, current production volumes
of 220,000-240,000 trucks per year are
sustainable over the longer term. In 2007
and 2008, volumes were well above
300,000 tr ucks per year, which was
unsustainable when the recession hit.
However, demand in Northern Europe
is cur rently much slower than in
Southern Europe, making the picture a
little blurred. All the major truck makers
have witnessed this divide. For example,
Sweden-based commercial vehicle
group AB Volvo (BBB/Stable/A-2)
reported an increase in orders in the
second quarter of 2012 for their Volvo
brand, which is strong in Northern
Europe, and its Swedish and Russian fac-
tories plan to increase production.
Meanwhile, there was a 25% decline in
order intake for AB Volvos Renault branded
trucks, whose main markets are in Southern
Europe. Italy-based Fiat Industrial SpA
(BB+/Stable/B) saw orders for its Iveco-
branded trucks fall by 47% in Italy in the
second quarter, compared with the prior
year. Because Northern Europe is usually
the most profitable market for truck makers,
the current slowdown in demand will accel-
erate if the weakness in Southern Europe
spreads to Northern Europe.
Order intake is aligned with demand
Order books and delivery times remain
short, for example 6.5 to 8 weeks in the
case of Scania. Truck makers are much
more careful when taking orders now
than they were before the global reces-
sion of 2008 and 2009. This results in a
better match between orders and demand
(see chart 3) and fairly short delivery
times. It also means that the risk of can-
cellations is significantly lower than it was
in 2008, giving truck makers more scope
to adjust production volumes and costs.
Leaner cost structures
We believe that truck makers cost struc-
tures are in general slimmer and leaner
than they were five years ago following
extensive cost-cutting in 2009. They also
employ a higher proportion of tempo-
rary workers than in the past, enabling
Company Corporate Credit Rating* Business risk profile Financial risk profile
PACCAR Inc. A+/Stable/A-1 Satisfactory Minimal
Scania (publ.) AB A-/Positive/A-2 Satisfactory Modest
MAN SE A-/Positive/A-2 Satisfactory Modest
AB Volvo BBB/Stable/A-2 Satisfactory Intermediate
Navistar International Corp. B/Negative/ Weak Highly leveraged
Daimler AG A-/Stable/A-2 Satisfactory Modest
Fiat Industrial SpA BB+/Stable/B Satisfactory Significant
*As of Sept. 18, 2012. Truck brand IVECO.
Rated North American And European Truck Companies
them to adapt more quickly to softening
demand. We foresee this ability being
put to the test in the coming year.
Increased replacement demand
We expect that the present increase in
the number of truck owners replacing
vehicles will cushion a slowdown. Low
production levels in 2009 and parts of
2010 will likely have led truck users to
postpone replacement purchases,
resulting in pent-up demand. This built-
up demand could materialize in 2013,
ahead of the introduction of the Euro 6
emissions standard in 2014.
U.S. Outlook: Is The Recent
Rebound In Demand Sustainable?
Until now, the outlook for the North
American commercial vehicle market
has been stronger than the European
market, in our view. Demand for heavy-
duty trucks has recently rebounded in
North America following a severe four-
year downturn between 2006 and 2010,
when two-thirds of the market disap-
peared ( see char t 4) . The l engthy
i ndustr y downturn i ncreased the
average age of the truck population to
seven years, the highest in more than 20
years. This built up a significant need
for repl acements, whi ch the U. S.
markets strong performance in the past
18 months reflects.
In light of this, the weak order intake
in the second quarter surprised us. Volvo
and Ger many-based vehicle maker
Daimler AG (A-/Stable/A-2) reported
47% and 33% declines in their North
American order intake, respectively.
Therefore as with Europe, the outlook
for the U.S. market will remain highly
uncertain until the fourth quarter, when
the larger trucking fleets traditionally
submit their orders for 2013.
We believe that there are still sound
prerequisites underlying demand in the
U.S. truck market: a need to replace
aging tr ucks, a strong second-hand
market, and increasing sales of spare
parts. Truck makers themselves remain
cautiously optimistic with regard to the
second half of 2012, due to solid order
backlogs. However, the recent sudden
drop in orders could reflect a degree of
overproduction, and if this leads to
inventory build-up over the coming 6 to
18 months, it could preclude a rebound
in demand and could worsen the out-
look for 2013.
Will The Adjustments
Truck Makers Have Been
Making Be Enough?
A clear downward trend in average
industry profitability in the first half of
2012 has fol l owed two years of
strengthening profit margins after the
recession of 2008 and 2009. Weakening
in the Brazilian market and a surpris-
ingly weak order intake in the U.S. in the
second quarter will put renewed pres-
sure on truck makers margins. This
makes truck makers flexibility to alter
thei r producti on vol umes and cost
structures to mirror changes in demand
increasingly important.
We believe that investment-grade
truck makers are poised to adjust their
production volumes, costs, and inven-
tories to demand, and therefore will be
able to manage a continued moderate
downturn. However, uncertai nty i s
considerably higher than it was six
months ago, and if a second recession
materializes, this flexibility will be put
to the test. CW
1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012e
0
50
100
150
200
250
300
(000s)
0
20
40
60
80
100
120
140
eEstimate.
Sources: EU, ACEA (Association des Constructeuers Europens dAutomobiles).
European Sentiment Indicator reading (right scale) Number of trucks (left scale)
Chart 3 Outlook For Western European Truck Market
1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011
0
50
100
150
200
250
300
350
400
(000s)
U.S. heavy truck (class 8) retail sales*
*Standard & Poors estimates for 2012.
Sources: ACT Research Co., Wards, and industry reports.
Chart 4 Outlook For North American Heavy-Duty Truck Market
Michael Andersson
Stockholm (46) 8-440-5930
Sol B. Samson
New York (1) 212-438-7653
Truck Makers
A
s the world economy has slowed, so has demand in the
largest segment of tire manufacturing: the replacement
industry. Consumers have been driving less and cutting
back on their tire purchases. The underlying reasons for this shift
in behavior include stubbornly high unemployment, prevailing
economic uncertainty, and rising fuel prices.
Life In The Slow Lane
Adjusting To The Fall In Replacement Tire Demand
Overview
We believe global demand for replacement tires will remain weak this year.
As a result, the major tire makers are pursuing a number of strategies to adjust
to falling tire volume.
Our rating outlook on these companies is largely stable, but we are carefully
monitoring the effects that declining replacement tire demand is having on
credit quality.
U.S. replacement tire shipments in 2011
accounted for over 80% of the overall
industry, but we expect shipments to
fall about 2% in 2012. And with the
weak global economic forecast, theres
not much hope that demand for
replacement tires will increase any
time soon. Standard & Poors econo-
mists expects GDP growth of just 2.1%
in the U.S. this year and only 1.8% in
2013and our expectati ons for
another U.S. recession remain at about
25%. The picture in Europe is gloomier,
as Souther n Europe i s i n mi dst of
seri ous downtur n and even the
stronger northern region appears to be
succumbing to the spreading weakness.
We expect replacement tire shipments
to fall 5% to 10% in Europe in 2012.
Major Players In The Tire Market
Three tire makersBridgestone
(unrated), Michelin, and Goodyear Tire &
Rubberdominate the global tire
market, which grossed $188 billion in
2011. Thirty-four percent of the global
market belongs to four of the major tire
makers Standard & Poors Ratings
Services rates (see table 1):
France-based Compagnie Generale

des Etablissements Michelin S.C.A.
(Michelin; BBB+/Stable/A-2);
U.S.-based Goodyear Tire & Rubber

Co. (BB-/Stable/);
Ger many-based Continental AG

(BB-/Positive/); and
U.S.-based Cooper Tire & Rubber Co.

(BB-/Stable/).
All of these companies have held up
relatively well through the recent decline
in replacement demand. These firms are,
in our opinion, large enough to enjoy
most of the benefits of scale, which
include efficient marketing and distribu-
tion, substantial budgets for research
and development (R&D) and capital
investment, and good geographic diver-
sity that allows them to offset regional
market difficulties.
Bridgestone, Michelin, and Goodyear
have a combined share of about 42% of
the global market. Each has annual sales
of more than $16 billion (based on 2010
sales) and leads its home market. They
also have strong brand names, wide dis-
tribution networks, and solid, diverse
customer bases.
Bridgestone, the No. 1 global player
based on the l atest ranki ngs (2010
sales), has almost 16% of the global
market, and it maintains a stronger
foothold in its home market of Japan
than Goodyear or Mi chel i n does i n
theirs. Michelin, the second largest,
has about 15% of t he gl obal t i re
mar ket and has the most bal anced
market positions worldwide of the top
five: It is No. 1 in Europe and No. 2 in
North America. At No. 3, Goodyear has
about 11% of the global market and
conti nues to face sti f f competi ti on
from Michelin and Bridgestone in its
North American market.
All three top tire makers are feeling
pressure from smaller competitors. Since
2008, each has lost at least four per-
centage points of market share to
smaller playersmany of which are
from Asia, in part because those local
firms have been able to capitalize on
their fast-growing emerging economies
(see table 2). Still, the global reach of the
big three distinguishes them from their
smaller counterparts.
Cont i nent al , t he wor l ds four t h-
largest tire maker, is well-established
in Europe, but its global share is signif-
icantly lower than the three largest
players, at just over 5%. The company
has only a small presence in North
America, where its business has suf-
fered from weak profi tabi l i ty, most
notably because of its small share of
the aftermarket business.
Cooper Tire, the ninth-largest tire
maker worldwide, has established a good
market position in the U.S. in the low- to
mid-price replacement tire segment. The
company has strengthened its focus on
the light-truck and high-performance
segments, thereby increasing its share
in those markets from a low base.
Compagnie Gnrale
des Etablissements The Goodyear Cooper Tire &
Michelin S.C.A. Tire & Rubber Co. Continental AG Rubber Co.
Corporate credit rating BBB+/Stable/A-2 BB-/Stable/ BB-/Positive/ BB-/Stable/
Business risk profile Satisfactory Fair Satisfactory Weak
Financial risk profile Intermediate Aggressive Aggressive Aggressive
Market position Very strong in Europe; Very strong in North and Strong in Europe; Strong niche position
very strong in North South America; strong in modest in U.S. in U.S.; growing
America; strong in Asia Europe; modest in Asia presence in China
Revenue generation Focus on segments with Broad product coverage Relatively broad product Focus on developing
above-average growth focused on each market range, but with a focus on branded products; still
rates, e.g., high-performance segment; strongest in the high-performance and has a large exposure
tires; strong in truck tires premium and midtier brands winter tire segments to the value segment
including the retread business
Cost and asset efficiency High-quality and High-quality and Quality and low-cost Low-cost production
price-premium strategy; price-premium strategy; production strategy strategy; high utilization
relatively high-cost structure, targeting U.S. to reduce due to reduced
e.g., when compared with high-cost structure manufacturing capacity
Continental in the U.S.
Diversification Good Good Moderate Fair
Table 1 | Global Tire Makers Business Risk Peer Group Comparison
The company has a presence in Asia,
Europe, and Mexico as well.
Falling Tire Demand
Tire makers are in a stronger position
than pure auto suppliers because the
market volume of replacement tires
(more than 80%) consi derably out-
weighs the volume that original equip-
ment manufacturers sell. The replace-
ment market is traditionally more stable
than car and truck production cycles.
In addition, customers shopping for
replacement tires tend to be less price-
sensi tive and have l ess purchasi ng
power than the automakers. Therefore,
we consider tire producers to be more
like consumer goods companies, which
show relatively consistent margins in
normal economic periods.
Because it has fewer competitors, the
original equipment market for trucks has
historically had higher margins than for
cars. (Bridgestone and Michelin have the
highest market shares in truck tires.) But
demand tends to be more volatile in the
truck segment.
In the aftermarket, however, margins
are considerably higher for cars. This is
probably attributable to higher storage
and logistics costs for truck tires. Among
car tire makers, companies such as the
top three, with the largest market share
of high-end tires (such as winter tires
and high-performance tires) tend to have
better margins.
While the original equipment market
is still showing solid growth, growth in
the replacement market, the largest
part of the tire market, is weak. In the
U.S., we expect tire shipments to the
ori gi nal car/l i ght tr uck equi pment
market to grow almost 18% year over
year in 2012. However, we expect them
to fall almost 2% for the replacement
market. For trucks, we expect tire ship-
ments to rise 12% for original equip-
ment and decrease 6% for the replace-
ment market.
Replacement tire demand has been
weakeni ng i n t he U. S. si nce 2007,
when total light vehicle tire shipment
was 238 million. In 2011, that figure
was 223 million, and we expect it to
decline further to 220 million in 2012
(see table 3). A number of factors influ-
ence demand i n t he repl acement
mar ket , such as mi l es dri ven and
average tire age. According to the U.S.
Department of Transportation, miles
driven in 2011 fell over 3% since the
peak in 2007. We think this drop has
been a key f act or i n t he f al l of f i n
replacement tire demand. And under-
lyi ng that decl i ne, i n our vi ew, has
been hi gh unempl oyment and eco-
nomic uncertainty.
Nevertheless, the major global players
are pursuing a number of strategies to
adjust to the falling tire volume. First,
companies have adjusted their cost
str uctures and continue to do so.
Second, they are focusing on selling into
the premium and mid-tier branded
market segments, where they can sell
innovative products more easily. Third,
manufacturers plan to take advantage of
labeling requirements in both the U.S.
and the EU that will highlight the high-
value-added features of the most inno-
vative tire makers.
Tire makers are pursuing
low-cost strategies
Most of the tire makers we rate have
expanded production in regions with low
labor costs, such as Eastern Europe,
South America, and Asia. Setting up pro-
duction in these regions has a twofold
benefit: It helps global tire makers cap-
ture sales growth in the emerging mar-
kets, and lowers labor costs, translating
into higher profits. For companies that
export some of their production from
low-cost countries, the savings from
employing cheaper labor outweigh the
costs of shipping tires to other destina-
tions for sale.
Michelin has a relatively high pro-
por t i on of product i on f aci l i t i es i n
Western Europe and the U.S., where
labor costs are high. We estimate less
than 30% of its production capacity is
i n rel at i vel y l ow-cost regi ons.
However, in recent years Michelin has
been expandi ng i ts busi nesses and
building up capacity in low-cost coun-
tries with strong growth prospects,
such as Indi a, Chi na, and Brazi l .
Michelins goal is to increase sales in
such regions from 31% of total rev-
enue in 2011 to 40% by 2015.
Goodyear has a large proportion of its
production capacity in high-cost regions,
also expanded into Asia and Latin
America to capitalize on faster growth in
the emerging markets. Its market posi-
tion is particularly strong in Latin
America, where it has six plants in Brazil,
Chile, Colombia, Peru, and Venezuela.
Latin America represented about 11% of
Goodyears total sales in 2011. The com-
pany also manufactures tires in nine
plants in China, India, Indonesia, Japan,
Malaysia, and Thailand. The Asia-Pacific
region represented about 11% of
Goodyears total sales in 2011.
Continental has a higher proportion of
its production in low-cost regionspar-
ticularly Eastern Europe and Brazil
than the other rated producers do. The
company also recently announced plans
to expand into China.
To boost long-term sales growth and
gain access to low-cost manufacturing,
Cooper Tire focuses on its Asian expan-
sion strategy. Coopers Kunshan busi-
ness in China manufactures tires for the
l i ght vehi cl e market. Producti on at
Kunshan should allow Cooper Tire to
export up to 4 million tires into the
North Ameri can mar ket. Cooper
Chengshan Tire produces radial and
bias medium truck tires as well as pas-
senger and light truck tires for the global
While the original equipment market is still showing
solid growth, growth in the replacement market,
the largest part of the tire market, is weak.
market. Cooper also has a manufac-
turing facility in Mexico to serve both
the Mexican and U.S. markets. In addi-
tion, the company has a manufacturing
facility in the Republic of Serbia to pro-
duce tires for the European market.
Expansion into China, India, and
South America will likely continue for
the next f ew years, but demand i n
these developing markets isnt great
enough to significantly change global
market shares for these companies in
the next three to five years, especially
given the slowing economic growth in
these regions. In addition, we believe
the tire makers are all following sim-
ilar strategies to increase production
in these markets.
High-value-added products may
boost margins for the top names
Tires have become better engineered in
the past few years, mainly to improve
saf ety and f uel ef f i ci ency. R&D
spendi ng suppor ts new product
advances, such as improving tire trac-
tion and performance under various
weather conditions, enabling tires to
function temporarily even with a loss of
air pressure, extending durability, and
increasing fuel efficiency. These fea-
tures allow manufacturers to charge a
premium for their tires.
Historically, of the tire makers we
rate, Michelin has spent the most on
R&Dabout 3% to 4% of annual
salescontributed to its reputation for
quality among global tire makers. The
company has been responsible for sev-
eral important tire developments
among them, the introduction, in 1946,
of the radial tire, now the industr y
standard i n devel oped mar kets.
Michelin is working on advances such
as self-repairing tires and tires that can
carry more weight, which could gen-
erate significant growth in future years.
In 2011, Goodyear spent about 2%,
and Cooper Ti re spent about 1%.
Continentals R&D spending is about
2.0% to 2.5% in its rubber division.
Over the last decade, the top players
capital expenditures were relatively high
and generally accounted for more than
6% of sales because of the need to
invest in high-cost production facilities
and equipment to remain cost competi-
tive (see chart 1).
Michelin has had the highest capital
expenditures among its peers, aver-
aging 7% of sales in the past 10 years.
It expects to spend significantly more
in the coming years (around 2 billion
in 2012) as it builds three large plants
i n Chi na, I ndi a, and Brazi l , whi l e
expanding capacity in specialty tires in
t he U. S. Goodyear has spent an
average of about 3. 8% of sal es on
capital expenditures during the past 10
years; however, the companys ratio of
capital spending to revenue was 4.6%
in 2009, 5% in 2010, and 5% in 2011.
Conti nental s capi tal expendi tures
have been sl i ghtly bel ow i ts peers
since the company completed its pro-
duction relocation a number of years
ago. But we expect Conti nental to
As of year-end 2011
Passenger cars/light trucks (%) Commercial trucks (%)
U.S. Europe Asia U.S. Europe Asia*
Original equipment market 11.2 7.0 (2.0) 53.0 35.0 (3.0)
Aftermarket (2.8) 5.0 10.0 4.4 6.0 4.0
*Excluding India.
Sources: Michelin, Rubber Manufacturers Association.
Table 3 | Tire Demand Since Fourth-Quarter 2010, By Region And Market
2010 2009
rank rank Company Country 2010 sales 2009 sales
1 1 Bridgestone Corp.* Japan 24,425 20,500
2 2 Groupe Michelin France 22,515 19,600
3 3 Goodyear Tire & Rubber Co. (The) U.S. 16,950 15,649
4 4 Continental A.G. Germany 8,100 6,500
5 5 Pirelli SpA** Italy 6,321 5,548
6 6 Sumitomo Rubber Industries Ltd. Japan 5,850 4,630
7 7 Yokohama Rubber Co. Ltd. Japan 4,750 3,956
8 8 Hankook Tire Co. Ltd. South Korea 4,513 3,760
9 9 Cooper Tire & Rubber Co.6 U.S. 3,361 2,779
10 10 Maxxis Intl/ Cheng Shun Rubber Taiwan 3,356 2,723
Others 51,859 40,855
Total 152,000 126,500
Top ten market share 66% 68%
Market share of rated companies 51% 53%
*Bridgestone owns 16% of Nokian Tyres P.L.C. (#20 on this years ranking) and 43% of BRISA/Bridgestone (#37).
Goodyear and Sumitomo operate 75/25 joint ventures in North America and western Europe. Goodyear sold its
Latin American farm tire business ($250 million annual sales) to Titan I April 2011. Continental acquired Indias
Modi Rubber Ltd., (No. 74, with $78 million annual sales). **Pirelli is setting up a joint venture with Sibur & Russian
Technologies; taking over Kirov, Russia tire plant. Cooper boosted share in Corp. Occidente, Mexican affiliate, to
58% in first-quarter 2011. Estimated.
Source: Rubber & Plastics News.
Table 2 | Top 10 Tire Manufacturers Global Market Share
Passenger tire (%) Truck tire (%)
Natural rubber 14 27
Synthetic rubber 27 14
Carbon black 28 28
Steel 1415 1415
Fabric, fillers,
accelerators, etc. 1617 1617
Average weight New 25 lbs; New 120 lbs;
scrap 22.5 lbs scrap 110 lbs
Source: Rubber Manufacturers Association.
Table 4 | Raw Material Composition
By Weight
increase its spending during the next
few years as it increases capacity in
China. Cooper Tires capital expendi-
tures averaged more than 5% from
2001 to 2010, but as a percentage of
revenue that figure has been declining
in the past three years.
More new cars are being equipped
with high-performance tires that can
run faster and handle better. These tires
also have larger diameters, so theyre
more expensive. Tire makers focus on
building brands with a variety of per-
formance characteristics, such as roll
resistance, fuel ef ficiency, durability,
and noise reduction.
For instance, we believe Michelin
can charge premium prices because of
its strong brand awareness and image,
and the range of innovative products it
of fers. We consider Michelins prof-
itability to be on par with, or stronger
than, that of its peers with a similar
range of products. However, Michelins
higher cost structure partly offsets its
ability to charge higher prices. Also,
Michelins margins benefit from the
speci al ty ti res busi ness ( i ncl udi ng
earthmovers tires, agricultural tires,
and two wheels), which has signifi-
cantly higher margins than the tradi-
tional tires business (27% reported
operating margin in the first half of
2012) thanks to very strong demand
and industry undercapacity.
Goodyear targets the premium and
branded mid-tier segments of the tire
mar ket and conti nues to i ntroduce
innovative, value-added tires for the
consumer and commercial markets.
During 2011, it launched its Assurance
TripleTred All-Season tire in North
America and the Eagle F1 Asymmetric
2 and Dunl op Wi nt erSpor t 4D
i n Europe. I n Asi a, t he company
l aunched t he Goodyear Eagl e F1
Asymmetric 2 for luxury sports per-
formance vehicles and the Goodyear
Eagle F1 Directional 5 for mid-range
spor t s perf or mance vehi cl es. The
company has al so announced t he
launch of nine new and retread tires in
its commercial truck business.
Continentals tire margins remain
strong, even though they include the
low profitability operations in the U.S.
In addition, Continental has relocated
most of its production sites to low-
cost regions and continues to benefit
f rom a hi gh- margi n product mi x
(notably, winter tires and high-per-
formance tires).
New labeling requirements will help
buyers make more informed choices
The EU plans to implement tire labeling
requirements that will become effective
Nov. 1, 2012. The regulation requires
suppliers to ensure that tires are labeled
to indicate fuel efficiency, wet grip, and
external rolling noise, each scaled from
A to G. The best class is A and colored
green; the least efficient or least desir-
able is G and colored red. The require-
ments will become tighter over time
until 2016, when the tires rated G will
be forbidden.
Similarly, in the U.S., the National
Hi ghway Transpor t at i on Saf et y
Administration enacted a final rule on
the labeling of tires. The goal is to
educate consumers about the trade-
offs among fuel efficiency, safety (wet
traction), and durability (tread wear).
Each of these characteristics will have
a ranking on a scale from 0 to 100.
The worst is 0 and colored red; the
best is 100 and colored green.
Ensuring that manufacturers provide
tire ratings will mean that a consumer
purchasi ng ti res desi gned to of f er
better fuel ef fi ci ency, for exampl e,
does not have to sacrifice traction or
durabi l i t y. Consequent l y, bet t er-
informed consumers might be more
likely to purchase more fuel-efficient
tires, which would reduce the use of
gasoline and lower greenhouse gas
emissions. We believe these regula-
tions should especially benefit the top
three tire makers, whose scale allows
them to invest in the R&D to make
hi gher-val ue ti res that best sati sf y
these requirements.
We believe the level of preparation for
the new requirements varies significantly
from one tire maker to another. For
example, more than 95% of Michelins
tires already meet the 2016 require-
ments. On the contrary, smaller tire
makers, focused on lower quality prod-
uctsincluding Chinese manufac-
turerswill need to make material
adjustments to cope with the new
labeling requirements. As a result, we
would expect the imports from these
players to the EU to diminish by 2016
since some will not be able to adapt in
time. This should alleviate the competi-
tive pressure on Tier 3 tires, which
should benefit large installed tire makers
in the European markets.
Tailwinds And Headwinds
Other factors hel pg and hurt ti re
makers. Somewhat offsetting the slow-
down in tire demand is the decline in
raw material costs. Stable or falling raw
materi al pri ces benefi t ti re makers
because these are the largest compo-
nent in the cost of goods they sell and
2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
0
1
2
3
4
5
6
7
8
9
10
(%)
Source: Company figures.
Continental Michelin Goodyear Cooper Industry average
Chart 1 Tire Makers Capital Expenditures As A Percentage Of Sales
hel p det er mi ne t he l evel of prof -
itability. Moreover, companies that
have streamlined their operations and
lowered fixed costs are in a better posi-
t i on t o deal wi t h f al l i ng demand.
However, companies with legacy costs
such as unfunded pension and postre-
tirement health care obligations carry
an extra burden in competing against
firms without those obligations.
Raw materials costs are
falling for now
The two most important raw materials in
the tire industry are natural rubber and
synthetic rubber (an oil derivative),
although manufacturers also use steel
and petroleum-based chemicals, and nat-
ural gas is the principal energy source.
Natural rubber prices have been volatile
over the past few years. At the end of
2011 the price of natural rubber was
$1.32 and it rose substantially during the
first few months of 2012 before falling to
$1.16 at the end of August 2012. Also, in
the beginning of 2012, oil prices (West
Texas Intermediate) reached about $110
per barrel before falling to below $80 in
June and then rising to around $96 at the
end of August 2012.
Prices for natural rubber are volatile
for a variety of reasons. For one, pro-
duction is sensitive to climate condi-
tions, which are hard to predict, and
t here i s a seven-year l ag bet ween
planting and harvesting, which makes
i t hard t o predi ct f ut ure yi el ds.
Geopolitical unrest in the major rubber
tree growing regions of the world
such as Thai l and, Mal aysi a, and
Indonesi acan al so contri bute to
rising prices. Furthermore, global tire
demand so far thi s year i s growi ng
faster than r ubber producti on; thi s
pushes up the price of natural rubber,
Company Liquidity Comments
Compagnie Generale des At June 30, 2012, Michelin reported 1.5 billion of cash Strong liquidity, further reinforced by the renewal of
Etablissements Michelin S.C.A. and marketable securities, and access to an undrawn committed back-up revolving credit facility until 2016
1.5 billion syndicated credit facility maturing in 2016. and recent 400 million bond issuance maturing in
This is substantially above the 1.3 billion debt coming 2019. According to management, the existing bank lines
due in the following 12 months. contain no material adverse change clauses or covenants,
apart from customary negative pledges and cross-default
clauses.
Goodyear Tire & We estimate that the company requires about $1 billion for Adequate liquidity. Nevertheless, in light of increased
Rubber Co. (The) seasonal working-capital expansion, which normally peaks capital expenditures and rising pension contributions, we
during the third quarter. The company has cash balances in expect free operating cash flow to be negative for at least
excess of normal operating needs and borrowing availability this year and therefore require the company to use its
under multiple secured, committed facilities that are revolving credit facilities, cash balances, or some other
sufficient to meet operating and financing needs during form of financing.
the next two years. Liquidity as of June 30, 2012,
consisted of about $2.2 billion in cash and $2.5 billion
available under various credit facilities.
Continental AG Liquidity is supported by cash and cash equivalents of 1.4 The next large maturity is a syndicated bank facility
billion as of June 30, 2012, of which we view 400 million maturing in April 2014, of which 2.9 billion is currently
as necessary to support ongoing operations. Continental outstanding, excluding the amounts drawn under the
likewise has available committed and unused credit lines of revolver. Continental has indicated that it will start
2.4 billion as of June 30, 2012. The majority of these lines addressing this maturity in early 2013, which corresponds
comprise the 1.6 billion of availability under the 2.5 with our observations over past years that Continental
billion revolving credit facility due April 2014. Discretionary refinances larger maturities in a timely manner.
cash flow is projected to be positive in 2012. Short-term
maturities of 1.7 billion (this excludes RCF maturities)
are covered with existing financial flexibility.
Cooper Tire & Rubber Co. As of June 30, 2012, cash and cash equivalents totaled $241 Adequate liquidity. Undrawn credit facilities in addition
million. Coopers $200 million, asset-based loan revolving to the cash position provides a cushion to fluctuations in
credit facility expires in July 2016. The company also has working capital requirments.
an accounts receivable securitization program for up to an
additional $125 million, which expires in June 2014.
Additional borrowing capacity through both of these
facilities at June 30, 2012, was $279 million. These
facilities have no financial covenants and are governed
by a borrowing base.
Table 5 | Global Tire Manufacturers Liquidity Comparison
Goodyear Cooper Tire Michelin Continental
We expect revenue growth We expect revenue growth We expect revenue growth around We expect revenue growth of
to rise modestly in 2012. to increase to between 5% 10% and positive free cash flow about 10% with an EBIT margin
We see operating income of and 10% in 2012. We generation. of about 10%. Free cash
over $1.1 billion. Free cash see operating income of at flow of about 0.6 billion to
flow should be negative given least $200 million. Free 0.7 billion according to our
high capital expenditures. cash flow should be positive. baseline expecations.
Sources: Company data, Standard & Poors estimates.
Table 6 | Forecasts For 2012
but t he i mbal ance i n demand and
supply can also bring about greater
volatility as speculative sentiment in
the commodity markets rises and falls
(see chart 2).
For most tire makers that follow a
f i rst-i n, f i rst-out ( FIFO) i nventor y
method, there i s typi cal l y a l ag of
about six months between the time
prices of raw materials rise and the
time the effect shows up on the income
statements. For tire makers that follow
a l ast-i n, l ast-out (LIFO) i nventor y
method, such as Cooper Tire, the rise
in raw materials costs should affect the
income statements sooner.
The raw material content of truck
ti res i s di f f erent f rom that of pas-
senger car and light truck tires (see
t abl e 4) . For i nst ance, commerci al
truck tires use proportionately more
natural r ubber than other ki nds of
tires. Consequently, price increases for
different types of raw materials do not
have a uni f or m ef f ect on t he t i re
makers cost str uctures. Mi chel i ns
commercial truck businesses generate
a disproportionately higher share of
their total sales than those of the other
rat ed t i re maker s. Theref ore, we
expect t hese t wo compani es t o
struggle most with the sharp increase
in natural rubber prices.
Depending on the volume mix of pas-
senger car and light truck tires and com-
mercial truck tires, raw materials repre-
sent about 40% to 60% of the cost of
goods sold. None of the tire makers sig-
nificantly owns any raw materials sup-
pliers, and fluctuations in raw material
prices have historically affected all com-
petitors nearly simultaneously and
almost to the same degree. Because raw
materials are publicly traded commodi-
ties, and all market players use pre-
vailing world market prices, tire makers
cant benefit much from economies of
scale in procurement.
The most direct way to address rising
raw materials costs is to raise prices, and
since the beginning of 2012, most major
tire manufacturers have done so. On
April 1, 2012, Goodyear increased prices
on all its brands as much as 6% in the
U.S. and Canada. On March 1, 2012,
Cooper Tire increased prices, averaging
3% to 4%, on its commercial truck tires.
Michelin also announced a series of
price increases since the beginning of
2011, which continue to benefit rev-
enues and margins in 2012: In the first
half of 2012, price increases accounted
for about 10% revenue growth and
allowed Michelin to post a marked
improvement in operating margins
(+270 bps) despite declining volumes.
The top three tire makers have histori-
cally initiated price increases, while
other tire makers mostly follow their
lead. However, companies that target the
more price-sensitive value segment of
the market, including various Chinese
tire firms, may take the opposite tack
and use lower prices to gain market
share or weaken a competitor.
We do not expect the maj or ti re
makers to raise prices much more in
2012 since overall raw materials costs
have subsided. The price of natural
rubber, an essential ingredient in tires,
at $1.16, is at a low versus the past
few years. Oi l pri ces, though qui te
volatile, remain below the recent peak
prices that occurred in the early part
of 2011 and 2012. Cooper Tires raw
material index of 262 was lower by
about 2% on a year-over-year basis as
of June 2012 because cer tai n raw
materials, including natural rubber and
polybutadiene, decreased in price. It
expect s i t s raw mat eri al i ndex t o
decrease sequentially by 5% to 10%
duri ng the thi rd quar ter compared
with the second. Goodyear Tire sees
raw material costs being flat on a year-
over-year basis in the third quarter.
Overall for 2012, the company expects
them to increase about 7% in 2012,
which is significantly lower than the
raw material cost increases in 2011 of
about 30% versus 2010.
When raw material costs rise, all tire
makers need to raise their prices; oth-
erwise margins come under pressure.
Lower raw materials costs, all things
being equal, can boost profitability if
ti re pri ces stay i ntact. However, i n
We do not expect the major tire makers to raise
prices much more in 2012 since overall raw
materials costs have subsided.
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(THB/gram)
0
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(%)
THBThai Baht.
RSS3 (left scale) EBITDA margin (right scale)
Chart 2 Thailand RSS3 Rubber Auction Prices Versus Adjusted EBITDA Margins
Asi a, pri ces t end t o adj ust more
quickly to falling input prices than in
North America and Europe. The lagged
ef fect of rising raw material prices
can be a boost to EBITDA margins,
whereas the lagged effect of falling raw
material prices can be a decrease in
EBITDA margins (see chart 2). Once
there is a recognizable upward trend in
natural rubber prices, the company can
institute a series of tire price increases
that will tend to more than offset the
rise in rubber costs, leading to higher
margins down the road. If the industry
enters a period of declining raw mate-
rial prices, tire makers could start to
compete more on price to keep or gain
market share, leading to greater pres-
sure on profits.
Since the end of 2009, the U.S. has
imposed tarif fs (Tarif f 421) on light
vehicle tires imported into the U.S.
from China. The tariff is set to expire
in September 2012. We believe that
companies like Cooper Tire that com-
pete in the value portion of the tire
market are better positioned to com-
pete with the Chinese imports. Cooper
Tire increased its ef ficiency at U.S.
plants and can source from its low-
cost operations in China and Mexico.
Also, the cost advantage of Chinese
competitors is not as great as it was in
2009 because of the higher costs of
labor, freight, and utilities, as well as
currency inflation. In addition, the top
three tire makers like Goodyear Tire
generally target the mid-tier and pre-
mium segments. Nevertheless, tariffs
on cheap imports essentially place a
floor on prices; therefore, once the tar-
i f fs expi re we woul d expect to see
price pressure in the value segment of
the markets. Moreover, pricing pres-
sures coul d ri ppl e up t he product
chain as well.
Scaling production to meet
changing demand
In our view, the industry generally has
high operating leverage because of high
fixed costs, such as:
Labor (including mostly unionized

manufacturing labor, with high wages
and benefits), which, depending on the
tire produced and the companys pres-
ence in low-cost regions, constitutes
about 20% to 30% of total production
costs;
Large manufacturing plants with

costly production equipment that
requires heavy spending on capital
reinvestment and maintenance; and
R&D activities.
Fixed costs are generally lower in
China and Southeast Asia, where labor
makes up less than 10% of total costs and
manufacturing ranges from 10% to 15%.
Given the competitiveness of the
industry, tire makers must continually
work to improve their cost structures.
This need intensified during the eco-
nomic downturn in 2009, and industry
players took major restructuring actions,
including cutting manufacturing
capacity, finding low-cost sourcing, or
implementing various productivity
enhancements, among other things.
Because ti re manufacturers have
high fixed costs, they have relatively
limited flexibility to adjust their short-
term production in response to cyclical
changes i n demand. Consequently,
falloffs in production can lead to signif-
icant unabsorbed overhead costs that
cut into profitability. Achieving the
most economical use of production
capacity remains difficult, particularly
for companies that serve both the orig-
inal equipment and replacement mar-
kets, given the more volatile nature of
original equipment production and its
demanding customer base. For most
major players, original equipment rev-
enues make up approximately 20% of
total sales. (Cooper Tire does not sell
in the original equipment market in
North America and has only minimal
original equipment sales in China and
the U.K.)
Gi ven the economi c and pol i cy
uncertainty in Europe and the high
i nventor y of wi nter ti res at many
dealers after last years mild winter, we
expect tire makers to align production
with demand. For example, Goodyear
sai d that, i n the second quar ter of
2012, it cut production by over 5 mil-
lion units due to lower sales volumes.
Goodyear Tire expects further cuts to
production and will take other cost
saving actions in the second half of
2012, most because of the economic
weakness in Europe. As a result of the
production cuts, the company expected
that underabsorbed fixed costs would
be approximately $150 million in 2012.
Continental also reduced capacity last
year in France and Germany, which
involved about 270 million in restruc-
turing charges.
It continues to be a different story in
China and Southeast Asia, where in
2011 strong demand in the domestic
market supported high capacity utiliza-
tion rates. As a result, many tire manu-
facturers either added capacity or opti-
mized existing facilities to meet the
demand and maintain market share.
But slower growth in some Asian mar-
kets could result in oversupply and
cuts to capacity down the road.
High legacy costs are a
burden from the past
Most of the major tire manufacturers
have significant unfunded postemploy-
ment benefit obligations. (Under our
accounting methodology, we add
unfunded pension and other postem-
ployment benefit liabilities to the bal-
ance sheet as debt because they are
financial obligations that companies
must pay over time.)
In the past few years, interest rates
and swings in the valuation of the plan
assets have made pension liabilities
highly volatile. Although these liabilities
are often regarded as very long-term
debt, they can increase suddenly and
require additional unexpected spending.
According to our adjustments,
Michelin had 2.6 billion in unfunded
pension liabilities at the end of 2011.
Michelin is reducing the number of its
defined benefit plans, even though it is
increasing defined contribution plans.
Continental had 1.7 billion in unfunded
pensions at the end of 2010.
Goodyears total pension and other
unfunded postretirement obligations
add about $3.67 billion to its debt. The
company made global pension contri-
butions last year of $294 million. It
expects its contributions to fall this year
to between $550 million and $600 mil-
lion. However, we expect recent legisla-
tion in the U.S. to allow companies to
use a di scount rate based on the
average relevant interest rate for the
past 25 years, which should alleviate
the immediate cash flow impact of ele-
vated unfunded pension obligations.
Directions In Cash Flow
And Liquidity: Snapshots
Of The Top Players
Michelins credit metrics have markedly
improved: The companys funds from
operations (FFO) to debt ratio was
above 40% in 2010 and 2011, compared
with an average of 24% from 2006-2009.
Operational improvements led to a
meaningful increase in FFO, to 2.2 bil-
lion in 2011 from 1.5 billion in 2009.
However, the drag of raw materials costs
on working capital, along with Michelins
large capital expenditure plan, has ham-
pered free operating cash flow (FOCF)
generation. FOCF was negative 474
million in 2011, but we anticipate it to
become positive again in 2012, with help
from lower working capital outflows as
rubber prices decrease.
In light of increased capital expendi-
tures and rising pension contributions
over the past two years, we expect
Goodyear again to use FOCF in 2012,
which will require the company to use
its revolving credit facilities, cash bal-
ances, or some other form of financing.
We expect capi tal expendi tures to
increase to between $1.1 billion and
$1.3 billion as Goodyear modernizes its
existing manufacturing facilities and
expands production capacity in Latin
America and China.
Continental has historically had the
strongest FOCF among the top five com-
petitors. The company generated signifi-
cant cash from 2005 to 2011, reporting
positive FOCF before acquisitions during
this period. However, Continental has
significantly changed the scope of its
business and its financial risk profile
after buying the Germany-based auto
supplier VDO in late 2007. Tire revenues
and sales with rubber-related products
represent about 35% to 40% of
Continentals total revenues.
Cooper Tires FOCF was about nega-
tive $30 million in 2011, compared with
$55 million in 2010. We expect Coopers
capital expenditures to fall in the range
of $180 million to $210 million this year
and for FOCF to be at least $30 million.
We consider Michelin to have the
strongest liquidity and financial flexi-
bility, which are reflected in their invest-
ment-grade ratings (see table 5). We view
Goodyears liquidity and financial flexi-
bility as adequate in the near ter m
because of the companys healthy cash
balances and access to credit facilities.
In the medium term, the company faces
a highly leveraged capital structure and
burdensome pension funding require-
ments. Cooper Tire has good liquidity
because of its excess cash balances,
unused bank lines, and limited near-term
debt maturities.
Global Tire Demand Could
Stay Weak In 2013
Our outlook for global replacement tire
demand this year is weak, while the
original equipment market should be
mixed. In the U.S., we expect the con-
sumer original equipment market to
grow about 5% and the commercial
original equipment market to grow over
20%. Neverthel ess, we expect the
replacement market to decrease by at
least 1% compared with 2012.
Its likely to be worse in Western
Europe. We expect the consumer orig-
inal equipment market to grow less
than 1% and commerci al ori gi nal
equipment markets to decline 10% in
2013. We think the replacement market
in Europe will show negative growth in
2013 as well.
Demand for car and truck tires in the
rest of the world should grow in line
with the pace of economic and social
advancement in developing countries,
such as India and China. The IMF is
forecasting Chinas GDP growth to be
around 8.5% in 2013, compared with
actual GDP growth of 8% in 2012 and
9.2% in 2011. For India, its forecasting
GDP growth to be around 6. 5% i n
2013, compared with 6.1% in 2012 and
7.1% in 2011.
There are two basic threats to tire
makers profitability in this year and
beyond. First, the continuing deteriora-
tion in the world economy could pro-
long sluggish tire demand. The strength
of demand for consumer and commer-
cial truck tires depends on a number of
variables outside the companies con-
trolsuch as the number of cars and
trucks on the road (and their mileage),
freight tonnage, the unemployment
rate, and consumer conf i dence.
Second, if the industry enters a period
of relatively stable or declining raw
material prices, tire makers might trade
off price discipline for the chance to
gain market share, leading to greater
profit uncertainty. Consequently, we are
carefully monitoring the ef fects that
declining replacement tire demand is
having on credit quality (see table 6).
After all, the risks can be higher than
you think when youre driving in the
slow lane. CW
Lawrence Orlowski, CFA
New York (1) 212-438-7800
Antoine Cornu
Paris (33) 1-4420-6796
Werner Staeblein
Frankfurt (49) 69-33-999-130
Xavier Jean
Singapore (65) 6239-6346
Tire
We are carefully monitoring the effects that
declining replacement tire demand is having
on credit quality
SPECIAL REPORT
FEATURES
E
conomic growth around the world has been slowing, particularly in
Europe. We expect GDP growth of only 2.1% in 2012 and 1.8% in
2013 in the U.S., and that GDP in the European Economic and
Monetary Union (eurozone) as a whole will decline by 0.6% in 2012 and
grow by just 0.4% in 2013. But Standard & Poors Ratings Services doesnt
expect the slowdown to significantly hurt global rental car companies
earnings and cash flow or our ratings on the sector. These companies have
been resilient in past downturns by cutting costs and quickly reducing
their fleets, and we expect them to respond similarly this time around.
Global Rental Car Companies
Have The Resilience To Ride
Out A Weaker Economy
Standard & Poors rates six global car
rental companies: Enterprise Holdings
Inc. (BBB+/Stable/A-2), Avis Budget
Group Inc. (B+/Stable/), Hertz Global
Holdings Inc. (B+/Watch Neg/), and
Dollar Thrifty Automotive Group Inc.
(B+/Watch Neg/) in the U.S.; Localiza
Rent A Car S.A. (BBB-/Stable/) in
Brazil; and France-based Europcar
Groupe S.A. (B/Stable/).
Four of these six companies do busi-
ness in EuropeEuropcar, Avis Budget,
Hertz, and Enterprise. Both Avis Budget
and Enterprise have increased their
exposure over the past year: Avis Budget
acquired European car renter Avis
Europe on Oct. 3, 2011, and on Feb. 1,
2012, Enterprise acquired PSA Peugeot
Citroens car rental business, which oper-
ated in France under the name Citer and
in Spain under the name Atesa. (Citer
and Atesa had already been operating as
franchise partners of National, one of
Enterprises three brands.) In addition,
economic growth in Brazil, where
Localiza has the largest market share,
has begun to slow.
Throughout 2012, we expect eco-
nomic weakness and the attendant lower
demand to only modestly diminish car
renters earnings and cash f low. And
when economic growth resumes, we
expect demand to recover, which would
result in higher earnings and cash flow.
Upgrades Outpaced Downgrades
Over The Past Year
Despi te pressure on revenues and
earnings in Europe, most companies
have benefited from good cost con-
trols and strong used-car prices, which
have aided their margins. These fac-
tors resulted in two upgrades over the
past year.
In December 2011, we raised our cor-
porate credit rating on Dollar Thrifty to
B+ from B following improvements in
its operating and financial performance.
In April 2012, we raised our corporate
credit rating on Localiza to BBB- from
BB+ to reflect the companys better
market position, higher profitability, and
improved credit metrics.
However, in January 2012, we down-
graded Europcar to B from B+ and
assigned a negative outlook based on its
weaker-than-expected operating per-
formance, large upcoming debt maturi-
ties, and potential refinancing chal-
lenges. We subsequently revised the
outlook to stable in May 2012 when the
company successfully refinanced 2012
and 2013 debt maturities.
We also placed our ratings on both
Hertz and Dollar Thrifty on CreditWatch
with negative implications in August
2012 after Hertz announced that it had
entered into a definitive agreement to
acquire Dollar Thrifty for $2.6 billion of
cash and assume $1.6 billion of its debt.
Demand Weakened
In Europe
We expect the weak economic outlook
to continue to hamper European car
rental transactions over the foreseeable
future. This holds especially true for
demand in Southern European countries
such as Spain and Portugal, which repre-
sent about 25% of Europcars revenues.
Forecast a decline in GDP of 2.1% in
2012 and a further 0.4% decline in 2013
in Italy, and a decline in GDP of 1.7% in
2012 and a further decline of 0.6% in
2013 in Spain, compared with modest
growth in Germany and France. In the
first half of 2012, Europcars transaction
volume fell 1.4% as business customer
activity declined. However, the leisure
segment has held up surprisingly well,
with stable demand in Southern Europe
as a result of continued travel by
Northern European and U.S. tourists.
The eurozone represents about 20% of
consolidated revenues for both Hertz
and Avis Budget.
Despite the difficult market, we dont
expect a marked deterioration in car
rental companies European operating
margins. This is in part because we
expect these companies to manage the
size of their f leets and maintain high
fleet utilization rates. We also expect
them to benefit from slightly lower fleet
sourcing costs, as European automotive
original equipment manufacturers face
declining demand and may thus offer
better prices to car rental companies.
We bel i eve car rental compani es
would respond to a prolonged recession
in Europe by returning vehicles to the
auto manufacturers through predeter-
mined vehicle repurchase programs
that cover the majority of their auto
fleets in Europe. In the past, these com-
panies have reduced their fleets rela-
tively quickly to meet weaker demand.
After the Sept. 11, 2001, attacks in the
U.S., car rental companies reduced their
fleets by about 20% within the following
month by reducing capital spending on
new vehicles and returning used vehi-
cles to manufacturers.
North American Profitability
Remains Relatively Strong
Revenues and margins in car rental com-
panies North American operations have
remained relatively healthy because
growth in transaction volume has offset
lower pricing. In addition, the companies
have continued to benefit from cost
reductions and a strong used car market,
which has resulted in higher used-car
prices and strong gains on sale when
they dispose of vehicles. Car rental com-
panies use gains on the sale of vehicles
to offset depreciation expenses, which
reduces total vehicle costs. The four
North American car rental companies
have also benefited from significant debt
refinancing over the past few years,
which has extended debt maturities and
Car rental companies would respond to a
prolonged recession in Europe by returning
vehicles to the auto manufacturers
lowered interest expenses. All of these
factors resulted in higher operating mar-
gins and profitability and have con-
tributed to stable to modestly improved
credit metricstrends that we expect
will continue even if the U.S. economy
grows only moderately.
Will The Third Time Be The
Charm For A Hertz Acquisition
Of Dollar Thrifty?
After two previous attempts in 2010 and
2011, Hertz returned with a new bid to
acquire Dollar Thrifty on Aug. 27, 2012,
when it announced that it had entered
into a definitive agreement to acquire
the company for $2.6 billion of cash and
assume $1.6 billion of its debt. The
acquisition would be funded through a
combination of Hertzs cash, Dollar
Thriftys cash, and debt, for which Hertz
has committed financing.
Hertzs operating and financial per-
for mance has been improving: Its
EBITDA interest coverage was 4.6x,
funds from operations (FFO) to debt was
22%, debt to capital was 87%, and debt
to EBITDA was 4.3x for the 12 months
ended June 30, 2012. Just two years ear-
lier, EBITDA interest coverage was 3.3x,
FFO to debt was 19%, debt to capital
was 88%, and debt to EBITDA was 5.2x.
Hertzs proposed acquisition would
result in an increase in its market share
in the U.S. There are currently three
major on-airport car rental companies,
each holding about 30% of the market:
Hertz, Avis Budget Group Inc. (parent of
the Avis and Budget brands), and
Enterprise Rent-A-Car Co. (parent of the
Enterprise, Alamo, and National brands).
Dollar Thrifty accounts for most of the
balance. Dollar Thrifty focuses on the
leisure segment, which has been faster-
growing and more prof-
itable than
business rentals over the past few years,
while Hertz serves a mixture of business
and leisure travelers. The acquisition,
which requires regulatory approval and
the divestiture of certain assets
(including Hertzs modest leisure
Advantage brand and some Dollar
Thrifty airport locations), will give Hertz
a stronger presence in the leisure seg-
ment, with a brand that can compete
aggressively without under mining
Hertzs pricing structure.
Each of Hertzs bi ds has become
i ncreasi ngly more costly, and Avi s
Budget made counterbi ds agai nst
Hertzs first two bids. Thus far, it has not
responded to the latest bid. We do not
expect Avis Budget to make a coun-
terbid this time because of the high
price it would have to counter with, as
well as its focus on integrating the Avis
Europe acquisition.
We will evaluate Hertzs business and
financial risk profiles, pro forma for the
Dollar Thrifty acquisition, to resolve the
CreditWatch listings. We would affirm
the ratings on both companies if we
believe increased earnings and cash flow
from Hertzs stronger post-merger
market position and the expected rev-
enue and cost benefits from the merger
would more than offset the incremental
debt, and then withdraw the corporate
credit rating on Dollar Thrifty (it has no
rated debt) when the acquisition is com-
pleted. We would expect a downgrade, if
it were to occur, to be caused by weaker
credit metrics related to the incremental
debt related to the acquisition and to be
limited to one notch.
The Brazilian Car Market Will
Likely Keep Growing
Despite the recent economic slowdown
in Brazil, our overall outlook for the car
rental industry is still positive. In the
next four years, Brazil will play host to
two major sporting events: the 2014
Fi f a Worl d Cup and the 2016
Summer Olympics. With the
anticipated increase in
tourism, and given the
historical inefficiency of
Brazilian public transport,
we expect demand for car
rentals to increase significantly during
these events. Even though hi gher
demand may strain rental companies
operati ons, the pressure wont be
enough to warrant significant invest-
ments to increase car rental fleets, in
our view. Since the spike in demand will
last only a few weeks, we believe the
companies can easily cope with higher
demand by managing their inventories
and pri ces. However, we expect
increased brand recognition and a shift
in local perceptions about renting cars
as people become more accustomed to
renting cars to have a longer lasting,
beneficial impact on Brazilian car rental
companies. The Brazilian car rental
market also presents some consolida-
tion opportunities since there are only a
few large participants, with the rest
highly fragmented.
The Industry Can Likely Weather
A Weaker Economy
Having successfully responded to the
tough industry conditions of 2008 and
the first half of 2009, which included
frozen credi t mar kets, a prol onged
recession, and U.S. automaker bankrupt-
cies, we believe the industry is in better
shape now to withstand lower demand if
the gl obal economy conti nues to
weaken for a prolonged period. During
the recession, the industry reduced its
f l eets and costs, and i mpl emented
ongoing cost reductions since then.
Most companies in the industry also
successfully refinanced debt maturities,
which resulted in extended maturities
and lower funding costs. We also believe
the industry is in good shape to benefit
from improving conditions when the
market turns around. CW
Betsy R. Snyder, CFA
New York (1) 212-438-7811
Lisa L. Jenkins
Washington D.C. (1) 202-383-3625
Antoine Cornu
Paris (33) 1-4420-6796
Marcus Fernandes
So Paulo (55) 11-3039-9734
Rental Car
SPECIAL REPORT
FEATURES
E
ven as economic uncertainty persists in the U.S., recession
looms in Europe, Chinas economy slows, and evolving
intra-Latin America trade issues could make the
manufacturing footprint there less efficient, the U.S. automakers
continue to demonstrate that they can maintain and perhaps move
beyond their improvements in credit quality from late 2009 to
2011. All three companiesGeneral Motors Co. (BB+/Stable/),
Ford Motor Co. (BB+/Positive/), and Chrysler Group LLC
(B+/Stable/)continue to generate free cash flow in their
automotive operations, providing improved flexibility in how they
deploy their substantial cash balances.
Can General Motors, Ford,
And Chrysler Continue
Their Resurgence?
Overview
The U.S. automakersGM, Ford, and Chryslerhave returned to profitability in

North America and, as a result, have higher ratings than they have in several
years.
Given the recession in Europe and the slowdown in China, North American
results will be crucial to continuing stability.
Better results, particularly in Europe for GM and Ford, will be key to any upside
in credit quality.
These three U.S. automakers represent a
significant portion of light vehicle sales in
North America, with close to a combined
45% market share in the first eight months
of 2012 (see chart 1). Their combined share
of the global market is more modest, at an
estimated 22% in 2011. Aligning produc-
tion and product mix more closely with
market demand in North America has
enabled all three automakers to reduce
fixed costs and the sales levels they need
to break even. Challenges in the rest of the
world bear watching, but we dont think
they are likely to generate downgrades
under our base-case scenarios, which
include weak demand in Europe, a slower
Chinese economy, and intra-Latin America
trade headwinds.
Each companys prospects vary, of
course, but we believe the opportunity for
all three to be profitable and cash-flow pos-
itive in North America remains solid, even
as competition remains fierce amid eco-
nomic uncertainty, a recovery in Japanese
automaker inventory, and Volkswagens
increased focus on North America.
The greatest potential for Ford and GM
to improve profitability lies primarily in
Europe, and to a lesser degree in South
America, in our view. But both companies
could be a couple of years away from the
former, given struggling European
economies. For Chrysler, North America
remains the main market and, even under
Fiats ownership and direction, we expect
that the company will keep its focus there.
How The U.S. Automakers
Got From 2011 To Here
General Motors
In September 2011, we raised the rating on
GM to BB+ from BB- (the initial October
2010 rating after the company emerged
from bankruptcy) and assigned a stable out-
look. This reflected, among other consider-
ations, the prospect that GM would con-
tinue to generate free cash flow and profits
in its automotive manufacturing business
because of improvements in its U.S. cost
base (from lower headcounts and greatly
reduced retiree health care costs, among
other items). Prospects for gradual improve-
ment in light-vehicle sales in North America
in 2012 and 2013 were another factor. We
assume GMs automotive free operating
cash flow (FOCF) during 2012 will be at
least $2 billion (equivalent to about a mid-
single-digit percentage of our estimate of
debt in 2012). We also assume that GM can
sustain its pretax automotive EBIT margin
in North America in the upper-single-digit
percentage area and its total automotive
EBIT margin in the mid-single-digit area.
Developments during 2012 that we have
incorporated into the current rating include:
Losses in Europe that seem likely to

persist for the rest of 2012 and prob-
ably into 2013, and
GMs plan for substantial changes to

its pension obligation for U.S. salaried
retirees.
Ford
In October 2011 following the ratifica-
tion of the new four-year UAW labor
contract, we raised the rating on Ford to
BB+/Stable/. The upgrade reflected
our view that, among other things, Fords
prospects for generating free cash flow
and profits in its automotive manufac-
turing business remained intact because
of its now-competitive cost base in
North America (as with GM, from lower
headcounts and greatly reduced retiree
health care costs, among other items).
In August 2012, we revised our out-
look on Ford to positive, affirming our
BB+ rating. Some of the main points
we made at the time were:
Fords performance in North America

continues to underpin good overall
automotive cash flow and profitability.
2004 2005 2006 2007 2008 2009 2010 2011 2012*
0
5
10
15
20
25
30
(%)
*2012 refers to year-to-date August data. GMs and Fords shares include legacy brands.
Source: Wards AutoInfoBank.
General Motors Corp. Ford Motor Co. Chrysler
Chart 1 U.S. Light-Vehicle Market Share
D
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1.50
2.00
2.50
3.00
3.50
4.00
4.50
($/gallon)
December 2007 to August 2012
Source: Energy Information Administration (Regular Conventional Retail Gasoline Prices).
Chart 2 Gas Prices (Regular Conventional Retail)
We believe Ford will act with increasing

decisiveness and commitment to
restructure Europe to profitability in the
face of the likelihood of several more
years of weak vehicle sales in Europe.
We could raise the rating to invest-

ment grade ( BBB- or higher) if,
among other factors, Ford demon-
strates it can improve the balance of
profitability across regions.
Developments during 2012 that we have
incorporated into the current rating include:
Losses in Europe that seem likely to

persist for the rest of 2012 and prob-
ably into 2013.
Fords plans to offer lump sum pay-

outs to salaried retirees and former
employees to settle their pension obli-
gation. Because this would reduce
assets and liabilities, it could be a
modest positive over time.
Chrysler
Our May 2011 B+/Stable/ rating on
Chrysler Group LLC remains unchanged
and reflects:
Our expectation that Chryslers prof-

itability and cash generation in North
America will continue (the lower U.S. cost
base is a major factor in this assumption);
Chryslers ef forts to improve con-

sumer perception and broaden its
lineup of smaller, more fuel-efficient
vehicles over the next few years; and
Fiats ownership (now 58.5%), the

main benefit of which we view as
strategic and operational, rather than
a source of addi ti onal fi nanci al
resources.
(See table 1 for the recent rating history of
the three companies.)
A Comparison Of Business Risk
Fundamentals
The highly cyclical and competitive
nature of the automotive industry is a
major consideration in the business risk
profiles of all three companies.
We assess GMs business risk profile
as fair, primarily reflecting:
The companys substantial scale, with

2011 net sal es and revenues of
$148.9 billion;
A recent, but in our view, sustainable,

return to profitability in North America;
Reliance on the light-truck segment in

the U.S.;
Difficult conditions in Europe, with

probable losses for 2012 and perhaps
some or all of 2013;
Significant geographic and product

diversity, with substantial sales outside
of North America in Europe (not a
benefit currently), China, Brazil, and
Russia; and
Automotive margins that are in the

mid-single-digit range.
We also assess Fords business risk
profile as fair, reflecting, among other
factors:
The companys global scale, with 2011

sales of $128.2 billion;
A growing track record of profitability

and maintaining retail share in North
America;
Reliance on the light truck segment in

the U.S.;
Difficult conditions in Europe, with

probable losses for 2012 and perhaps
some or all of 2013;
Geographic diversity that provides at

least a modest share in key developing
markets, which significant exposure to
European markets largely offsets; and
Automotive margins that are in the

mid-single-digit range.
Our assessment of Chryslers business
profile as weak mainly reflects:
Heavy reliance on the light-truck seg-

ment;
Limited geographic diversity;
The companys shorter track record of

profitability in North America;
EBITDA margins that are currently

fair, in the upper-single-digit range;
and
The benefits of Fiat ownershipbut

also recognition that this involvement
is still a work in progress.
The U.S.-based automakers face the
same major industry risks as others in
the global automaker sector, including:
Global production overcapacity;
High operating leverage (high fixed

cost manufacturing footprint);
Highly cyclical and volatile end-

market demand;
Making expensive products but having

limited pricing power and often fickle
consumers; and
The industrys labor-intensive nature, and

its organized and powerful labor force.
Our business risk analysis includes an
assessment of the long-term underlying
profitability of the business, given these
substantial industry risks.
Solid results on the home front;
volumes have been supportive;
companies adapt to mix trends
GM and Ford have significant global
presences. In 2011, the majority (68%)
of GMs vehicle sales came from out-
side North America and 58% of Fords
unit sales in 2011 were from outside
North America.
GMs non-North American sales are
more evenly split across the globe, with
Europe accounting for 19% of sales,
while Fords European sales tallied over
25% of sales. Chrysler is the least global
and most dependent on North America,
with 90% of its 2011 vehicle volume in
North America.
We believe, however, that domestic
sales and production this year and next
will be the key factor in determining
domestic automaker credit quality. At
the same time, for Ford and GM, geo-
graphic diversity will be more of a head-
wind than a benefit in the near term.
Domestic perfor mance is the most
important factor in short-term credit
quality in our view because we expect
that the majority of cash flow generation
will be in North America. One always
important additional factor is the price of
gasoline in the U.S. and what direction
its moving in, which shapes consumers
vehicle size preferences.
We think Ford has solidly reestab-
lished itself on the home front. GM has
also made progress in our view.
Chryslers product portfolio continues to
evolve under Fiat, and the ramp up of
sales following the recent launch of the
Dodge Dart passenger car is important.
We assume that U.S. sales volumes
will be higher in 2012, at about 14.1 mil-
lion (see U.S. Economic Forecast: Keeping
The Ball In Play, published Aug. 17, 2012,
on RatingsDirect, on the Global Credit
Portal), than in 2011, and our econo-
mists base-case assumption is for a 5%
increase in 2013. We suspect that con-
sumers are less cautious about making
big-ticket purchases now than they were
in 2011, but recurring mixed economic
news creates uncertainty.
The industry has shown relative disci-
pline in limiting overproduction and
excess sales incentives since 2009, and
this helps profitability as long as it con-
tinues. We think discipline on incentives
has a fair chance of remaining intact
over the near term, but they remain a
marketing tool for the industr y.
Automakers may rediscover reasons to
overproduce or artificially stimulate
sales by offering higher incentives, which
could dampen the ability to maintain
profit margins. Alternatively, if sales
soften unexpectedly and inventories bal-
loon, incentives could expand signifi-
cantlyalthough this is not our current
base case.
Automakers aim to produce vehicles
that appeal to a range of evolving con-
sumer tastes in a number of markets. In
the U.S., we track market share monthly
and monitor longer-term trendsup or
downbut we do not have absolute per-
centages we regard as acceptable for
market share (see chart 1).
We believe all three domestic com-
petitors are highly sensitive to product
mix shiftsespecially away from light
trucks, which include pickup trucks,
vans, SUVs, and crossover utility vehi-
cles (CUVs). The sales of larger vehicles
(excluding CUVs) are lower than they
were a few years ago. For the first eight
months of 2012, SUV sales represented
7% of total sales, down from 13.1% in
2007. Even with the growth in CUVs,
light-truck sales are likely to remain
lower than in 2006 and earlier (mid-50%
area of total sales) with some ebb and
flow related to gas prices.
CUVs have become a meaningful
share of the U.S. market, representing
23.3% of sales in the first eight months
of 2012 (see table 2), up from 17.2% in
2007. The CUV category is very com-
petitive. GM had U.S. market share of
19.1% (versus Fords 13.6%, Chryslers
5.5%, and Toyota Motor Corp.s 12.7%)
for the first eight months of 2012. We
believe CUVs remain less profitable than
full-size pickups, in part because the
CUV market has more competition. Still,
in our view GMs and Fords market
shares indicate that they have competi-
tive product offerings.
We believe that pickups and other
classes of large vehicles will remain sen-
sitive to fuel prices. However, more fuel-
efficient vehicles might make them less
price-sensitive than in the past. We
assume gasoline prices will remain
volatile based on 2008s steady rise,
2009s sudden decline, and 2011s and
2012s jostling between $3 and $4 per
gallon (see chart 2).
We believe that GM and Ford are
better positioned for higher fuel prices
than Chrysler because they have broader
product line offerings with a higher per-
centage of cars than Chrysler does (see
table 2 and chart 3). Chryslers product
offering is narrower and most heavily
weighted toward light trucks, though
under Fiat ownership, this seems likely
to change gradually.
Despite progress in the car segment, we
believe GM and Ford are still under-
weighted in small cars, even with some rel-
ative successes (e.g., the Chevy Cruze and
the Ford Focus) (see chart 4). This segment is
the most likely to benefit in a sharply higher
gas price scenario but also may require the
greatest shift in mindset for American con-
sumers, who have shown a proclivity for
larger vehicles. However, smaller vehicles
have gained share in recent years and in the
first eight months of 2012.
But even after expanding their pas-
senger-car lineups, GMs and Fords
Hyundai/Kia Toyota Honda GM Ford Nissan VW Chrysler
0
5
10
15
20
25
(%)
*Year-to-date August 2012.
Note: Historical data for GM includes discontinued brands.
2010 2011 2012*
Chart 3 Small Car Market Share By Company
Ford Focus Chevrolet
Cruze
Chevrolet
Sonic
Ford Fiesta Fiat 500
(Chrysler)
Buick
Verano
Dodge
Caliber
0
2
4
6
8
10
12
(%)
*Year-to-date August 2012.
Standard & Poor's 2012.
2010 2011 2012*
Chart 4 Top Michigan Three Small Cars As A Percentage Of Total Small Cars
product mixes are still more skewed
toward light trucks than the overall
market. In the first eight months of 2012
(according to Wards AutoInfoBank),
light trucks accounted for 58.8% of GMs
U.S. sales, compared with 48.9% for the
overall U.S. market. Ford is even more
weighted toward light trucks (64% of
2012 sales through August) than GM.
The health of the U.S. large-pickup
market remains critical for GM, Ford,
and Chrysler, because their collective
market share in this segment is 92.2%,
and we believe these companies enjoy
better margins with this segment than
with many others. We believe the pickup
market will remain smaller than it was in
2005 (2.5 million units), but it could
expand as housing and construction
markets rebound. The market ended
2011 at 1.5 million units, versus the 1.3
million units sold in 2010. So far in the
eight months of 2012, sales were 11.7%
higher than in the same period of 2011.
Geographic diversity and growth
prospects for key foreign markets
We view GM as having the best geo-
graphic diversity of the three U.S
automakers, while Chrysler has the least.
GM reports it had a 13.6% market share
in China in 2011the largest of the three
U.S. automakers. GMs reported European
share was 8.8%, and its Brazilian share
was 17.4%. Ford reported its shares for
the roughly equivalent large markets as
2.7% in China, 8.3% in Europe, and 9.8%
in Brazil. So for now, Ford has much
smaller shares in the large non-European
international markets, which we expect to
experience faster growth over time.
Chryslers North American unit sales rep-
resented about 90% of its total sales in
2011, although it has some potential to
expand internationally over time, espe-
cially to Brazil and Italy, as a result of
links with Fiat, which has a solid presence
in those countries.
China: We assume that passenger
vehicle sales growth in China will be in
the upper-single-digit percentage area in
2012similar to 2011s growth rate but
slower than the double-digit rates in the
years prior and in excess of the normal-
ized sales growth rate of some other
large markets. Within this growth trend,
luxur y foreign brands, and foreign
brands more broadly, may experience
higher growth than the overall market.
GMs sales in China, including those
made through joint ventures, repre-
sented about 28% of the companys total
vehicle units sold in 2011. GMs Chinese
operations primarily comprise three joint
ventures: Shanghai General Motors Co.
(GM owns 49%), Shanghai Automotive
Industry Corp.-GM-Wuling Automobile
Co. Ltd. (44%), and First Automobile
Works-GM Light Duty Commercial
Vehicle Co. Ltd. (50%).
We view the companys position in
China as a net positive rating factor.
However, GMs significant position there
exposes itmuch more than Ford or
Chryslerto a potential Chinese down-
turn or a significant slowing of that
market. Still, if sales growth continues,
even at a slower rate, we believe it will be
dif ficult for other global volume
automakers that have a relatively small
position in China to easily displace the
current leaders: GM, Volkswagen AG,
and luxury automakers Daimler AG and
BMW AG. The luxury makers, in partic-
ular, are generating large profits in China.
General Motors Co. Ford Motor Co. Chrysler Group LLC
12/1/2007 B/Stable/B-3 B/Stable/B-3 B/Negative/
12/1/2008 CC/Negative/ CCC+/Negative/ CC/Negative/
3/1/2009 CC/Negative/ CC/Negative/ CC/Negative/
4/1/2009 CC/Negative/ SD// D//
6/1/2009 D// CCC+/Negative/ NR
9/1/2009 D// CCC+/Developing/ NR
12/1/2009 NR B-/Stable/ NR
12/1/2010 BB-/Stable/ B+/Positive/ NR
6/1/2011 BB-/Positive/ BB-/Positive/ B+/Stable/
9/1/2011 BB+/Stable/ BB-/Positive/ B+/Stable/
10/1/2011 BB+/Stable/ BB+/Stable/ B+/Stable/
8/1/2012 BB+/Stable/ BB+/Positive/ B+/Stable/
Note: Ratings for GM before 2010 and Chrysler before 2011 are for predecessor companies. For clarity, not all
ratings during the time period are shown. NRNot rated.
Table 1 | U.S. AutomakersSelected Corporate Credit Rating History
Eight months ended August 2012
General Ford Chrysler Toyota U.S. Light
Motors Co. Motor Co. Holding LLC Motor Co. Ltd. Vehicle Market
Small car 13.7 13.9 3.8 21.1 20.0
Midsize car 23.7 16.4 17.0 30.2 22.1
Large car 0.2 3.7 9.7 0.0 1.7
Luxury car 3.6 2.0 0.0 7.2 7.3
Total car 41.2 36.0 30.5 58.4 51.1
Crossover utility vehicle 24.5 20.6 11.2 20.5 23.3
SUV 6.8 9.0 25.8 4.3 7.0
Van 4.0 7.3 16.0 5.6 5.9
Pickup 23.5 27.2 16.5 11.2 12.6
Total light truck 58.8 64.0 69.5 41.6 48.9
Grand total 100.0 100.0 100.0 100.0 100.0
Table 2 | U.S. Automaker Product Mix Vs. Market Mix (%)
Although Fords sales and profits in
Chi na are much more modest than
GMs, at the end of 2011, Ford had
const r uct i on for four new pl ant s
underway in the region. Its Chinese
operations currently consist of three
joint ventures, two of which involve
Mazda. In August 2012, the company
announced that it will bring its luxury
Lincoln brand to China in the second
half of 2014.
Chryslers China presence is limited,
but we assume the company will move
to expand in this large market.
(For our views on the effect of a hard
landing in China please see The Credit
Overhang: Implications For The Global
Automotive Sector Of A Hard Landing In
China, May 29, 2012.)
Europe: The competitive trends in
Europe are much gloomier than in most
Data as of 2011
GM Total GM (%) Ford Total Ford (%) Chrysler Total Chrysler (%)
Automotive revenues (bil. $)
North America 90.2 61.2 75.0 58.5 47.0 85.6
South America 16.9 11.4 11.0 8.6 7.9 14.4
Europe 26.8 18.1 33.8 26.4
ROW, including China 24.8 16.8 8.4 6.6
Other (11.2) (7.6)
Total revenues 147.5 100.0 128.2 100.0 55.0 100.0
Reported automotive EBIT 7.7 5.8 2.0
Margin (%) 5.2 4.5 3.6
Net Income (bil. $) 9.2 20.2 0.2
Wholesale units (units in 000)
North America 2,924 32.4 2,686 45.1 1,682 90.7
South America 1,065 11.8 506 8.5
Europe 1,735 19.2 1,602 26.9
China 2,547 28.2 519 8.7
Asia 755 8.4 646 10.8
Other* 173 9.3
Total 9,026 100.0 5,959 100.0 1,855 100.0
Market Share (%)
North America 18.4 15.7 10.8
Europe 8.8 8.3 <1
Latin America 18.8 9.3
China 13.6 2.7
Other 4.7 4.3
Global share 11.9 7.8 2.5
Employees 207,000 164,000 55,687
Ownership (%)
UST 30.0
Canada 8.4
UAW VEBA 12.3 41.5
Fiat 58.5
Old GM 5.2
Public & other holders, incl mgmt 44.1 100
Total 100 100 100
ROWRest of world. USTU.S. Treasury. *All of Chryslers non-North American sales. Ford has common stock and class B stock. Voting rights are 60% common stock and 40%
class B. As of April 12, 2012, per GM proxy.
Source: Company reports, S&P estimates.
Table 3 | Selected Data Comparisons For GM, Ford, And Chrysler
other markets. Our base case for the
major auto markets in Europe is for a
fifth consecutive year of a decrease in
registrations in 2012and 2013 could
well represent a sixth. We expect 2012
auto industry sales in Europe to be at
least 6% below 2011EU27 passenger
car registrations were down about 7.0%
for the first six months of 2012 (but
highly mixed: France was down 13.3%,
Germany was up 0.6%, and Italy was
down 20. 6%). We believe losses in
Europe for many nonluxur y volume
makers are likely for 2012 and perhaps
2013, primarily because of the excess
capacity and a weak economy.
We view GMs European operations
(Opel/Vauxhall) as being in a turn-
around mode. We believe GM will focus
on cost and capacity reductions, but not
neglect the product pipeline. The former,
however, is a long and complex task for
all volume makers in Europe. GM is
funding the restr ucturing from its
internal funds, which we view as suffi-
cient for this purpose.
GMs European operations lost about
$600 million in the first half of 2012 as
the sovereign debt crisis, high unemploy-
ment, low consumer confidence, and
overcapacity weighed on the market.
U.K. market share fell slightly in the first
half to 11. 5%, as did GMs Ger man
share, to 7.8%. Market share in Russia
rose, but share in Italy declined in the
period. We expect GMs weak earnings
performance to continue in Europe for at
least the rest of 2012 and into 2013,
even if the company makes some
progress on cost reductions.
Fords results also deteriorated sub-
stantially in Europe in the first half of
2012, as operating margin was negative
3.9%, down from 2.6% in the year earlier
period. Fords market share in the region
fell to 7.7% from 8.3% in the first half of
2011. Hurting results were lower
industry sales and market share, along
with dealer stock changes. Given the dif-
ficult outlook for the European economy,
Ford expects its European losses to
exceed $1 billion for the year (it has lost
$553 million in the first half).
Chrysler has minimal European sales.
In conjunction with its agreement with
Fiat, Chr ysler terminated its dealer
agreements in the region. Beginning in
June 2011, Fiat became the distributor
for Chrysler products in Europe.
(For our views on the effect of a hard
landing in Europe please see The Credit
Overhang: A Protracted European
Recession Could Hur t Some U.S. Auto
Sector Ratings, Aug. 2, 2012.)
Brazil: Brazil represents a significant
market for U.S. automakers. With sales of
about 2.7 million personal vehicles in
2011, Brazils auto market is larger than
Frances but smaller than Germanys. We
assume sales will rise in the very low
single digits year over year in 2012.
Brazilian economic growth and currency
exchange rates are key, as tariffs and
prospective capacity additions are likely
to pressure automaker margins even if
sales riseand especially if they dont.
GM reported that it had the No. 3
market share in Brazil, at 16.9% in the
first half of 2012, down from 17.5% year
over year. GMs South American opera-
tions reported about $64 million of EBIT
in the first half of 2012, down year over
year because of higher costs and lower
wholesale volumes. The EBIT margin
was 1.6%, down from around 3.1% in the
same period of 2011.
Fords pretax margin in Latin America
decreased substantially in the first half of
2012, to 1.2% from 9.1% year over year.
Higher costs, lower sales volumes, and
unfavorable exchange rates accounted
for these lower margins. Ford estimates
that its combined first-half market share
in the region was 9.4%, roughly equal to
its 9.5% share in the year-earlier period.
Chrysler has little exposure in Brazil,
but under its agreement with Fiat, it has
focused on strategies to benefit from Fiats
longstanding presence in the country.
More broadly in Latin America, a
series of circumstances (including eco-
nomic slowdown and cross-border cur-
rency valuations) has led to changes in
the rules on local content and tariffs in
and between Brazil, Mexico, and
Argentina. We think these rules will
likely reduce, to a certain degree, trade
among countries as tariffs on imports are
temporarily raised and quotas are in
place. Many auto manufacturers,
including GM and Ford, have manufac-
turing footprints that have evolved
around free-trade agreements and so
when costs or restrictions are added to
trade flows, the manufacturing footprint
is less efficient. On the other hand, many
rated automakers in Brazil have local
production that has benefited from tax
incentives. We plan to monitor develop-
ments between these three countries to
gauge any net unfavorable ef fect on
automaker profits in the large Brazilian
market in particular.
Favorable volume and costs in North
America have resulted in significant
profitability, supporting weak results
in some other markets
All three U.S. automakers are now prof-
itable to var ying degrees in North
America (see table 4).
We believe the main reasons for the
return to profitability are dramatic reduc-
tions in fixed costs, combined with a sus-
tained rebound in production volumes and
better inventory and incentive manage-
ment. Even with some higher structural
costs (i.e., those that typically dont directly
vary with production, such as fixed labor,
pension, and product development costs)
we believe that all three automakers will
remain solidly profitable in North America
in 2012 and 2013. Risks to our expectations
include economic contagion from Europes
sovereign debt crisis or a steep decline in
Chinas economic growth hurting the U.S.
sales recovery. A loss of industry discipline
on production and inventory could exacer-
bate these conditions.
General Motors: GM announced con-
solidated net income of $3.2 billion for
the first half of 2012 and the first-half
North American adjusted EBIT margin
was 7.7%, about the same as in 2011.
The global adjusted EBIT margin in the
first half was 3.7%, down from 4.4% over
the same period in 2011. We believe
GMs consolidated global automotive
operations should generate mid-single-
digit adjusted EBIT margins. GMs
European operations lost around $600
million in the first half of 2012, though
we assume that the company will be
cash flow positive overall in 2012 despite
European losses.
Ford: The automaker announced a
consolidated pretax profit of $3.6 billion
for the first half, down from $5.4 billion
for the first half of last year. Fords global
automotive operations produced $2.4 bil-
lion in pretax profit in the first half (down
about $2.5 billion year over year) despite
market share declines in most regions.
In the first half of 2012, the automo-
tive operating results in North America
were positive as wholesale volume, rev-
enue, and operating profit and margin
were all higher than 2011. We assume
full-year pretax profits and operating
margins in this region will remain solid,
reflecting higher volumes and a competi-
tive cost structure. Fords European oper-
ations lost $553 million in the first half,
and we expect losses for the full year.
Chrysler: Chrysler reported a first-half
2012 net profit of over $900 million and
an EBITDA margin of 8.5%. We expect
that Chryslers recent profitability in
North America will continue, even if
margins dont improve.
Government ownership of
GM is not a rating factor
We view GM as a government-related
entity (GRE) under our criteria because
of the U.S. Treasurys current partial
ownership. However, we continue to
view the link between GM and the U.S.
Treasury as limited because we expect
the Treasurys ownership position to
decline over time. Our BB+ rating on
GM ref lects our opinion of the
automakers stand-alone credit profile
because we believe the likelihood of
government support is low.
A Comparison Of Financial
Risk Fundamentals
All three companies have solidified their
financial risk profiles over the last year
despite a worsening market in Europe in
the case of GM and Ford. These two com-
panies are also making further moves to
reduce their pension obligations. We view
GMs and Fords financial risk profiles as
significant and Chryslers as aggressive.
Cash flow adequacy: North America
is the primary source of cash flow
We think the ability to generate solid
cash flow seems sustainable as long as
U.S. sales and production remain at or
above recent levels.
Still, although all three automakers are
now generating cash in their automotive
operations, the volatility of cash flows
remains a risk, in our view. U.S. vehicle
sales and production are likely to become
volatile again, but we believe the compa-
nies would cut production to prevent
excess inventory. Still, automakers typically
use cash when vehicle production falls
because the payment of accounts payable
from past production must be repaid, but
cash from current receivables (production)
is lower. Alternatively, efforts to keep pro-
duction lines running in the face of falling
demand can lead to increasing incentive
activity and diminished margins due to
lower average selling prices.
In 2011, GM generated $1.2 billion in
automotive operating cash flow, lower
(Mil. $) Q1 2010 Q2 2010 Q3 2010 Q4 2010 Q1 2011 Q2 2011 Q3 2011 Q4 2011 Q1 2012 Q2 2012
General Motors Co.
North American revenues 19,286 20,266 20,676 22,807 22,110 23,128 21,884 23,111 24,176 22,900
North American pretax profit (after special items)* 971 1,456 1,987 701 2,876 2,249 2,195 2,119 2,303 1,965
Special items (123) 0 0 (324) (1,483) - - 622 612 -
North American pretax profit (before special items) 1,094 1,456 1,987 1,025 4,359 2,249 2,195 1,497 1,691 1,965
Pretax margin before special items (%) 5.7 7.2 9.6 4.5 19.7 9.7 10.0 6.5 7.0 8.6
Ford Motor Co.
North American pretax profit (after special items) 1,123 1,669 1,555 547 1,820 1,742 1,456 932 1,884 1,958
Special items (30) (229) (33) (123) (24) (166) (94) 43 (249) (52)
North American pretax profit (before special items) 1,153 1,898 1,588 670 1,844 1,908 1,550 889 2,133 2,010
Pretax margin before special items (%) 8.2 11.2 9.8 3.9 10.3 9.8 8.6 4.5 11.4 10.1
Chrysler Group LLC
North American pretax profit (after special items)** (162) (139) (45) (167) 160 238 259 275 506 541
Special items (10) (26) 24 (36) 20 48 49 39 33 52
North American pretax profit (before special items) (152) (113) (69) (131) 140 190 210 236 473 489
Pretax margin before special items (%) (1.6) (1.1) (0.6) (1.2) 1.1 1.4 1.6 1.6 2.9 2.9
*North American pretax profitNorth American EBIT minus total interest expenses, net. Overall special items as North American-specific number not available. Effective Q2
2010, Ford no longer reports special items by geographic segment. Amount allocated to North America Standard & Poors estimate. Represents total Chrysler sales, as no explicit
regional classification givenNorth America represents 90% of Chryslers sales. **Pretax profitnet income/loss plus/minus income taxes. Includes restructuring, employee
benefit, and VEBA-related items.
Source: Company reports and Standard & Poors estimates.
Table 4 | Quarterly Revenue And Profit Progression For GM, Ford, And Chrysler
than in 2010 due to increased capital
expenditures. We expect the company to
generate positive cash flow in its global
automotive operations of at least $2 bil-
lion in 2012 (before any voluntary pen-
sion contributions).
We expect Ford to generate positive
cash flow in its global automotive opera-
tions of at least $2 billion to $3 billion,
roughly equivalent to about 10% of esti-
mated adjusted automotive and postre-
tirement debt in 2012.
Chryslers reported FOCF for 2011
was $1.6 billion, after capital spending of
$3 billion. We expect the company to
generate at least $1 billion in positive
cash flow in 2012. For the first half it was
$2.6 billion; Chryslers guidance for the
year is for more than $1 billion.
Capital structure/Asset protection
All three companies have manageable
debt burdens now for the ratings, but
some further debt reduction is likely over
time. The improvement in debt and
debtlike obligations has occurred for
three main reasons:
The 2007 health care deal with the

UAW became effective in early 2010,
eliminating a large portion of post-
retirement health care obligations.
UAW managed trusts, rather than the
U.S. automakers, are now responsible
for funding postretirement health
care benefits.
The companies have reduced debt

(including pension funding) from cash
flow, excess cash balances, and debt
exchanges.
GM and Chrysler have reduced debt

from bankruptcy proceedings.
Unfunded pension obligations for
defined benefit plans remain a major
debtlike obligation for the U.S.-based
automakers. Still, they have made
progress regarding this liability, notwith-
standing a lower discount rate that raises
the liability. All three automakers have
faced the same difficult conditions as
other U.S. corporations with such pen-
sion plans: lower discount rates and
volatile market returns.
General Motors: We consider GMs cap-
ital structure as leveraged because the
company still has significant unfunded
pension and retiree liabilities, even if bal-
ance sheet debt is relatively low.
As part of its IPO, GM sold mandato-
rily convertible preferred stock (which
we view as equitylike) and has reduced
its pre-IPO series A preferred equity
(which we view as debt-like).
Ford: We view Fords capital structure
as leveraged because the company still
has significant unfunded pension and
retiree nonpension liabilities, which were
about $22 billion as of Dec. 31, 2011,
even as Ford reduced balance-sheet debt
by $6 billion in 2011. Balance-sheet debt
was about $14.2 billion as of June 30,
2012. Unlike its other Michigan-based
competitors, Ford is using U. S.
Department of Energy (DOE) loans over
the next few years and has now drawn
fully on the $5.9 billion loan facility with
the DOE.
Ford remains in a solid net cash posi-
tion ($9.2 billion as of June 30) but is not
in a net cash position when factoring in
the postretirement obligations. The com-
panys book equity was $17 billion on
June 30, up from $15 billion on Dec. 31,
2011, which was the first time it had pos-
itive book equity in several years.
Chrysler: We view Chryslers capital
structure as more leveraged than Fords
or GMs because the ratio of the
adjusted companys debt and debtlike
obligations to EBITDA was 4.6x at the
end of 2011, compared with about 3.6x
for GM and 3.5x for Ford. Chrysler, like
the other domestic automakers, still has
significant unfunded pension and
unfunded retiree liabilities. We do not
expect it to undertake an IPO in the near
term, based on company statements.
The company moved into a net cash
position on June 30, 2012, but may not
be able to sustain that into 2013.
Liquidity
We view all three automakers liquidity as
adequate under our criteria. We focus on
bank lines and cash balances as the main
sources of liquidity (most automakers
have long tended to carry a large amount
of cash). While automakers may be able
to extract cash from working capital when
production is increasing because they
receive cash faster than they need to pay
it to their suppliers, the reverse is typically
true when production falls, and these out-
flows can be massive (see table 5).
Financial policies
We believe all three companies remain
committed to less financial risk than was
the case in the pre-2008 era. Some com-
panies have been more explicit than
others. Ford has said that further debt
reduction is an objective, setting its mid-
decade debt target at $10 billion, versus
$14.2 billion as of June 30, 2012.
We believe that all three companies
also seek to have their pension plans
closer to fully funded. In the first-quarter
2012, Ford contributed $1.1 billion to its
plan, and we assume it will contribute a
total of about $3.8 billion in 2012, which
we would view as equivalent to debt
reduction. The company also announced
plans to of fer lump-sum payouts to
salaried retirees and former employees
to settle their pension obligation. We
wouldnt expect this to change the
unfunded amount materially, but
because it would reduce assets and lia-
bilities, we believe it could be a positive
over time.
In June, GM announced it would ter-
minate its U.S. salaried pension plan and
transfer existing active employees to a
new, separate plan. The company will
offer either actuarially determined lump-
sum payouts or an equivalent annuity to
salaried retiree and certain for mer
employees to settle its pension obliga-
tions. We view these actions as positive,
and although we do not expect the pro-
posal to materially change the net
unfunded amount, it will reduce assets
and liabilities significantly.
Each company is building an
improved track record even with unfa-
vorable conditions outside the U.S. Less
than four years ago, all three were
burning cash in their automotive opera-
tionsalthough so were many other
automakers in that rapidly declining
global economy.
A separate development since 2008
for GM and Chrysler is that both compa-
nies have mostly new management
teams and have made changes to their
boards of directors. In our view, Ford
has the most management continuity,
although it also seems possible that CEO
Alan Mulally could retire in the next year
or so from his current position.
Three Different Approaches To
Auto Finance Operations
Historically, all three automakers owned
and controlled a large captive finance
unit, but today only Ford does. GM and
Chr ysler have taken dif ferent
approaches. GM purchased, rebranded,
and is expanding a subprime auto lender
as GM Financial. Chrysler has not bene-
fited directly from a large auto finance
operation since before the reorganiza-
tion, and we dont expect this to change
anytime soon, but it continues to main-
tain relationships that are helping cus-
tomers finance purchases and leases.
The ability to provide competitive
financing directly or indirectly to retail
consumers retail and dealers (wholesale
financing for inventory that the dealers
hold for sale) is a crucial aspect of the
sales process for all automakers.
Most dealers are not liquid enough to
purchase their vehicle inventory out-
right. Automakers provide sales incen-
tives to dealers, along with wholesale
financing. The arrangement usually ties
repayment of this floorplan financing
to the sale of the vehicle. For con-
sumers, the finance function provides
loans and leases.
As sales recover, the need to increase
financing capacity has increased and
conditions in the important auto asset-
backed securities (ABS) market have
been robust this year.
General Motors
GM sold its finance arm, GMAC LLC,
several years ago. Now, it relies on its
purchased subprime lender General
Motors Financial Co. Inc. (BB/Stable/;
formerly AmeriCredit Corp.), its former
unit Ally Financial Inc., and other banks.
We believe GM will continue to
expand the GM Financial portfolio
(assets were $14.6 billion as of June 30),
perhaps into floorplan and leasing. The
company disclosed in August that it has
made a bid for Ally Financials interna-
tional operations, which, if successful,
could more than double GM Financials
consolidated assets. In March, the com-
pany acquired GMAC Venezuela from
Ally Financial for $29 million. While in
our view this process would require cap-
ital redirection and entail some execu-
tion risk, it would further move GM back
toward a more traditional captive model,
albeit at a still smaller scale than Ford
Motor Credit. Separately, we believe
residual values will remain volatile and a
risk to GMs future results as GM
Financial expands leasing.
We consider GM Financial to be a
strategically important subsidiary of
GM, but we do not yet equalize the rat-
ings. Our belief that GM Financial pro-
vides its parent with a dedicated source
of subprime and lease financing for the
purchase or lease of new GM vehicles in
the U.S. and Canada supports the strate-
gically important designation.
Ford
Ford Credit is a traditional captive
finance company with assets of around
$100 billion as of June 30. Ford Credits
results are benefiting from the industry-
wide strength in used vehicle prices
(which leads to lower cost lease resid-
uals) and from reduced credit losses as
consumer credit quality stabilizes at
many financial institutions. We believe
residual values will remain volatile and a
risk to Ford Credits results. Ford Credit
reported net income of $3 billion in
2011. We expect that earnings will con-
tract in 2012, while still remaining prof-
itable and capable of sending cash to its
parent. In our view, earnings will decline
because the company will be unable to
materially shrink its reserve for loan loss,
and net lease revenues also may fall.
Chrysler
We view Chryslers lack of a captive
finance unit as a strategic complication,
since various third-party financial institu-
tions provide financing (including lease
financing) for the majority of consumers,
as well as for the companys dealers. We
understand that each financial institu-
tion, rather than Chrysler itself, sets the
lending standards. The moderation of
credit losses, due to the stabilization of
consumer credit quality, is boosting the
financial results of the companys finan-
cial ser vices partners. Some lease
residual risk (mainly vehicles with daily
rental companies) is the responsibility of
Chrysler, so we believe residual values
will remain a factor in the companys
future results.
Still, we do not believe that any lack of
financing availability has significantly
constrained Chryslers sales, and adding
As of June 30, 2012
(Bil. $) General Motors Co. Ford Motor Co. Chrysler Group LLC
Automotive debt 10.2 14.2 12.5
Current automotive debt maturities 1.4 1.3 0.2
Unfunded pension and OPEB year-end 2011 32.7 22.0 9.2
Adjusted total debt to EBITDA (year-end 2011) (x) 3.6 3.5 5.3
Cash 33.8 23.7 12.1
Bank linesavailability 5.9 10.2 1.3
Cash and available bank lines as % of 2011 revenues 26.7 24.9 24.4
Automotive cash flow 1H 2012 2.0 1.7 2.6
Goodwill and intangibles 37.6 0.1 4.7
Book equity 36.1 17.1 (5.1)
Market capitalization* 35.9 38.7 N/A
Market capitalization/book equity (%) 99.6 226.4 N/A
GM cash flow excludes termination of wholesale advance agreement with former unit. *As of Sept. 11, 2012.
N/ANot available.
Source: Company reports and Standard & Poors estimates.
Table 5 | Selected Capital Structure And Liquidity Comparisons
a captive operation would not be a
panacea, in our view, since it would
require substantial capital redirection
and entail execution risk.
Credit Quality Continues To
Improve, But Questions Remain
Credi t qual i t y for GM, Ford, and
Chrysler has been mostly stable since
2011. The fall 2011 UAW contracts
were consistent with the profitability
l evel s that the previ ous agreement
supported. The Canadian auto worker
contract is being renewed this fall and
we assume that these agreements will
be renewed without any lengthy labor
disruptions. Ford and GM face chal-
lenges outside of North America, par-
ticularly in Europe, and consistent with
that view, our positive outlook for Ford
focuses on late 2013 at the earliest for
an upgrade.
Standard & Poors rating outlooks
General Motors: Our rating outlook on
GM is stable, reflecting our view that
GMs performance will remain consis-
tent with our assumptions for the rating
over the next year, including:
Automotive-related FOCF of about

mid-single-digit percentage levels of
debt (excluding voluntary pension
contributions);
Prospects for debt to EBITDA of

about 3x;
Automotive EBIT profit margins in the

mid-single-digit area for North
America;

remaining at about $30 billion;
GMs continuing ability to cope suc-

cessfully with the evolving competitive
structure of the global auto industry,
including the avoidance of large losses
and cash use in Europe; and
GM Financials continuing profitability.

The outlook on GM is stable, and we
do not expect to raise our rating in light
of a weak economic outlook. However,
we could raise our rating if, among other
things, the gradual improvement in light-
vehicle demand continues, and GMs
prospects for generating free cash flow
and profits in its automotive manufac-
turing business continue to solidify.
Ford: Our positive rating outlook on
Ford ref lects our view that we could
raise our corporate credit rating on
Ford to investment-grade within 18
monthsalthough this is not likely
before late 2013. The most important
factor in an upgrade to investment-
grade woul d be Fords abi l i ty to
improve the balance of profitability
across regions. And we would expect
Ford to be on track for sustainable prof-
itability outside of North America, par-
ti cul arl y i n Europeal though we
believe results in Europe will worsen
before improving. Other factors that
would support a higher rating include:
Ford sustai ns debt to EBITDA at

about 2.5x;
Automotive-related operating free cash

flow remains at about 15% of debt;
Pretax automotive profit margins in

North America reach the upper-single-
digit percentage area and the mid-
single-digit area globally;

remains greater than $30 billion;
U.S. consumers continue to demon-

strate enthusiasm Ford products;
Ford successfully copes with the

evolving competitive structure of the
global auto industry and develops rea-
sonable prospects for profitability in
developing markets such as China;
and
Ford Credit continues to be profitable

and demonstrates underwriting stan-
dards consistent with an investment-
grade rating.
Chr ysl er: Our rating outlook on
Chrysler is stable. We assume operating
margins (before depreciation and amor-
tization) will be around 8%. This
assumption incorporates our view that
Chryslers retail and fleet share in the
U.S. is at least 10% (it was 11.4% for the
first eight months of 2012 for light vehi-
cles, according to Wards AutoInfoBank).
We anticipate that the gap between
the ratings on Fiat and Chrysler (cur-
rently one notch higher for Fiat) will
not increase but could decrease. This
could occur with additional progress in
i ntegrati on of the two enti ti es or
because of weaker performance by one
or both companies.
Although the outlook on Chrysler is
stable, we could raise the rating in the
next year if, among other things:
The gradual improvement in light-

vehicle sales accelerates more than
we expect; and
The companys prospects for gener-

ating free cash flow and profits signifi-
cantly exceed our assumptions, per-
haps because of the continued
benefits of Fiats involvement. For
example, we could consider raising
our Chrysler rating if we gain confi-
dence that its free cash generation in
2012 would be over $1 billion (equiva-
lent to around 5% of estimated
adjusted debt).
We currently do not expect an IPO
of Chr ysl er i n the near future, but
even so, we would not expect one to
change the rating. We would, however,
review this assumption if an eventual
IPO led to a substantial reduction in
Chryslers debt.
Amid Global Uncertainty, Credit
Quality Will Rely Most On The
U.S. Market
All three U.S. automakers have returned
to profitability in North America, and
our ratings on the three are higher than
they have been in several years. We
think that the ability to be profitable
and generate cash at sales levels com-
fortably above scrappage, in combina-
tion with debt reduction, supports the
current ratings. There are many simi-
larities, but also differences, among the
companies strategies and prospects.
But one common theme, in our view, is
that success in North America will con-
tinue to be the main hedge against any
downside and better results (particu-
l arly i n Europe) wi l l be key to any
upside in credit quality. CW
New York (1) 212-438-7808
Dan Picciotto, CFA
New York (1) 212-438-7894
Michael E. Durand
New York (1) 212-438-5655
General Motors
SPECIAL REPORT
FEATURES
G
rowing global economic risks will likely slow earnings growth
among U.S. auto suppliers for the remainder of this year and
into 2013, but most should sidestep any significant
deterioration in their credit quality. Following the Great Recession,
these companies benefited from higher auto production after the
multidecade lows of late 2008 and early 2009. Most have
successfully reduced their break even sales volumes while
improving their credit ratios, building up their cash balances,
and refinancing debt. Since August 2009, weve raised our
ratings on nearly 75% of the rated U.S. auto suppliers and have
assigned stable outlooks to most (see charts 1 and 2), but our ratings on
about one-third are still lower than in March 2008.
U.S. Auto Suppliers
Could Largely Weather
Slowing Global
Economic Growth
Overview
We think most U.S. auto suppliers can weather growing macroeconomic risks
with little impact on their credit quality.
A prolonged downturn lasting two or more years would affect auto suppliers
earnings and ratings, especially for commodity parts suppliers with limited
geographic or customer diversity or those with specific operational challenges.
However, the extent and depth of downgrades would likely be less severe than in
2008-2009.
The steps U.S. auto suppliers have taken
to strengthen their businesses have
given most companies some cushion in
their ratings under our current base-
case scenario. Weve also evaluated
how well this cushion would hold up
under the i mpact of a hypotheti cal
downside scenario. We believe certain
U.S. auto component companies could
face downgrades or negative outlook
revisions if a marked downturn, espe-
cially in Europe, lasts two yearspar-
ticularly if economic contagion spills
over to other regions. Companies that
are most at risk for downgrades are
suppliers of commodity parts with lim-
ited geographic or customer diversity or
those with specific operational chal-
l enges, such as l arge restr ucturi ng
charges related to underperforming
assets or earnings pressure from unre-
covered raw-material cost hikes.
Our Baseline Scenario For
U.S. Auto Suppliers
We expect our ratings and outlooks on
auto suppliers to hold up under our
baseline economic scenario, which calls
for continued improvement in North
American auto sales and production (see
table 1), a gradual recovery in sales and
production in Europe following a
decrease in new-vehicle registrations of
at least 6% in 2012, and some industry
growth in South America and Asia.
Under our base case, revenue growth
for large (Tier 1) auto suppliers (see
t abl e 3) shoul d remai n posi tive, on
average, into 2013. Profit margins for
these companies have been solid, and
credi t measures are meeti ng or
exceeding our expectations for nearly
all issuers with stable outlooks. This
should provide some cushion against
tougher macroeconomic conditions
affecting the industry.
We assume auto suppliers revenues
will grow in the mid- to high-single-digit
percentages in 2013 (see tabl e 2). A
majority of the U.S. auto suppliers derive
most of their revenues (with a median of
about 60% of sales) from North
America, while others are more geo-
graphically diverse, with revenues that
are more aligned to global production
A- BBB+ BBB BB+ BB BB- B+ B B- CCC+ D
0
1
2
3
4
5
6
7
8
9
(No. of issuers)
*List only includes a constant set of suppliers that we have rated since March 2008.
As of March 28, 2008 As of Aug. 5, 2009 As of Sept. 19, 2012
Chart 1 U.S. Auto Supplier Long-Term Rating Distribution*
Positive Stable Negative Watch Pos Watch Neg
0
5
10
15
20
25
(No. of issuers)
*List only includes a constant set of suppliers that we have rated since March 2008.
As of March 28, 2008 As of Aug. 5, 2009 As of Sept. 19, 2012
Chart 2 U.S. Auto Supplier Outlook/CreditWatch Distribution*
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5,000
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15,000
20,000
25,000
30,000
35,000
(Mil. $)
(1,500)
(1,000)
(500)
0
500
1,000
1,500
2,000
2,500
3,000
(Mil. $)
March 2008 to June 2012
*See table 3 for list of suppliers.
Source: Company reports.
EBITDA (right scale) Free oper. cash flow (right scale) Revenue Debt
S
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Chart 3 Aggregate Quarterly Data For 11 U.S. Auto Suppliers*
levels. Hence, despite the bleak outlook
for Europe, our base-case estimate
assumes that worldwide revenues
improve somewhat in 2013. The exact
rate of growth for some suppliers will
depend on the pace of North American
auto production, and for others on the
extent of recovery in commercial-truck
demand and the replacement market.
Because of the more cyclical nature of
the U.S. commercial-truck market, we
see limited rating upside for suppliers to
this sector given the increasingly hazy
outlook for global heavy truck markets in
the second half of 2012 and into 2013.
For companies serving the auto parts
aftermarket (e.g., parts and service, or
other products that tend to be less
cyclical), we estimate that revenue
growth will remain about flat for the next
12 months. Demand arising from the
aging vehicle population (almost 11
years) will only partly offset regional
economic sluggishness and lower-than-
historical growth in miles driven.
Because of this dynamic, financial per-
formance of some aftermarket compa-
nies has been disappointing and has
resulted in some negative rating actions.
We estimate growth in EBITDA mar-
gins will be modest (less than 75 basis
points) this year and next. Auto suppliers
will likely increase capacity utilization
and thus benefit from economies of
scale. But they could also face rising pro-
duction costs as they ramp up capacity if
the industrys recovery is faster than
anticipated. Suppliers costs could rise
for some or all of their main raw mate-
Baseline
% change
2009 2010 2011 2012e 2013f 2014f
Real GDP (3.10) 2.40 1.80 2.10 1.80 2.80
Consumer spending (1.90) 1.80 2.50 1.90 2.20 2.50
Equipment investment (16.40) 8.90 11.00 8.30 7.00 7.20
Nonresidential construction (21.10) (15.60) 2.70 10.30 0.60 5.70
Residential construction (22.70) (3.90) (1.60) 11.90 11.00 20.20
Federal government 6.10 4.50 (2.80) (2.80) (3.10) (3.00)
S&L government 2.20 (1.80) (3.40) (1.70) (0.80) 0.10
Exports (9.10) 11.10 6.70 4.00 4.40 5.40
Imports (13.50) 12.50 4.80 3.80 3.80 4.70
CPI (0.30) 1.60 3.10 2.00 1.60 1.90
Core CPI 1.70 1.00 1.70 2.20 1.90 2.10
Nonfarm unit labor costs (1.40) (1.10) 1.90 1.20 2.40 2.10
Nonfarm productivity 3.00 3.10 0.70 0.90 0.40 1.00
Level
Unemployment rate 9.30 9.60 8.90 8.20 8.00 7.70
Payroll employment (mil.) 130.80 129.90 131.40 133.20 135.00 137.30
Federal funds rate 0.20 0.20 0.10 0.10 0.10 0.30
10-yr. T-note yield 3.30 3.20 2.80 1.80 2.10 3.00
AAA corporate bond yield 5.30 4.90 4.60 3.60 4.00 4.70
Mortgage rate (30-year conventional) 5.00 4.70 4.50 3.70 3.50 4.50
3-month T-bill rate 0.20 0.10 0.10 0.10 0.10 0.20
S&P 500 Index 947.00 1,139.00 1,269.00 1,372.00 1,475.00 1,481.00
S&P operating earnings ($/share) 56.86 83.77 96.44 101.86 107.41 119.67
Current account (bil. $) (382.00) (442.00) (466.00) (516.00) (443.00) (509.00)
Exchange rate (major trading partners) 92.60 89.80 84.60 88.20 92.50 90.00
Crude oil ($/bbl, WTI) 62.00 79.00 95.00 92.00 90.00 86.00
Saving rate 4.70 5.10 4.30 3.90 3.50 4.00
Housing starts (mil.) 0.55 0.59 0.61 0.76 0.93 1.24
Unit sales of light vehicles (mil.) 10.40 11.60 12.70 14.10 14.80 15.60
Federal surplus (FY unified, bil. $) (1,416.00) (1,294.00) (1,297.00) (1,133.00) (846.00) (691.00)
eEstimate. fForecast. FYFiscal year.
Table 1 | S&P Economic Outlook August 2012
rials, including steel, aluminum, rubber,
lead, and resins. Contractual price reduc-
tions from customers or automakers that
are trying to offset weaknesses (mainly
in Europe) will also remain a damper on
revenue growth.
By mid-2010, EBITDA margins for
auto suppliers were higher than they
were before the recession, but they have
since dipped. After dropping from these
peaks (which we expected), margins
have remained roughly flat, at 8% to 9%,
in recent quarters. These levels seem
more sustainable than the mid-2010
highs (see charts 3 and 4). But we expect
some suppliers selling value-added prod-
ucts, such as BorgWarner Inc., Harman
International Industries Inc. , TRW
Automotive Inc., Dana Holding Corp.,
and Tenneco Inc. , to consistently
achieve double-digit EBITDA margins,
given what we view as their resilient
market positions within specific end-
markets and their reasonable prospects
for maintaining cost controls and finan-
cial flexibility.
Overall, ongoing (if slower) revenue
growth suppor ts credi t qual i ty for
most of the large auto suppliers we
rate ( see t abl e 3) . But a si gni f i cant
recessi on i n 2013 (wi th auto sal es
declines) is still a possibility and would
pose downside risks to our ratings,
especially for suppliers in the B cate-
gory, and potential outlook revisions
to negative on others.
Economic Risks Are Growing
Europe remains the primary area of risk
for the global economy, in our view. Our
baseline forecast for Europe, the Middle
East, and Africa calls for essentially flat
GDP through the end of 2013 for the
whole of Europe, with contractions of
more than 2% in Italy and Spain. We
bel i eve the ri sk that European
economi es wi l l fal l i nto a genui ne
double-dip recession next year is high,
at 40%. The European Economic and
Monetary Union (eurozone) accounts
for about 36% of median sales for the
U.S. auto suppliers we ratea signifi-
cant but manageable percentage, in our
opinion, because of their customer mix
in the region. Still, a more severe euro-
zone recession or sovereign crisis that
spills over into the global economy
poses risks for U.S. auto component sup-
pliers performance.
A serious economic slowdown in
China (meaning low-single-digit GDP
growth) is another risk factor. We expect
Chinas GDP growth to decline more
than one percentage point this year, from
9.2% in 2011. Chinas influence on the
U.S. auto component sector will likely
continue to grow, although direct sales
to China are still relatively lowtypi-
cally less than 10% of overall sales for
the rated auto suppliers. Other emerging
economies, like Brazil and India, have
also slowed this year, which so far has
not had a significant impact on the sup-
pliers we rate.
In July, our U.S. deputy chief econo-
mist raised the odds of a U.S. recession
to 25%, from 20% in February. The revi-
sion reflected worries about the euro-
zone debt crisis, the potential for a sub-
stantial slowing of Chinas economy,
and the U.S. governments possible year-
end fiscal cliff. Although the new odds
are still better than the 40% likelihood
we had assumed in August 2011, they
still dont bode well for the sectors
demand prospects.
Now, with the risks of a global eco-
nomic slowdown continuing, and with
few signs that the event risks we cited
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(%) (x)
March 2008 to June 2012
eEstimate. fForecast. *See table 3 for list of suppliers. Downside scenario.
Quarterly EBITDA margins (adjusted) Debt to EBITDA (right scale)
0.0
1.0
2.0
3.0
4.0
5.0
6.0
7.0
8.0
Chart 4 Aggregate Profitability And Leverage Trends For 11
U.S. Auto Suppliers*
2012 2013 2014 2015

0
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2,000
3,000
4,000
5,000
6,000
7,000
8,000
(Mil. $)
*As of Dec. 31, 2011 (updated for refinancing completed by Aug. 31, 2012).
$3,533
$6,773
$2,033
$1,539
Chart 5 Debt Maturities For U.S. Auto Suppliers
are cl oser to bei ng resol ved, were
revisiting a question we first asked
nearly a year ago (see What A Double-
Di p Recessi on Coul d Mean For Aut o
Suppliers, published Nov. 7, 2011, on
Rat i ngsDi rect , on t he Gl obal Credi t
Portal): How would U.S. auto suppliers
fare if hard times return?
Our Downside Scenario
To answer this question, we updated our
hypothetical downside scenario for 2013,
in which we assume a 10% to 15%
decline in revenue and a 150- to 200-
basis-point drop in adjusted EBITDA
margins from our 2012 expectations for
a sample group of 11 U.S. auto suppliers
(see table 3). We believe these public
companies are the most representative
of the sectors overall performance
during the downturn. The drop in rev-
enue is consistent with our hypothetical
downside assumptions for U. S. ,
European, and Chinese auto sales/pro-
duction and, to a lesser extent, with
potential appreciation in the U. S.
dollarparticularly against the euro
which would translate into fewer U.S.
dollars for foreign sales. We based our
EBITDA decline estimate on trends
weve observed during past downturns,
and we view it as a conservative assess-
ment (given auto suppliers subsequent
cost reductions).
In our economists pessimistic fore-
cast, for instance, U.S. auto sales might
fall 13% to 12.9 million units in 2013
(compared with our current baseline
forecast of 14.7 million units), which
would likely weigh on suppliers earn-
ings and credit quality (see table 4). In
our downside scenario for 2013, we esti-
mate that sales and production would
decl i ne further i n Europe and stay
roughly flat in China.
Most, but not all, U.S. suppliers derive
the majority of their revenues from
North America. Europe accounts for
much of the remainder, ranging from the
single-digit percentages for some sup-
pliers to more than 50% for others, and
most derive 10% to 15% revenues from
Asia/Pacific. We believe profit margins
for suppliers with significant sales in
Europe will remain tight through 2013,
primarily because of tough competition
resulting from excess production
capacity and weak economies.
Companies such as TRW and Harman,
which benefit from mainly supplying to
European carmakers with heavy exports
to Asia (such as BMW and VW), will
likely feel less pressure from the down-
Rating* Outlook* Business risk profile Financial risk profile
BorgWarner Inc. BBB+ Stable Satisfactory Intermediate
Johnson Controls Inc. BBB+ Stable Satisfactory Intermediate
Harman International Industries Inc. BBB- Stable Satisfactory Intermediate
TRW Automotive Inc. BB+ Positive Fair Intermediate
Lear Corp. BB Stable Weak Intermediate
Dana Holding Corp. BB Stable Weak Significant
Tenneco Inc. BB Stable Weak Significant
Stoneridge Inc. BB- Stable Weak Significant
American Axle & Manufacturing Holdings Inc. BB- Stable Weak Aggressive
Federal-Mogul Corp. B+ Stable Weak Aggressive
Exide Technologies B Negative Vulnerable Aggressive
*As of Sept. 18, 2012
Table 3 | 11 Rated U.S. Auto Suppliers
Base-case Downside
U.S. light-vehicle sales growth, 2013 (mil. units) 14.8 (up 5% year over year) 12.9 (down 8.5% year over year)
U.S. light-vehicle production, 2013 up 4.6% year over year 10%15% decline year over year
Europe light-vehicle sales growth, 2013 Roughly flat 8%10% decline year over year
Europe light-vehicle production, 2013 up 3.8% year over year 10% decline year over year
China light-vehicle sales growth, 2013 up 14.7% year over year 0%5%
China light-vehicle production, 2013 up 15.2% year over year Flat
Estimate for aggregate 2013 revenue increase, year over year Mid- to high-single-digits 10%15% decline
Estimate for aggregate 2013 EBITDA margins (adjusted) 9.5% 7.5%8.0% (or 25%33% EBITDA decline)
Estimate for aggregate adjusted leverage 2013 About 2.1x About 3.2x
Sources: LMC Automotive (previously, a forecasting division of J.D. Power); Standard & Poors estimates.
Table 2 | Standard & Poors Assumptions
turn in Europe, but could face declining
profits if the Chinese economy (and sales
of foreign brands) slows significantly (see
Implications For The Global Automotive
Sector Of A Hard Landing In China, pub-
lished May 29, 2012). We assume that the
various governments in Europe will not
take strong actions to bolster their light-
vehicle markets or to support capacity
reductions in the sector.
Earnings Prospects Are
Resilient Despite Risks
Despite a shaky global economy and our
assumption of a hypothetical drop in
EBITDA margins (under our downside
scenario), we believe auto suppliers
earnings will likely remain somewhat
resilient. However, their financial poli-
cies may become more shareholder-
friendly before a potential sustained
downturn, which could subsequently
threaten their credit quality.
Under our downside scenario, we esti-
mated EBITDA for each of the compa-
nies in our sample and calculated an
adjusted-debt-to-EBITDA ratio, our stan-
dard measure of leverage. Aggregate
leverage for these auto suppliers would
increase by about 1x. A few low-rated
companies (like Federal-Mogul Corp.
and Exide Technologies) could face
downgrades, but for others, leverage
would still not be significantly higher
than our expectations for the ratings, at
least for companies rated BB or higher.
As such, we believe the impact on credit-
worthiness of a slowdown in 2013 would
be moderate if it lasts for only one year.
Our general view is that this downside
scenario isnt likely to create the same
kind of industr y havoc that ensued
during the Great Recession, as the auto
industr y plummeted. For one thing,
sales of 12.9 million vehicles (in our U.S.
downsi de esti mate) woul d be 24%
above 2009 sal es, and automakers
should be somewhat profitable at that
level. However, the cuts in production
would likely force automakers to use
some cash and test thei r di sci pl i ne
regarding incentives.
A number of companies have argued
that they can be profitable at lower
global production levels, which would
give them greater resilience in a down-
turnan assumption that we think is
reasonabl e. We expect most of the
cost reductions theyve already made
to be permanent because they resulted
from reducing production capacity,
adjusting their manufacturing foot-
prints, or increasing their proportions
of temporary workers, especially in
Europe. Also, because many suppliers
have smaller production plants with
f ewer empl oyees than automaker s
have, closing unprofitable plants is
somewhat easier and comes with less
risk of political resistance.
Generally, through more favorable
contract negotiations, many auto sup-
pliers are now better able to recover
commodity costs (which make up a sub-
stantial portion, 40% to 75%, of their
cost of goods sold) than before the
downturn, which lessens the impact of
price swings. As a result of earlier cost-
cutting and generally better liquidity, we
think most auto suppliers could survive
in our hypothetical downside scenario
although a deeper or longer downturn
would put some at risk.
For auto suppliers in the BB cate-
gory, the ability to negotiate a marked
recession in Europe remains an impor-
tant factor in our analysisespecially
when consi deri ng posi tive rati ng
actions. We expect some suppliers to
of fset some pressure through higher
end-market sales to emerging markets
and through thei r exposure to the
German automakers, given that the
German luxury makers are still bene-
fiting from exports to Asia. Given their
recent track record, we believe many of
these companies are likely to sustain
EBITDA margi ns at or above the
double-digits, expand their global manu-
facturing presence in step with their
automaker customers, and continue
their successful innovation of end prod-
ucts. We also believe suppliers are likely
to gear capital spending toward expan-
sion in China and less toward Europe,
where they are more likely to spend on
restructuring related to high-cost facili-
ties in Western Europe.
Downside Rating Risks Persist
Our downside scenario would likely have
the biggest credit impact on suppliers
that derive a large portion of their rev-
enues from Europe, those that dont par-
ticipate in higher-growth areas, such as
safety and fuel efficiency, and those with
a limited presence in the more stable
aftermarket/replacement components
market. Downgrades may be more likely
for suppliers in the B category, although
our projections of the markets evolution
in late 2013 and 2014 will have a strong
bearing on our rating decisions.
In our downside scenario, the extent
of the declines in profitability and the
overal l i mpact on credi t measures
would vary according to the individual
compani es overal l credi t heal th.
Unfavorable cost structures (with lower
levels of temporary workers in Europe)
and low exposure to premium segments
(with large export potential) would
exacerbate the impact of higher fixed
overheads on low-capacity utilization
rates. For instance, we believe suppliers
that have the most exposure to Peugeot
S.A., Fiat SpA, and Renault S.A., for
which we expect demand to decline
more than the overall industry average,
would be at the greatest risk under our
downside scenario. Most U.S. suppliers
we rate do not have large exposures to
those automakers.
Suppliers that dont have significant sales
in developing economies, where growth
Our downside scenario would likely have the biggest
credit impact on suppliers that derive a large
portion of their revenues from Europe
continued during the last downturn, would
likely experience the worst margin contrac-
tions, as would those with minimal after-
market revenues, which tend to be less
cyclical. Absent any significant consolida-
tion, we believe the financial health of
many smaller companies would remain
fragile and that they would depend on their
Tier 1 customers for periodic financial
assistance in another sharp downturn.
The rat i ng i mpact of per si st ent
higher gas prices on auto suppliers
would vary, in our view. We would not
expect $4-plus gas prices to trigger
si gni fi cant downgrades, as several
companies have attempted to align
t hei r exposure t o gas pri ces by
gearing their products toward fuel-
efficient vehicles. However, suppliers
with significantly higher-than-average
exposure to light tr ucks relative to
passenger cars for the industry could
f ace ear ni ngs decl i nes. Thi s i s a
pot ent i al ri sk f act or f or Cooper-
St andard Aut omot i ve I nc. , Dana
Hol di ngs, and Ameri can Axl e &
Manufacturing Inc. Also, if gas prices
were to rise significantly in 2013, we
believe tiremakers would have trouble
raising prices because tire demand in
As of June 2012
% change
2009 2010 2011 2012e 2013f 2014f
Real GDP (3.49) 3.03 1.74 1.21 (0.03) 1.69
Consumer spending (1.89) 2.03 2.17 1.82 1.33 0.69
Equipment investment (16.02) 14.58 10.42 5.32 2.68 5.74
Real nonresidential construction (21.24) (15.84) 4.55 1.93 (4.91) 4.92
Residential construction (22.54) (4.58) (1.50) 6.61 (5.28) 10.11
Federal government purchases 6.01 4.51 (1.94) (3.03) (3.09) (3.03)
S&L purchases (0.91) (1.80) (2.23) (2.25) (2.06) (0.93)
Total exports (9.41) 11.32 6.67 3.19 (1.18) 4.56
Total imports (13.58) 12.53 4.93 3.08 (0.16) 0.64
CPI (0.32) 1.64 3.14 1.24 0.79 2.34
Core CPI 1.70 0.96 1.66 1.99 1.29 1.83
Nonfarm unit labor costs (0.67) (2.00) 1.61 1.50 2.21 1.05
Nonfarm productivity 2.37 3.99 0.61 (0.10) 0.16 1.33
Exchange rate with major trading partners 4.31 (3.02) (5.89) 7.80 3.18 (3.82)
S&L receipts 0.45 5.68 0.94 (0.77) 1.30 4.97
S&L outlays excl. gross investment 0.73 2.87 2.86 0.06 0.56 3.72
Level
Unemployment rate (%) 9.30 9.60 8.90 8.40 9.10 9.30
Payroll employment (mil.) 130.80 129.90 131.40 132.70 132.20 132.80
Federal funds rate (%) 0.20 0.20 0.10 0.10 0.10 0.10
10-yr. Treasury note yield (%) 3.30 3.20 2.80 1.60 1.70 2.40
AAA bond yield (%) 5.30 4.90 4.60 3.80 4.10 4.60
30-yr. fixed-mortgage rate (%) 5.00 4.70 4.50 3.70 3.80 4.50
3-month Treasury bill rate (%) 0.20 0.10 0.10 0.00 0.00 0.00
S&P 500 Common Stock Index 947.00 1,139.00 1,269.00 1,186.00 1,163.00 1,242.00
S&P 500 Operating Earnings ($/share) 56.86 83.77 96.44 93.58 83.23 95.44
Current account balance (bil. $) (377.00) (471.00) (473.00) (457.00) (408.00) (483.00)
West Texas Intermediate oil price ($/bbl)) 61.69 79.41 95.07 82.06 79.88 96.29
Household savings rate (%) 5.15 5.33 4.65 4.15 3.50 2.96
Housing starts (mil.) 0.55 0.59 0.61 0.67 0.62 0.83
Unit sales, light vehicles (mil.) 10.40 11.55 12.74 13.44 12.93 13.84
Unified federal budget surplus (FY, bil. $) (1,416.00) (1,294.00) (1,297.00) (1,151.00) (920.00) (750.00)
eEstimate. fForecast. FYFiscal year.
Table 4 | Pessimistic Economic Scenario
North Ameri ca woul d drop as con-
sumers cut down on driving.
Sustained higher gas prices could also
challenge our baseline assumption that
transportation cost inflation will be less
of a headwind in 2013 for some parts
distributors, as well as our estimate that
growth for aftermarket suppliers will be
f lat. These companies could suffer if
customers defer short-ter m discre-
tionary maintenance because theyre
driving less.
Overall, if our downside scenario
appears likely to materialize and persist
beyond 2013, the sectors credit quality
will weaken. At a minimum, we would
likely revise some outlooks to negative,
despite the improvements in overall liq-
uidity and the significant cost reductions
suppliers made after the last downturn,
which are still mostly intact.
Debt Maturities And Covenants
Are Manageable, For Now
In our view, refinancing risk is manage-
able for the remainder of 2012 and into
2013, but will grow for several suppliers
toward 2014 and 2015. Less than 10% of
the approximately $40 billion in obliga-
tions we rate in the sector come due
before the end of 2013, with about 17%
maturing in 2014 (see chart 5). With cash
and bank availability on hand, most
issuers in the auto sector will have ade-
quate liquidity to meet their near-term
debt maturities (see Liquidity Descriptors
For Global Corporate Issuers, published
Sept. 28, 2011).
Moreover, most suppliers financial
risk profiles have improved in the past
12 months. When faced with economic
uncertainty, companies are likely to
cut discretionar y expenditures and
shareholder payouts to preserve liq-
uiditywhich we view as key to main-
taining credit quality when economic
pressures grow.
The publ i c debt mar kets are
becoming more accommodating: Our
rated auto suppliers refinanced nearly
$2.7 billion in debt during the first eight
months of 2012, at better rates or
extended maturities. However, some
auto suppliers have credit agreements
that tighten covenants over time, so if
the recovery we expect in our base case
does not occur, they would likely need
to pay down some debt to maintain
adequate headroom.
Moreover, the auto suppliers we rate
B+ or lower could face significant
refinancing risks in 2014, when their
amount of debt maturing more than
triples from that in the previous year.
The state of the capital markets and
investor appetite for auto debt over
the next two year s wi l l be cri ti cal
determinants of auto suppliers refi-
nancing ability.
Uncertainty Is A Risk To Credit
Quality In 2013
Our stable outlook for most companies
in the sector reflects subdued economic
prospects under our base-case forecast
but also acknowledges some cushion
within many companies credit ratios
against weaker-than-expected perform-
ance, thanks to the ongoing rebound in
auto sales and production in the U.S.
Although weve taken almost exclu-
sively positive rating actions on U.S. sup-
pliers over the past three years, we
remain more cautious about the sectors
credit quality after 2012, notwith-
standing the fact that credit ratings on
most companies still havent returned to
pre-recession levels. In fact, more than
one-third of the 35 global auto suppliers
(that weve rated since March 2008) still
have lower ratings than they had in
March 2008. And merger and acquisition
activity cant be blamed: Companies
have invested in small bolt-on acquisi-
tions and joint ventures to break into
fast-growing emerging markets over the
past few years, but no large combina-
tions have occurred.
If a sustai ned gl obal economi c
decline looked to be in the offing, we
would likely lower our ratings on some
suppliers (mostly in the speculative-
grade category), but perhaps not to the
extent that we did in 2009assuming
light-vehicle demand in the U.S. and
Europe showed signs of bouncing back
by early 2014. Downgrades might also
resul t i f l i qui di ty ti ghtens or i f the
downturn seemed likely to last longer
than the last one.
In the meantime, factors that could
challenge our base case and even our
downside scenario include:
An adverse shift in investors risk

appetites and perceptions of the sector;
Lack of discipline by automakers in

controlling production, inventory, and
incentives relative to retail sales;
Commodity price spikes and signs that

suppliers were having trouble recov-
ering the increased costs;
Higher working capital investments

than we cur rently anticipate to
increase inventories;
The adoption of aggressive finan-

ci al pol i ci es t o boost growt h or
meet shareholders expectations,
which could threaten credit quality
if developed economies fall back
into recession;
A prolonged drop in sales, rather than

the decline and recovery that we saw
in 2008-2010 and assume in our 2012-
2013 downside scenario; and
Any serious supply chain disruption

that the industry is not nimble enough
to address promptly.
Overall, we expect that over the next
few years, a continued recovery in auto
sales and demand for light-vehicle com-
ponents is more likely than not. If sales
dont recover, however, we believe many
suppliers are better prepared to weather
a downturn now than in late 2008, in
part because of improved prospects for
their automaker customers.
Still, if global light-vehicle produc-
tion were to decline sharply for several
more years, excess manuf acturi ng
capacity could become an even larger
problem. While this possibility is out-
si de the range of even our cur rent
downside scenario, a further decline in
plant utilization would hurt margins,
thereby worsening key credit meas-
uresand potentially leading to some
downgrades. CW
Nishit K. Madlani
New York (1) 212-438-4070
New York (1) 212-438-7808
Auto Suppliers
M
ore and more, U.S. banks are turning to auto lending as
other areas of consumer finance face low demand and
weak margins. A resurgence in auto purchases and
favorable asset quality are making auto lending a source of
robust asset growth for U.S. banks. Standard & Poors Ratings
Services observed this trend last year (see Several U.S. Banks
Turn To Auto Loans To Help Offset Sluggish Asset Growth, published
June 3, 2011, on RatingsDirect, on the Global Credit Portal); recent
lending volumes have exceeded those of 2008 and 2009, despite
this asset class relatively stable performance through low points
of the consumer credit cycle. We expect that asset quality in the
prime portion of the auto finance industrywhere most of the
bank lending activity occurswill remain solid.
U.S. Banks Affinity For
Auto Loans Continues
Overview
Auto lending continues to attract

U. S. banks as other areas of
consumer finance are facing low
demand and weak margins.
In our view, auto lending could be

an area of profitable growth for
U.S. banks, provided banks do not
sacrifice lending standards to gain
market share.
We think that success in this area

will also depend on the quality of
dealer relationships and service
standards.
However, as lenders compete for market
position, margins and underwriting stan-
dards could weaken slightly, and some
banks could pursue more subprime auto
lending business. At the same time, we
expect that high service standards and
strong dealer relationships will have a
significant bearing on success and could
offset the competitive pressure to make
riskier loans. The net impact that these
trends will have on lenders credit pro-
files will depend on each companys suc-
cess in defending or growing its market
position while ef fectively managing
credit performance.
Loan Performance Is Holding Up
Even As Auto Loan Volumes
Continue To Climb
Strong vehicle sales have contributed to
a 9% year-over-year median increase in
reported retail auto loan balances for
U.S. bank lenders as of June 30, 2012
(see table). This compares with a pro-
jected 11% overall increase in new
vehicle sales in the U.S. in 2012. In first-
quarter 2012, subprime lending as a
share of new U.S. auto financing experi-
enced double-digit growth from first-
quarter 2011, while the prime lending
volume share fell slightly, according to
Experian. The rise in bank auto loan bal-
ances likely reflects increased subprime
lending on the part of some institutions,
among other factors.
So far, auto loan performance has
remained solid even as loan volumes
rise. The ratio of delinquent loans (30
days or more past due) to total loans for
the banks l i sted i n the tabl e fel l to
1.71% in the second quarter of 2012
from 2.23% a year earlier, according to
Federal Reserve data. Similarly, the
ratio of net charge-offs to total loans
dropped to 0. 46% f rom 0. 68%,
reflecting in part high used-car prices,
which helped to limit charge-of fs on
loans that have defaulted. However,
were watchful of the impact that com-
petitive pressure could have on loan
As of June 30, 2012 As of June 30, 2011
Institution Percent change (mil. $) (mil. $)
Ally Financial Inc. 18.4 62,068 52,406
Wells Fargo & Co. 2.9 45,180 43,888
JPMorgan Chase & Co. (0.5) 39,421 39,633
Bank of America Corp. (14.6) 27,115 31,739
Capital One Financial Corp. 95.3 25,252 12,931
TD Bank US Holding Co. 27.2 12,839 10,089
U.S. Bancorp 8.6 12,103 11,143
Fifth Third Bancorp 4.4 11,068 10,603
SunTrust Banks Inc. 10.5 9,862 8,927
BB&T Corp. 5.5 9,055 8,580
RBS Citizens Financial Group Inc. 11.2 8,560 7,697
PNC Financial Services Group 93.4 7,166 3,705
Huntington Bancshares Inc. (13.9) 5,473 6,353
BMO Financial Corp. 16.3 5,199 4,470
BancWest Corp. 20.0 3,583 2,987
M&T Bank Corp. (10.3) 2,550 2,844
Regions Financial Corp. 29.6 1,916 1,479
BBVA USA Bancshares Inc. 8.0 1,520 1,408
Citigroup Inc. (85.6) 789 5,469
Total 9.1 290,718 266,351
Note: Sample includes institutions reporting more than $1 billion in loans in either period.
Source: Federal Reserve Y9C reports.
Retail Auto Loans Of Select U.S. Bank Holding Companies
terms and underwriting standards, as well
as the possibility that some lenders could
continue to increase their shares of near-
prime or subprime loans in an attempt to
boost margins or market shares.
Indeed, recent reports indicate some
easing of lending standards. The Feds
Senior Loan Officer Opinion Survey on
Bank Lending Practices, published Aug.
6, 2012, found that almost 23% of banks
reported easing approval standards for
auto loans over the previous three
months, while no banks reported tight-
ening standards. More than 10% of
respondents reported offering longer
maturities, and more than 30% indicated
that theyre offering narrower pricing on
auto loans.
The Auto Loan Market Is
Undergoing Some Changes
Ally Financial Inc., currently the industry
leader, is undergoing a transformation
that is closely connected to the changes
affecting the industry overall. Ally is in
the process of ending its ownership of
troubled mortgage lender Residential
Capital LLC (ResCap) through ResCaps
bankruptcy filing, which includes a pro-
posal to release Ally from its ResCap-
related obligations. Ally is also divesting
its non-U.S. operations so that it can
repay the capital it received from the U.S.
government in 2008 and 2009. Allys U.S.
market position will have to evolve as
agreements that have secured Allys
position as funding provider for General
Motors (GM) and Chrysler sales come to
an end in 2013. In second-quarter 2012,
GM and Chrysler standard and sub-
vented (manufacturer-subsidized) loan
originations constituted about half of
Allys U.S. auto originations, down from
more than 70% two years earlier. Some
of the changes in the U.S. auto finance
sector will continue to stem from Allys
efforts to diversify its funding relation-
ships beyond Chrysler and GM and, sim-
ilarly, from GMs and Chryslers efforts to
establish relationships with other funding
providers. For example, GM has an
agreement with Wells Fargo, under
which the bank will of fer subvented
loans and other services to GM dealers
in various regions.
Good Relationships And High-
Quality Service May Be The Keys
To Gaining Market Share
Although elevated competition in the U.S.
auto finance sector could lead to eroding
credit standards, other factors, namely
dealer relationships and service quality,
may be the ultimate determinants of sus-
tainable success. Increasi ngly, auto
dealers will make financing decisions,
even though a manufacturer may have
formal arrangements in place with one
or more financing providers. Dealers
will likely have growing opportunities
t o est abl i sh rel at i onshi ps wi t h a
number of l enders. The vol ume of
business a given lender secures will, in
many cases, depend on the strength of
rel ati onshi ps across a mul ti tude of
dealers, as well as the lenders effec-
tiveness in executing timely transac-
tions as opportunities arise.
Dealers decide which financing
providers to work with largely based on
the quality and extent of communica-
tions from a lender, the clarity of offering
terms and approval standards, and the
timeliness of approvals, according to JD
Power and Associates 2012 U.S. Dealer
Financing Satisfaction StudySM. JD
Power has identified growing interest in
preferred dealer arrangements, which
typically call for lenders to provide
higher service levels to dealers in return
for commitments relating to origination
volume shares. The adoption of such
arrangements could help to mitigate
future competitive pressure on credit
standards and create a modest barrier to
entry in favor of providers that are able
to meet high standards for customer
service and relationships.
Auto Loans Could Help
Banks Grow Their Consumer
Lending Businesses
Auto lending stands out as a potential
area of profitable growth in U.S. banks
consumer lending. But the impact that
this activity could have on banks credit
profiles will depend on the competitive
success each institution has in both man-
aging credit risk and meeting service
standards that adequately address cus-
tomer needs. CW
Tom G. Connell
Toronto (1) 416-507-2501
Kevin Cole, CFA
New York (1) 212-438-3818
Auto Loans
SPECIAL REPORT
FEATURES
T
he U.S. auto industry is in its third year of rebound, and the
U.S. auto loan asset-backed securities (ABS) market is a
beneficiary. Improved sales, strong used-vehicle values,
and growth (albeit sluggish) in the U.S. economy are each
contributing to this recovery. And investors, drawn to these
securities attractive spreads, continue to show more interest in
the sector.
The Recovery Continues
For U.S. Auto ABS, But
What Risks Lie Ahead?
Overview
We expect new U.S. auto loan ABS issuance to reach about $60 billion in 2012 (a
22% increase from 2011s $49 billion). Issuance slipped to $45 billion in 2009, a
56% decline from a peak of $103 billion in 2005, but has been climbing back
since then.
U.S. retail auto loan ABS volume totaled about $45 billion through August, a 39%
increase from $32.53 billion for the same period in 2011.
The sector is benefiting from improved auto sales, easier access to auto loans,
strong used-vehicle values, and growth (albeit sluggish) in the U.S. economy.
Factors that could influence the rate of growth in the industry include the effect
of regulatory changes, economic uncertainties in the U.S. and abroad, and some
recent loosening of credit standards for borrowers.
Auto ABS performance held up well during the recession, and upgrades outpaced
downgrades by a wide margin even during the worst of it.
Auto loan ABS collateral performance
softened during the downturn, but the
transactional structural features mitigated
higher losses and upgrades continued to
strongly outpace downgrades even during
the worst of it. But Standard & Poors
Ratings Services and savvy investors are
looking forward to see what, if anything,
could slow the current rebound.
A Look Back
After nine consecutive years of annual
new-vehicle sales between 16 million
and 17.5 million units through 2007,
sales dropped sharply to 13.3 million
units in 2008. Auto sales were even
weaker in 2009, at 10.6 million units, the
lowest annual number since the early
1980s. The weak economy slowed con-
sumer spending, and potential buyers
often had a harder time getting financing
than in prior years. In addition, uncer-
tainties leading up to the eventual
Chapter 11 bankruptcy filings of both
General Motors Corp. and Chrysler LLC
in 2009 further weakened consumer con-
fidence in the industry.
The U.S. auto loan ABS sector was not
immune to the larger industrys troubles.
After peaking at $103 billion in 2005, new
auto loan ABS issuance slipped to $45 bil-
lion in 2009, a 56% decline. Uncertainties
about the economy and the auto industry,
as well as fears of contagion from the
downturn in the mortgage market, caused
spreads to widen dramatically as investor
demand recoiled.
ABS collateral performance also weak-
ened during the period. Underwriting
standards had loosened in 2006, 2007,
and into 2008, and the weaker credit
quality of borrowerscombined with the
struggling economyspurred a greater
number of defaults on vehicle loans.
Softer demand for used vehicles led to
lower recovery rates on those defaults.
Using Standard & Poors Auto Loan Static
Index as a gauge, cumulative net losses
for those vintage years were significantly
higher than for prior vintages. Cumulative
net losses by Month 36 for the 2006 to
2008 prime vintages averaged 2% of the
aggregate original pool balance, double
the 0.95% average for the previous three
vintage years (see chart 1). In the subprime
sector, losses by month 40 averaged
13.89% for 2006 to 2008 originations, up
63% from the 8.52% average for the prior
three vintages (see chart 2).
Despite this tough credit cycle, auto loan
ABS performed as well as, if not better
than, we expected, and our rating actions
on the sector reflected this stability. In the
two most difficult years for the industry,
2008 and 2009, Standard & Poors lowered
only seven ratings as a result of credit dete-
rioration on U.S. ABS auto loans compared
with 118 upgrades over the same period
(see table). For the most part, these transac-
tions benefited from conservative securiti-
zation structures. Most employed a
sequential-pay structure, whereby credit
enhancement (on a percentage basis)
builds as the collateral amortizes, creating
greater loss coverage over time.
Where Things Stand Now
The recover y in both the U. S. auto
industry and the ABS market continues.
However, auto sales and ABS issuance
still have a way to go before returning to
prerecession levels.
U.S. annual auto sales continue to
bounce back, increasing almost 20% in
2011 to 12.7 million units from 10.6 mil-
lion in 2009. Pent-up demand following
the recession continues to strengthen
sales volumes. In addition, used-vehicle
sales have started to increase, with a 9%
rise to 38.8 million units in 2011, up from
35.5 million in 2009.
U.S. auto loan ABS volume has histori-
cally moved in step with new and used
vehicle sales. And while this trend has
continued, overall ABS volume had not
rebounded as quickly as sales because
many of the large bank lenders had
opted to fund their auto originations with
low-cost deposits rather than securitize.
That is changing in 2012 because of
even lower ABS funding costs and
investors buying residual interests in
bank auto loan ABS. This latter develop-
ment, improves the capital treatment of
bank securitizations.
For 2011, U.S. auto loan ABS volume
was up approximately 9% over the 2009
low, while total new-vehicle sales were
up 22%. Much of the increase for auto
loan ABS came from the subprime
sector: Subprime volume reached $11.8
billion in 2011, up almost 450% from a
low of $2.2 billion in 2008. In fact, 2011
subprime volume nearly equaled the
total volume for the three prior years.
The increase in overall auto loan ABS
issuance and a significant tightening in
spreads signaled a return of investor
appetite in this sector as underwriting
standards improved and the fear of con-
tagion from residential housing subsided.
Underwriting began to tighten signifi-
cantly in late-2008. For prime auto ABS,
FICO scores averaged 740 between 2009
and 2011, up from 715 in 2007 and 2008,
and the average loan-to-value ratio
dropped to 96.53% from 100.36% for the
same comparison periods. These improve-
ments signal a return to better-quality bor-
rowers and stronger loan terms. The sub-
prime sector has experienced similar credit
tightening in recent years.
These stronger credit fundamentals have
resulted in better collateral performance.
Cumulative net losses for the 2009 to 2011
vintages have been significantly lower than
those of prior vintages. For transactions in
the Auto Loan Static Index, cumulative net
losses by Month 20 on prime collateral
averaged 0.58% for 2009 and 2010 origina-
tions, down 60% from an average of 1.46%
for the prior two vintage years. Subprime
collateral showed similar improvements in
2009 and 2010, with a 47% decline in
Period Upgrades Downgrades
2001 56 0
2002 25 1
2003 32 22
2004 48 0
2005 87 0
2006 91 0
2007 116 2
2008 23 0
2009 95 7
2010 62 5
2011 144 2
2012
(through Sept. 12) 92 0
Total 871 39
Historical Ratings Activity
U.S. ABS Auto Loans
losses (to 4.62%) compared with the pre-
vious two vintages (8.87%). While losses
are trending higher for the 2010 vintage
than 2009 (5.32% compared with 3.92% at
Month 20), this increase stems from a
wider array of subprime issuers securi-
tizing in 2010 than in 2009. Standard &
Poors ratings on auto loan ABS remained
largely stable in 2010 and 2011, with 206
upgrades and only seven downgrades for
the two years combined, reflecting the
improving collateral performance.
Where The Sectors Headed
We believe the auto loan ABS market
will continue to grow over the next
couple of years. However, a number of
issues could influence both the speed
and the magnitude of growth.
Weve seen some loosening of credit
standards in the past few months, specif-
ically in the subprime sector, as declining
FICO scores and increasing loan-to-
value ratios demonstrate. At this time,
we believe this is simply a return to
normal lending standards as originators
look to increase originations following
the extreme tightening of underwriting
over the past few years. In our view, the
collateral underlying auto loan ABS
securitizations remains stronger than it
was before the recession. However, we
will be monitoring further changes in
lending standards as origination volumes
continue to grow.
If underwriting standards continue to
weaken, we would expect losses to
increase somewhat for the 2012 vintage
and later transactions. Any increase in
losses would be off of record lows, how-
ever. In addition to the softer under-
writing, we expect used-vehicle values to
decline after remaining at historical
highs over the past three years. After
bottoming out in late-2008, used-vehicle
values have enjoyed a strong run, prima-
rily because demand increased just as
the supply was shrinking due to a slow-
down in new-vehicle sales and leasing
(which reduced the number of used cars
returning to market). In fact, according
to Manheims Used Vehicle Value index,
values have been slowly declining since
April, and by August, they were 2.4%
lower than last year (see chart 3).
We expect that new-vehicle sales will
continue to increase in the coming years,
and the resulting turn-ins will help boost the
used inventory. Leasing has also been on
the rise in recent years, and we expect a
good number of lessees to return those
vehicles at the end of their terms. As the
supply of used vehicles continues to grow,
we would expect valuesand, in turn,
recovery rates on the ABS poolsto lessen.
We expect auto sales and auto loan
ABS volume to continue to grow as new-
1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31 33 35
(Month)
0.0
0.5
1.0
1.5
2.0
2.5
3.0
(%)
Subprime performance data extend out longer than prime data because the loan term is typically longer.
2003 2004 2005 2006 2007 2008 2009 2010 2011
Chart 1 Prime Auto ABS Static Pool Cumulative Net Losses
1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31 33 35 37 39
(Month)
0
2
4
6
8
10
12
14
16
(%)
Subprime performance data extend out longer than prime data because the loan term is typically longer.
2003 2004 2005 2006 2007 2008 2009 2010 2011
Chart 2 Subprime Auto ABS Static Pool Cumulative Net Losses
Jan 95 . 19 Jan. 1999 Jan 03 . 20 Jan 07 . 20 Jan. 2011
90
95
100
105
110
115
120
125
130
Chart 3 Manheim Used-Vehicle Value Index
vehicle sales move back toward pre-
recession levels. We are currently esti-
mating 14.1 million unit sales in 2012.
This is an 11% increase over 2011, and
we expect sales to continue to grow to
15.5 million to 16 million units by 2014.
Because of auto sales growth and the
continued decline in auto ABS funding
costs in response to strong investor
demand, we expect auto loan ABS
issuance volume to grow by 22% over
2011 to approximately $60 billion in 2012.
Weve seen an increase in subprime
issuance this year, and we expect this to
continue. A number of first-time securi-
tizers in the subprime sector entered this
market over the past few years, including
American Credit Acceptance, Exeter, JD
Byrider, and Westlake. When analyzing
these securitizations, we review the origi-
nator/servicers financial performance
and funding sources, management experi-
ence, and infrastructure, along with its
underwriting, collections, and servicing
platforms. Although some of these first-
time issuers have been able to achieve
AAA ratings on their transactions, weve
capped the ratings for many in the A or
AA categories pending further perform-
ance history. As origination volumes
grow, we expect more subprime finance
companies will turn to securitization as a
funding source.
Economic uncertaintiesboth at home
and overseasare a wild card that could
affect both ABS volumes and performance.
In the U.S., the economy continues to
improve, but at an anemic pace, and year-
over-year gas prices have risen. Standard &
Poors economists currently place the threat
of another U.S. recession at 20%. The more
imminent concern lies in Europe, where
events in Greece and elsewhere continue to
weaken the economy, increasing the possi-
bility of contagion to the U.S.
We dont believe Europes financial
issues have had a direct effect on U.S.
auto loan ABS performance. However,
fear of contagion could slow issuance if
investors become more risk-averse and
either pull back from investing in auto
loan ABS or demand higher risk pre-
miums, as they did last fall when the
European debt crisis came to the fore.
This could, in turn, make funding for
vehicle purchases more expensive, espe-
cially among lenders that rely heavily on
securitization as a primar y funding
source. Conversely, the strong perform-
ance and relative rating stability of auto
ABS in the recent downturn could actu-
ally boost investor interest in the sector.
Further more, Standard & Poors
recently examined the effect of a hard
landing in Chinas economy on the auto
industry. We currently assign only a 10%
probability to a hard landing in China,
which we define as a slowing of eco-
nomic growth to 5%. However, given
Chinas position as the worlds second-
largest economy, we believe its impor-
tant to anticipate the impact of such a
slowdown. Although China is an impor-
tant source of revenue and profits for
General Motors and a number of
European car manufacturers, we do not
believe a hard landing in China would
affect the corporate credit ratings on
these automakers if sales were flat for
one year (see The Credit Overhang:
Implications For The Global Automotive
Sector Of A Hard Landing In China, pub-
lished May 29, 2012, on RatingsDirect, on
the Global Credit Portal). Moreover, we
dont believe a slowdown in Chinas
economy will affect U.S. auto loan ABS
volume or performance.
Lastly, the impact of regulatory
changes across the financial sector on
auto lending and auto loan ABS volumes
is hard to predict. The Dodd-Frank Act
engendered a number of new require-
ments for securitizations, including
increased disclosure on representations
and warranties and mechanisms for
enforcing these rules (under Rule 17g-7). In
addition, Rule 17g-5 requires greater trans-
parency regarding the information rating
agencies use to arrive at credit ratings.
The Federal Deposit Insurance Corp.s
new rules regarding safe harbor and risk
retention slowed banks issuance of auto
loan ABS in recent years. However, bank
securitization has begun to pick up
again, with Huntington Bank, Bank of
America, and USAA issuing ABS trans-
actions in 2012.
The SEC plans to update Regulation AB,
which governs disclosure and reporting
requirements for securitizations, later this
year. Although the rules arent final yet, the
revisions will ultimately look to improve
transparency regarding the assets, and per-
haps the borrowers, underlying securitiza-
tions. Increased reporting requirements
often prove costly for issuers, and it
remains to be seen whether higher
issuance costs will slow volumes.
The Rebound Will
Likely Continue
Despite the myriad factors that could
influence the volume and performance
of U.S. auto loan ABS, we expect the
market to continue to grow as light
vehicle sales rebound and the economy
continues to strengthen. We believe that
while both sales and lending will con-
tinue to grow, lenders will heed the les-
sons from the downturn and wont liber-
alize their credit policies to the same
extent we saw in 2006 and 2007. As
such, we expect collateral performance
to remain at least consistent with our
ratings for the foreseeable future, and
upgrades should continue to consider-
ably outweigh downgrades. CW
We expect collateral performance to remain at least
consistent with our ratings for the foreseeable future
Mark M. Risi
New York (1) 212-438-2588
Amy S. Martin
New York (1) 212-438-2538
Auto ABS
T
he U.S. subprime auto finance market is experiencing a rebirth
following the 2008 to 2009 recession, with established companies
increasing their loan volume and new players backed by private
equity entering the fray. This has created growth opportunities for the
subprime auto loan asset-backed securities (ABS) market, but it also
presents challenges and risks, namely the potential for relaxed credit
standards to drive growth. In addition, private equity firms are funding
many of the newer finance companies and, given their objective to make
a profit on their investment, could pressure these companies to expand
more rapidly and take greater risks. Increased competition among these
lenders could also lead to aggressive underwriting and higher-than-
expected losses down the road.
The U.S. Subprime Auto Loan ABS Market
Not Seen Headed
For A 1997-1998
Style Contraction
Overview
The U.S. subprime auto loan ABS

market is growing again and, despite
some potential risks, its near-term
growth prospects look good.
Over the longer term, however, we

expect increased competition to
weaken credit standards and lead
to increased losses. We also expect
used vehicle values to decline,
which again will lead to higher
collateral losses. Nevertheless, we
believe credit enhancement and
other structural protections in ABS
transactions will serve to insulate
the AA and AAA classes from
incurring losses if a moderate BBB
scenario occurs.
Despite the recent credit crisis,

subprime auto ABS ratings per-
formance has been strong. We
raised the ratings on many of these
transactions and did not lower any
ratings due to deteriorating collat-
eral performance. The only down-
grades resulted from downgrades
on the related bond insurers.
As capital flows freely into this market
and competition strengthens, were
reminded of the industrys first boom
period in 1994 to early 1997, which was
followed by a severe contraction. During
that time, high loan losses and disclosed
accounting ir regularities (including
understated defaults) caused many sub-
prime auto finance companies to file for
bankruptcy between 1997 and 1998 and
then liquidate. These were fast-growing
firms that had recently completed initial
public offerings (IPOs) and were using
gain-on-sale accounting to show
strong quarterly earnings. (Under this
accounting method, companies booked
a profit when the loans were sold into an
ABS, even though they would realize the
income over several years and the
amount was subject to revision based on
actual losses.) In addition, many sub-
prime finance companies were collecting
loan payments in person across several
local branches (decentralized collec-
tions), which hindered the continuity of
loan servicing once these companies
ceased to operate. And most subprime
auto issuers were using bond insurance
as the primary source of credit enhance-
ment to cover what otherwise would
have been losses to ABS investors in cer-
tain transactions.
A lot has changed over the past few
years, however, and Standard & Poors
Ratings Services believes there are sev-
eral key differences in todays market
that bode well for the industry. First, sub-
prime origination volumes have not yet
returned to pre-crisis levels, so it appears
that there is still room for the market to
grow further without necessarily sacri-
ficing credit quality. Second, the new
subprime auto originators are mostly pri-
vate and, therefore, are under no pres-
sure to meet public quarterly earnings
targets (although their equity partners
may have aggressive longer-term growth
goals). Third, auto finance companies
are no longer using gain-on-sale
accounting. And fourth, most subprime
companies now service and collect pay-
ments centrally, which allows for more
focused collections efforts and smoother
servicing transfers when and if they
become necessary.
Vehicle Sales Indicate That The
Market Is Progressing, But
Theres Still Room For Growth
As a result of the U.S. credit crisis from
2008 through mid-2010, subprime auto
financing dried upreflecting a lack of
demand and investor interest in sub-
2006 2007 2008 2009 2010 2011 2012
0
5
10
15
20
25
30
35
(%)
Source: Power Information NetworkPIN, a business division of J.D. Power and Associates.
B (650679) C (625649) D (0624)
Chart 1 Loan Volume As A Percentage Of Used Vehicles Purchased
By FICO Score
2006 2007 2008 2009 2010 2011 2012
0
2
4
6
8
10
12
14
16
(%)
Source: Power Information NetworkPIN, a business division of J.D. Power and Associates.
B (650679) C (625649) D (0624)
Chart 2 Loan Volume As A Percentage Of New Vehicles Purchased
By FICO Score
2006 2007 2008 2009 2010 2011 Jan.Aug.
2011
Jan.Aug.
2012
0
5
10
15
20
25
(Bil. $)
ABSAsset-backed securities.
Chart 3 Subprime Auto Loan ABS
prime financingand has not yet
returned to pre-2006 levels. The market
has been making a strong comeback,
though, based on new and used vehicle
sales volumes in this segment. Through
Sept. 17, 2012, the percentage of used
vehicle retail sales to consumers with
subprime FICO scores (624 or lower) is
24.4%, a decline from 28.9% in 2006 (see
chart 1). This indicates that consumers
are either unwilling to or unable to pur-
chase and finance used vehicles as
readily as they were prior to the credit
crisis. Also, the percentage of new
vehicle retail sales to consumers with
subprime FICO scores is 11.5%, which is
also down from the peak of 13.8% in
2006 (see chart 2). Based on these results,
it appears subprime auto finance still has
room to grow, as a percentage of overall
auto finance, before reaching its prior
peak levels.
The Subprime Issuance
Landscape Has Changed
Dramatically Since 2006
In 2008, subprime auto loan ABS
issuance volume fell precipitously to
about $2 billion, or one-tenth of the $21
billion issued in 2006 (see chart 3 and
table 1). In our view, issuance contracted
because investors shied away from risk
and shunned most retail auto loan ABS
except for the AAA rated prime auto-
backed securitizations. This essentially
locked subprime auto finance companies
out of the ABS market until 2009. Some
warehouse providers also curtailed
lending to this market and, as a result,
many firms either severely scaled back
their origination volumes or quietly went
out of business, which reduced the
supply of new loans that could be
funded in the ABS markets.
Then in March 2009, the Federal
Reserve Bank of New York and the U.S.
Treasury Department implemented the
Term Asset-Backed Securities Loan
Facility (TALF) program to address the
lack of available credit to consumers.
The TALF programs goal was to
encourage investment in, and therefore
the issuance of, ABS backed by certain
asset categories. This helped to reopen
the auto loan ABS market that same
month, and by 2010 the subprime sector
had sprung back to life.
Once capital began flowing back into
the sector, auto finance companies
started to lend again. In addition, con-
sumersencouraged by the declining
unemployment rate (although it
remained at a relatively high level)
began replacing their old vehicles, the
average age of which was approaching
11 years, with a new or newer used
vehicle. As a result, subprime auto loan
ABS grew to $11.75 billion in 2011, and
based on year-to-dates issuance of
$11.9 billion (compared with $7.5 billion
from January through August 2011), we
believe it could reach $15 billion to $17
billion by year end.
We expect this increase given the
drop-of f in subprime financing and
issuance in 2008 and 2009. What is sur-
prising, however, is that dollar issuance
and unit volumes of subprime auto loan
ABS have grown to 26% and 46% of the
overall auto loan ABS market, respec-
tively, from 24% and 35% in 2006. We
attribute the percentage growth to one
main factor: Some of the largest prime
auto lenders, namely banks, have
stopped securitizing. Capital One, Wells
Fargo (formerly Wachovia Corp. and
Western Financial Services [formerly
WFS, which was acquired by Wachovia]),
and JPMorgan Chase have not securi-
tized in recent years due to their large
supply of low-cost deposits and regula-
tory changes that have made securitiza-
tion less attractive for banks. Therefore,
even the reduced volume of subprime
ABS (versus 2006 and 2007) comprises
an increased percentage of the overall
auto loan ABS market.
Bond Insurance Is No Longer
The Primary Type Of
Credit Enhancement
Over the past few years, issuers have
replaced bond insurance (which guaran-
teed timely interest and principal pay-
ments by final maturity) as the primary
source of credit enhancement in favor of
collateral-based support (internal credit
support), including subordination,
reserve accounts, overcollateralization,
and excess spread. Bond insurance fell
out of favor in 2008 when the providers
lost their AAA ratings, which led to
downgrades on insured transactions.
(See the appendix for more information on
when and why bond insurance became the
primary form of credit enhancement in sub-
prime auto loan ABS.)
We bel i eve the absence of bond
insurance, in and of itself, does not
pose a risk to investors for several rea-
sons. First, credit enhancement levels
remain high. The subprime auto loan
ABS that weve rated AAA in 2012 (for
which our expected cumulative net loss
was in the 10% to 15% range) have 44%
to 50% credit support (including excess
spread), which is suf ficient to cover
73% to 83% i n cumul ative gross
def aul ts usi ng a recover y rate of
approximately 40%. The subprime auto
loan ABS that weve rated AA in 2012
(for which our expected cumulative net
loss was in the 10% to 15% range) have
38% to 46% credit enhancement, which
is enough to support 63% to 77% in
cumul ative gross def aul ts usi ng a
recovery rate of about 40%.
Second, during the most recent credit
crisis, subprime auto ABS ratings with-
stood significantly higher-than-expected
losses without support from bond insur-
ance policies. Each subprime auto ABS
transaction that we rated had sufficient
internal credit support, enabling us to
maintain their Standard & Poors under-
lying ratings (SPURs) at BBB or higher
even though we downgraded some of
the bond insurers to BBB or lower from
AAA. A SPUR reflects our opinion of an
obligations stand-alone creditworthi-
ness, without accounting for the bond
insurance policy. Under our criteria, the
issue credit rating on a fully credit-
enhanced bond issue is the higher of the
rating on the bond insurer or the SPUR.
While collateral losses did rise to 1.5x to
nearly 2x our original expectations in
some cases, the sequential-pay struc-
tures and short bond lives helped the
transactions de-lever rapidly and credit
support grew as a percentage of the out-
standing receivables balance. This
helped increase coverage levels and pro-
vided a cushion against the higher
remaining losses. Credit enhancement
floors provided a similar benefit.
Furthermore, since 2009 we have
tested the stability of our ratings using
moderate (or BBB) stress scenarios,
which generally equal about 1.50x to
1.75x our initial base-case loss. If these
stress scenarios indicate that our AAA
or AA ratings would be downgraded
by more than one category in the first
year, or below BBB and BB in the
first three years, we would not be able
to assign AAA and AA ratings given
the str ucture presented. BBB and
lower-rated classes, however, could be
vulnerable to downgrades and defaults,
which is consistent with our rating sta-
bility criteria (see Methodology: Credit
Stability Criteria, published May 3, 2010,
on RatingsDirect, on the Global Credit
Portal). We believe these additional sce-
nari os further protect bondhol ders
from mul ti -categor y downgrades i f
losses rise above our initial expecta-
tions, which could occur for myriad
reasons, such as a recession or a ser-
vicer bankruptcy and liquidation.
This is not to say that bond insurance
didnt play an important role in subprime
auto finance. It did, especially during the
sectors infancy in the 1990s and during
its first major downturn from 1997 to
1999. Issuers favored bond insurance
because it stood as an ir revocable
promise to pay bondholders even if the
finance company itself failed. This
appealed to investors given the
industrys infancy, many securitizers
short performance track records, and the
challenges associated with transferring
loan servicing (untested at the time),
especially in a multi-branch walk-in col-
lections paradigm, which several compa-
nies (First Enterprise Financial Group
Inc. and Reliance Acceptance Group)
Jan. 2012
2006 2007 2008 2009 2010 2011 Aug. 2012
Subprime auto ABS issuance (bil. $) 21.40 15.30 2.17 2.58 8.68 11.75 11.91
Subprime as a % of total issuance
(by amount) 24 21 4 6 18 24 26
% bond insured 75 80 46 0 1 0 0
No. of originators 10 10 3 5 7 9 12
No. of transactions 26 23 5 5 16 23 21
Subprime as a % of total issuance
(by number of transactions) 35 34 11 13 30 29 46
Largest issuer Capital One GM Financial GM Financial GM Financial Santander Santander Santander
33% 32% 80% 62% 56% 40% 53%
Second largest GM Financial Capital One CPS DriveTime GM GM GM
(formerly 26% 12% 16% Financial Financial Financial
AmeriCredit) 22% 29% 38% 27%
Third largest HSBC Santander Credit Prestige DriveTime DriveTime DriveTime
13% (formerly Drive Acceptance 12% 3% 6% 4%
Financial) 14% 9%
Capital OneCapital One Financial Corp. GM FinancialGeneral Motors Financial Co. Inc. SantanderSantander Consumer USA Inc. CPSConsumer Portfolio Services Inc.
DriveTimeDriveTime Automotive Group Inc. HSBCHSBC Automotive Trust (USA). Credit AcceptanceCredit Acceptance Corp. PrestigePrestige Financial Services Inc.
Subprime Auto ABS Characteristics From 2006 Through August 2012
were using at the time. In fact, when
these types of companies went bankrupt
and ceased operations, the bond insurers
had to act decisively to transfer servicing
responsibilities and, because of the high
losses on the collateral, pay claims on
certain ABS.
Today, however, condi ti ons have
largely changed. We have a lot more
perfor mance data on thi s sector,
including how it performs during dif-
ferent cyclical periods and through var-
ious types of servicing transfers. We
have also seen many successful serv-
icing transfers, and most companies
use centralized collections platforms
and receive few wal k-i n payments.
Technol ogy has al so i mproved and
most compani es receive payments
electronically through debit or the ACH
system, from Western Union or other
third-party processors, or via a lockbox
account. Furthermore, subprime auto
ABS transactions frequently include a
back-up servicer, which often maps
the pri mar y ser vi cers col l ecti ons
system to i ts own before the deal
closes. Back-up servicers are also usu-
ally the custodian of the loan files (par-
ti cul arly for smal l er subpri me auto
finance companies), which allows for a
smoother servicing transfer than some
that occurred in 1998.
In addi ti on, we woul d have been
unable to rate some of the transactions
that came to market with bond insur-
ance in our highest rating categories
(AAA or AA) because our auto loan
ABS cri teri a l ook for at l east three
years of loan performance history
but preferably moreand adequate
protections in the structure to mitigate
a servicer bankruptcy. Many of the for-
mer l y bond-i nsured t ransact i ons
included issuers with short perform-
ance track records and decentralized
branch collection models.
Subprime Players Apply Lessons
Learned From Past Downturns
While the industrys self-inflicted bust
between 1997 and 1998 was character-
ized by many bankr uptcies and
accounting irregularities, the 2008 to
2010 contraction resulted from the credit
crunch in the capital markets and was
arguably beyond the companies control.
This time, while many firms shrank, sold
their portfolios for quick liquidity, or in
some cases sold their businesses, we saw
few (if any) bankruptcies and ratings
performance remained strong on sub-
prime auto ABS without bond insurance
(see the Ratings Performance Has Stayed
Stable Since 2004 section).
Many issuers survived because they
were led by experienced management
teams that had learned valuable lessons
from both the late-1990s and the liq-
uidity squeezes they faced from 2001 to
2003. So when the downturn hit, they
simply pulled out their previous play-
book and severely curtailed originations
and increased their focus on collections.
By shrinking their businesses, cash flows
improved and payments on the ABS
debt continued without defaults. Also,
prior to the downturn, some of the suc-
cessful companies had negotiated multi-
year warehouse funding commitments,
had diversified their funding across dif-
ferent sources, and had moved away
from using bond insurance on their
transactions. In previous downturns,
some companies insured their auto secu-
ritizations through one provider, and
when perfor mance weakened, their
transactions breached triggers that
cross-defaulted to their other deals. As a
result, the collections remaining after
paying debt service stayed in their ABS
deals, which crippled the companies
cash flow and ability to originate loans
and invest in their businesses.
Ratings Performance Has Stayed
Stable Since 2004
Despite the worst recession since the
Great Depression and the bankruptcies
of two large U.S. auto manufacturers,
Standard & Poors ratings on subprime
auto loan ABS have either remained
stable or have been raised. Since 2004,
we have upgraded more than 150 sub-
prime auto transactions and have down-
graded none for credit-related reasons.
The only negative volatility on our rated
transactions has been the ratings linked
to bond insurers and two subprime
defaults on subordinated classes, which
we initially rated in the BB category
and whose ratings were confidential.
(One default was in 1998 for failing to
pay timely interest and one was in 2002
for failing to repay principal in full by
final maturity [although a good majority
was repaid by final maturity]).
The Market Still Faces
Several Risks
The subprime auto loan ABS market sur-
vived this latest downturn and near-term
growth prospects look bright, but the
sector still faces myriad risks. Increased
competition remains one of the peren-
nial risks in the market as established
players jockey to maintain their market
share, new players try to make inroads,
and captive finance subsidiaries seek to
sell more vehicles. These risks could
lead to more liberal credit standards, as
we ve seen in the past. Other risks
include a recession, another freeze-up of
the capital markets, and lower used
vehicle values, which are more of a risk
for subprime auto finance companies
than for prime firms due to the greater
number of repossessions in subprime.
Used vehicle values and recovery
rates have been at historical highs over
the past three years, but they have
recently declined and we expect them to
decrease further, due to higher vehicle
sales and the associated increased
volume in trade-in vehicles and leased
vehicle returns. As recovery rates nor-
malize, losses on subprime auto loan
ABS will likely rise. We already stress
this in our rating analyses, however, by
assuming future loan defaults will carry
more normal recovery rates. We also
address this risk in our rating stability
analyses by stressing the ratings in a sce-
nario where overall losses increase to
1.5-2x our expected losses.
The Road Ahead Looks
Relatively Smooth For
Subprime Auto Loan ABS
The volume of subprime auto loans has
increased substantially since the 2008
to 2009 credit crisis, but we believe
theres still room to increase origina-
tions before the industry becomes over-
heated and irrational. And while com-
petition has intensified since 2010 due
to improved access to capital and a
sl ew of new pl ayers, i n our vi ew,
lending has not yet returned to the lib-
eral standards of 2007 and early 2008.
This could change quickly, however,
and we bel i eve i ts somethi ng that
mar ket parti ci pants shoul d watch.
Furthermore, the past business model
of decentralized walk-in collections,
which proved difficult to control and
resulted in the highest losses, largely
doesnt exist today. Most companies
now use a centralized collection plat-
form, so there are few walk-ins. In addi-
tion, the subprime auto ABS market is
hi ghly concentrated wi thi n two of
Standard & Poors rated issuers, General
Motors Financial Co. Inc. (BB; one
notch below its parent) and Santander
Consumer USA Inc. (A-), which repre-
sent 80% of i ssuance. Fi nal ly, the
i ndustr y has a l ot more data now,
including performance statistics from
the worst recession since the Great
Depression. Weve also learned that
many people are more willing to pay for
their vehicles than their homes because
they need their vehicles to get to work
and they are easier to foreclose on than
their underwater homes.
So are rough roads ahead for the sub-
prime auto loan ABS market? In the
short run (one to two years), we dont
bel i eve so gi ven that subpri me
financing has not yet returned to pre-
2006 to 2007 levels and most lenders
arent as aggressive (in terms of credit)
as they once were (loan-to-values gen-
erally remain lower than in 2006 to
early 2008). However, finance compa-
nies are paying more for their loans
(discounts/fees have declined) and this
will likely lead to lower profit margins.
In the medium term (the next three
years), we believe competition will
l i kel y weed out the hi ghest-cost
pl ayers, and some may not sur vive
when the industry experiences its next
downturn. Nonetheless, we believe that
credit enhancement and other safe-
guards will adequately protect AAA
and AA rated subprime auto ABS from
incurring defaults should another BBB
economic environment ensue.
Appendix: The Genesis Of
Bond Insurance In Subprime
Auto Loan ABS
The subprime auto loan ABS market
existed on a small scale before issuers
began using bond insurance to credit
enhance their transactions. From 1991
to 1993, Auto Fi nance Group, MS
Fi nanci al Inc. , and Auto One
Acceptance Corp. completed their first
Standard & Poors rated transactions
without the aid of bond insurance. The
transactions performed well and paid
i nvestors as agreed. Because these
companies were relatively new and we
also didnt have much experience with
this industry, we rated the transactions
A, which was consistent with their
credit support coverage.
It wasnt until the mid-1990s that bond
insurance became popular, when many
new specialty finance companies with
limited track records were looking for
ways to access the ABS market due to its
significant profit potential. These compa-
nies were drawn to bond insurance
because it allowed them to issue AAA
rated ABS despite their short operating
histories. At that time, bond-insured
transactions were generally enhanced
internally with BBB credit enhance-
ment and were rated AAA based on the
AAA rated bond insurers guarantee to
pay timely interest and principal by final
maturity. Therefore, issuers could struc-
ture a deal with only BBB credit
enhancement and obtain AAA pricing.
That all changed in 2008, however, when
the rating agencies began downgrading
the bond insurers as a result of the credit
crisis. Now, issuers have replaced bond
insurance with internal credit enhance-
ment, such as overcollateralization,
reserve accounts, and excess spread. CW
Amy S. Martin
New York (1) 212-438-2538
M. Scott Sehnert
New York (1) 212-438-2603
Mark M. Risi
New York (1) 212-438-2588
Auto Loan ABS
D
emand for property/casualty insurance, such as
automobile insurance, is fairly steady in the U.S. because
many consider insurance coverage essential, and most
states require it, though laws and regulations differ by state.
Compulsory car insurance helps protect people from at-fault
drivers who cannot compensate them for losses incurred. As a
result, policyholder premiums and volume nationwide have
remained relatively stable for many years despite economic
volatility and new automobile sales trends (see char t).
Consequently, Standard & Poors Ratings Services expects the
U.S. personal lines automobile insurance sectors credit quality
overall to be stable in 2012 and 2013.
The U.S. Personal Lines Automobile
Insurance Sector Is On Credit Cruise
Control Through 2013
Overview
Legal requirements in the U.S.

keep demand for automobile
insurance relatively high.
We expect the sectors overall

credit quality to remain stable
through 2012 and 2013.
Even though the premium charge

for auto insurance in the U.S. is
rising faster than loss-cost trends,
certain potential changes could
limit premium growth.
The private auto passenger insurance
marketthe worlds largest market by
premium, contributing nearly 40% of
the total $449 billion insurance market
in the U.S. in 2011is traditionally one
of the most active and competitive
product lines within property/casualty
insurance, and perhaps the industry as
a whole (see table 1). The commodity-
like nature of the product, the techno-
logical advances and sophistication in
pri ci ng and segmentati on, and the
amount of money the i ndustr y has
spent on advertising in the past several
years to bui l d mar ket share have
heightened this intensity.
The top personal-line auto insurers
operating performances, based on their
combined ratios (a metric used to assess
overall profitability), have generally been
profitable and stable relative to the overall
industry. The combined ratio incorporates
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
0
20
40
60
80
100
120
140
160
180
200
(Bil. $)
Standard & Poor's 2012.
Auto Insurance Direct Premiums Written
(Bil. $) 2011 direct premiums written % of total DPW
Auto/motor (incl. private and commercial) 182.76 41
Private passenger 169.15 38
Commercial auto 13.60 3
Commercial property 69.36 15
Credit/surety/pecuniary 12.77 3
Other liability 63.86 14
Personal accident and short term health 5.54 1
Personal property 73.31 16
Ships, aircraft, and cargo 4.24 1
Workers compensation/employers liability 36.83 8
Total 448.66 100
Table 1 | U.S. Statutory Data
Private-passenger Long-term financial Private-passenger
(%) auto market share strength rating/outlook auto combined ratio
State Farm 19 AA/Stable 92
AllState 10 AA-/Neg 92
GEICO 9 AA+/Neg 93
Progressive 8 AA/Stable 94
Average 93
Standard & Poors combined P&C industry 102
Table 2 | Underwriting Performance (2007 To 2011)
losses and expenses relative to premiums
insurers have collected. A ratio of less
than 100% generally implies profitable
underwriting performance before consid-
ering investment income. A ratio of more
than 100% generally indicates unprof-
itable underwriting before considering
investment income (see table 2).
Automobile premium volume in the
U.S. has been relatively flat since 2004.
We believe that this reflects price compe-
tition and the sluggish economy of the
past several years. One sign of the latter
has been lower premiums per policy (in
part through higher deductibles) as con-
sumers purchase less coverage. We have
observed moderate single-digit automo-
bile rate increases since mid-2008, and
we believe this is likely to continue as
insurers attempt to protect profit margins
and get ahead of increasing loss costs.
Although it varies by region, market seg-
ment, and regulatory oversight, the cost
of automobile insurance increased 3.6%
nationally in 2011, compared with 5.2%
the year before, according to Insurance
Information Institute figures.
A differentiating factor for automobile
insurance is that insurers are typically
able to implement price increases more
quickly because of the short-tail nature
of a policy (claims are usually known
and settled within 12 months). We do
not expect this sector to experience
price declines in the short to medium
term. In addition, in our view, U.S.-based
insurance companies that focus on
writing automobile insurance are suffi-
ciently capitalized for their current asset,
credit, and underwriting risks, though
capital adequacy can and does differ
from company to company.
For the U.S. automobile insurance seg-
ment, we believe several elements could
limit growth in overall premium income,
even though the premium charge for
auto insurance is rising faster than loss-
cost trends (claims inf lation). Some
examples are:
Changes to consumer buying behavior,

including less demand for the pre-
mium-type policies that offer bells and
whistles coverage pricing plans;
Subtle increases in deductibles for

physical damage (collision or compre-
hensive) to reduce monthly expenses;
A slower economy, including rela-

tively higher unemployment and high
gas prices;
Car owners keeping their vehicles longer

(the average age of passenger cars on
the road is approximately 11 years),
prompting drivers to switch to higher-
deductible comprehensive and collision
coverage at lower premiums; and
Pay-as-you-go driving products that

base premi um rates pri mari ly on
miles driven.
Although the outlook for the personal
auto sector is stable, we believe compe-
tition will remain fierce. We expect most
insurers to maintain strong competitive
positions through their well-recognized
franchises and technological capability
to remain profitable. The insurers that
remain committed to basic fundamen-
tals with a disciplined approach to grow
or sustain target market share and that
can capitalize on their competitive posi-
tions will be better positioned to suc-
ceed. The companies with the greatest
risk of downgrades are the ones that
report significantly weaker underwriting
performance than peers, or whose com-
petitive position weakens because of
significant erosion in their market share,
brand recognition, or technological and
market segmentation capabilities. CW
Patricia A. Kwan
New York (1) 212-438-6256
Neil R. Stein
New York (1) 212-438-5906
Auto Sector
U.S.-based insurance companies that focus on
writing automobile insurance are sufficiently
capitalized for their current asset, credit, and
underwriting risks
SPECIAL REPORT
FEATURES
S
tandard & Poors Ratings Services
uses its recovery ratings (estimates
of recovery prospects for creditors
in the event of a debt issuers payment
default) to determine its ratings on
speculative-grade companies (those rated
BB+ or below) debt issues (see Criteria
Guidelines For Recovery Ratings, published
Aug. 10, 2009, on RatingsDirect, on the
Global Credit Portal). Our recovery rating
methodology has three basic components:
Determining the most likely path to

default for a company;
Valuing the company following a

hypothetical default; and
Allocating that value to creditors based

on the relative priority of each claimant.
Here we focus on the second compo-
nent of the process in relation to our
recovery analyses of U.S. auto manufac-
turers and auto suppliers: valuing these
companies after a hypothetical default.
With several recent transactions in the
auto spaceprimarily sales of private-
equity owned companies to other pri-
vate-equity firmswe wanted to provide
transparency regarding our valuation
methodology, as the EBITDA multiples
we use to value these companies often
differ from the transaction multiples.
For the auto sector, we generally use two
approaches to value a company at default:
An enter prise or market value

approach that applies a market
derived multiple to expected earnings
(usually EBITDA) at emergence, and
A discrete asset approach that esti-

mates the market value of the com-
panys assets, either on a going-con-
cern or liquidation basis.
How S&P Values The
U.S. Auto Sector To
Arrive At Its Post-Default
Recovery Ratings
Overview
Standard & Poors uses its recovery ratings to determine its ratings on
speculative-grade companies debt issues.
For automakers and auto suppliers, we generally use an enterprise valuation

approach to value these companies after a simulated default.
We consider many factors in arriving at a default EBITDA multiple estimate for

these companies.
While our multiples usually vary from typical transaction multiples, we believe
our approach to valuing auto companies provides a consistent and accurate
method of arriving at recovery estimates.
When assigning recovery and issue-
level ratings for the U.S. automaker and
auto supplier sectors, we currently use
the market value approach for all but
one company (Chrysler Group LLC,
which we believe would liquidate in the
event of a default). Of course, an ideal
set of comparisons for determining a
suitable EBITDA market multiple does
not always exist. Depending on the
timing of the default, the market may
be at a cycl i cal hi gh (as i n 2006 to
2007) or a cyclical low (2008 to 2009).
Because our recovery analysis contem-
plates a future year in which the hypo-
thetical default will occur, it is difficult
to predict where in the cycle market
values will be at that point in time.
Also, as we have seen over the past
cycle, valuations are highly vulnerable
to the cost and availability of credit,
and extrapolating current market con-
ditions to a future hypothetical bank-
ruptcy date is problematic at best.
Using Adjusted Margins To
Determine Multiples
To address this volatility issueand
for increased comparability and con-
sistency in determining valuation mul-
tipleswe have created a calculated
approach that ref lects an auto com-
panys potential free cash flow before
debt service. We determine the mul-
tiple by calculating the companys cur-
rent adjusted EBITDA margin (defined
as EBITDA mi nus capi tal expendi -
t ures, di vi ded by revenues) . In an
industry that requires many of its par-
ticipants to reinvest continuously in
both tooling and plants to accommo-
date auto manufacturers new plat-
forms and current platform upgrades,
a measure of free cash flow (EBITDA
margin after capital expenditures) is
helpful in coming up with an appro-
priate valuation multiple.
We group the adjusted margins into
ranges, and correlate the ranges to indi-
vidual EBITDA multiples (see table 1).
This methodology has the advantage of
being consistent through market cycles
by supporting the concept that a com-
pany is worth what it has earned
(because we base the transaction mul-
tiple on actual cash flows) rather than
the concept that a company is worth
what someone will pay for it (which
would be the case if we based the mul-
tiple on forecasted cash flows).
We apply the appropriate multiple to
an estimate of EBITDA at emergence
from bankruptcy to arrive at a gross
ent er pri se val ue, whi ch we t hen
waterfall over each asset class in the
issuers capital structure after initial
deductions for estimated administra-
t i on cost s and pri ori t y cl ai ms. ( In
many cases, our estimate of EBITDA
at emergence is equal to our estimate
of f ree cash f l ow at def aul t al so
known as the insolvency proxy. We
cal cul at e t he i nsol vency proxy as
funds available plus free cash f low,
divi ded by fi xed charges. Si nce we
usually assume that funds available at
default equal zero and that EBITDA is
a proxy for free cash flow, EBITDA at
emergence is typically equal to fixed
charges at default.)
Our Auto Sector Multiples
We have compiled the multiples we used
to derive the latest recovery ratings for
publicly traded auto industry issuers (see
table 2).
In 19 of the 29 of these entities for
which we assign recovery ratings, we
used a multiple other than the one indi-
cated by our adjusted EBITDA approach,
although the difference is frequently only
half a turn (i.e., 0.5x). As in all parts of
Standard & Poors rating process, a
rating committee contemplates many
more aspects of corporate performance
than solely what historical financial
statements capture, or the results that
Adjusted EBIDTA margin EBITDA multiple
<3.5% 4.0x
3.5% to <5% 4.5x
5% to <8% 5.0x
8% to <10% 5.5x
10% to <13% 6.0x
13% to <15% 6.5x
>15% 7.0x
Table 1 | Multiple Methodology
company management or our credit ana-
lysts project.
The following considerations factor into
our decisions to use a different multiple
than the one indicated by the calculation:
Auto retailer vehicle
inventory adjustment
For the companies that carry an inven-
tory of vehicles for sale, the indicated
multiple is actually the multiple we use
to value the business, but we add back
most of the value of the auto inven-
tory to determine the gross enterprise
value, as we also consider fleet debt in
our recovery analysis. The multiple we
would use in this case is the derived
value (gross enterprise value divided
by EBITDA).
Forward looking
Our calculated margins are generally
for the most recent period. If we expect
the margins to rise due to permanent
cost improvements, then we may use a
higher multiple.
Margin sustainability/
Previous bankruptcy
Where we have concerns whether cur-
rent or forecasted margins are sustain-
able or achievable, we may use a lower
multiple or the discrete asset approach.
Retail
Companies with a retail component to
their business (sales to retailers) need to
invest less capital than other companies in
this sector (resulting in a higher adjusted
margin), and usually have a brand value
Adj Multiple Indicated TEV/LTM TEV/Fwd
Companies EBITDA (%) used (x) multiple (x)* EBITDA (x) EBITDA (x) Comment
Accuride Corp. 7.0 5.0 5.0 6.8 4.8
Allison Transmission Inc. 24.9 6.0 7.0 8.8 8.7 Concentration risk
American Axle & Manufacturing Holdings Inc. 8.0 4.0 5.0 5.3 4.5 Industry cap
Asbury Automotive Group Inc. 3.1 8.9 4.0 9.7 8.7 Fleet adjustment
Commercial Vehicle Group Inc. 4.2 5.0 4.5 5.0 5.0 Forward looking
Cooper Tire & Rubber Co. 3.1 5.0 4.5 4.3 3.8 Retail
Cooper-Standard Automotive Inc. 5.9 5.0 5.0 3.5 NA
Dana Holding Corp. 6.4 5.0 5.0 3.6 3.3
Delphi Corp. 9.3 5.0 5.5 4.7 4.8 Previous bankruptcy
Exide Technologies 4.8 4.5 4.5 5.5 4.3
Federal-Mogul Corp. 4.2 5.0 4.5 5.1 4.9 Forward looking
Ford Motor Co. 9.7 4.0 5.5 9.6 9.9 Industry cap
General Motors Co. 5.7 4.0 5.0 1.9 2.0 Industry cap
The Goodyear Tire & Rubber Co. 3.5 6.0 4.5 4.2 3.9 Retail
Group 1 Automotive Inc. 2.7 11.1 4.0 10.7 9.7 Fleet adjustment
Harman International Industries Inc. 6.2 5.0 5.0 6.2 5.2
KAR Auction Services Inc. 21.3 6.0 7.0 9.8 8.9 Multiple businesses
Lear Corp. 4.2 4.5 4.5 3.4 3.3
Meritor Inc. 4.9 5.0 4.5 3.9 3.9 Forward looking
Navistar International Corp. 4.0 4.0 4.5 17.6 15.2 Industry cap
Penske Automotive Group Inc. 1.9 11.2 4.0 11.8 12.0 Fleet adjustment
Remy International Inc. 8.5 5.5 5.0 5.8 N.A. Retail
Sonic Automotive Inc. 2.4 9.8 4.0 9.7 8.8 Fleet adjustment
Stoneridge Inc. 2.2 5.0 4.0 7.2 4.2 Forward looking
Tenneco Inc. 5.4 5.0 5.0 4.9 4.5
Tower International Inc. 3.3 4.5 4.0 3.5 3.4 Forward looking
TRW Automotive Inc. 6.8 5.0 5.0 4.8 3.4
Visteon Corp. 5.7 5.0 5.0 3.2 4.3
Wabash National Corp. 5.5 5.0 5.0 14.2 5.2
Average 6.4 5.7 4.8 6.7 5.9
LTM (last-12-month) market multiple and forward multiple are as of Aug. 27, 2012, and taken from S&P Capital IQ. *Calculated from the most recent historical year, unless that is
thought not to be representative of future performance, in which case the next forecasted year is used. TEVTotal enterprise value. N.A.Not available.
Table 2 | EBITDA Multiples For Publicly Traded Auto Industry Issuers
that we believe consumers would recog-
nize in a reorganization. We may use a
higher multiple in these instances.
Industry cap
We have traditionally capped original
equipment manufacturers at a multiple
of 4x to reflect the large capital reinvest-
ment and significant cyclicality of the
business. In the case of American Axle,
the cap relates to the close relationship
with General Motors. In Chryslers case,
the multiple is implied from the discrete
asset value method that we used as the
method of valuation.
Multiple businesses
Where the rated entity encompasses
several distinct businesses that have dif-
ferent returns, the predominance of one
business or another would inf luence
whether we would use a higher or lower
multiple than the indicated one.
Implications Of The Approach
The average of the multiples we use in
our U.S. automaker and auto supplier
recovery analyses is within one-quarter
of a turn of the S&P Capital IQ forward
market multiples for these companies,
although it is a turn lower than current
market multiples (see table 2). Because
we attempt to be forward looking in our
evaluations, even regarding simulated
defaults, this is not surprising.
The discrepancy, however, is higher
when comparing the multiples we use with
the implied multiples from bankruptcies in
the auto sectors. The average multiple that
disclosure statements indicate was roughly
one and one-half turns higher than the
average multiple that we are using, though
the actual current and forward market
multiples for these companies is lower
than those we are using (see table 3).
In trying to understand this phenom-
enon, it seems the most likely explanation
is that the emergence multiples compare
more closely to transaction multiples, and
transaction multiples are almost always
higher than going-concern market values.
Our view is that trading multiples repre-
sent more closely what stakeholders will
realize in recovery.
The goal of our valuation approach for
the automaker and auto supply sectors is
a consistent point of departure in
arriving at the appropriate valuation mul-
tiple for an individual company. While
the variance between our approach and
market valuations will change over time,
we believe that our approach helps us to
provide consistently determined recovery
estimates. CW
Indicated
S&P multiple S&P multiple LTM market Forward market emergence
indicated (x) used (x) multiple (x) multiple (x) multiple (x) Emergence
Accuride Corp. 5.0 5.0 6.8 4.8 6.7 Feb. 10, 2012
Cooper-Standard Automotive Inc. 5.0 5.0 3.5 N.A. 4.8 Feb. 10, 2012
Dana Holding Corp. 5.0 5.0 3.6 3.3 9.9 Feb. 8, 2012
Delphi Corp. 5.0 5.0 4.7 4.8 5.7 Oct. 9, 2012
Exide Technologies 4.5 4.5 5.5 4.3 7.2 May 4, 2012
Federal-Mogul Corp. 4.5 5.0 5.1 4.9 4.9 Dec. 7, 2012
Lear Corp. 4.5 4.5 3.4 3.3 9.2 Nov. 9, 2012
Remy International Inc. 5.0 5.5 5.8 N.A. 7.0 Dec. 7, 2012
Tower International Inc. 4.0 4.5 3.5 3.4 4.6 Dec. 7, 2012
Visteon Corp. 5.0 5.0 3.2 4.3 3.9 Oct. 10, 2012
Average 4.8 4.9 4.5 4.1 6.4
N.A.Not available.
Table 3 | S&P Multiples Compared With Implied Multiples From Bankruptcies
Analytical Contact:
Greg Maddock
New York (1) 212-438-7205
Auto Sector
I
n August, the aggregate spread for the
auto sector tightened slightly to 389
basis points (bps) from 394 bps, and
Standard & Poors economists noted that
auto sales climbed by 3% to 14.5 million
annualized units. The Federal Reserves
12-district Beige Book indicated an
increase in auto sales as economic activity
advanced gradually in early summer
through early August across most regions,
compared with the previous assessment
of modest to moderate growth between
early April and late May.
In addition, in our recent rising stars
report, we noted that Ford Motor Co.
recently became the largest issuer with the
greatest potential for upgrade to invest-
ment-grade, with US$90.5 (71.6) billion in
rated debt. (See Rising Stars In Emerging
And Developed Markets, Including The U.S.
The Aggregate Auto Sector Spread
Tightened As Sales Picked Up
And Europe: The Rising Stars Count Increases
To 21, published Sept. 12, 2012, on
RatingsDirect on the Global Credit Portal.)
Speculative-grade issuance decreased
to $1.8 billion from $4.6 billion over the
week from Sept. 4 to Sept. 11, 2012 and
spreads tightened by 23 basis points
(bps) to 623 bps. The speculative-grade
spread is tighter than both its one-year
moving average of 684 bps and its five-
year moving average of 750 bps.
Investment-grade issuance decreased to
$17.1 billion from $19.7 billion over the
past week and spreads widened by 1 bp
to 201 bps. The investment grade spread
is tighter than both its one-year moving
average of 213 bps and its five-year
moving average of 246 bps. Over the
past week the Credit Default Swap North
America High Yield Index spread tight-
ened by 47 bps to 494 bps, and it is
tighter than at the start of the year when
it was 662 bps. The Credit Default Swap
North America Investment Grade Index
tightened by 6 bps to 131 bps, and it is
tighter than at the start of the year when
it was 138 bps.
Standard & Poors Global Fixed
Income Research group provides U.S.
option-adjusted spread composites con-
sisting of more than 13,000 investment-
grade and speculative-grade issues.
Credit spreads are a measure of the
markets valuation of credit risk and are
quoted in bps (one-hundredth of a per-
centage point). They reflect daily move-
ments in credit spread levels within var-
ious bond market sectors.
The spreads are calculated daily
above the U.S. Treasury yield curve for
various bond market sectors, subsectors,
rating categories, rating designations,
outlooks, CreditWatch placements, and
maturities. Issues included in the com-
posite bond spread calculations have the
following characteristics:
Face amount outstanding of at least

$100 million.
U.S. dollar-denominated issues of

companies domiciled within or out-
side the U.S.
Rated by Standard & Poors Ratings

Services.
Issues may have embedded call, put,

and sinking fund options.
Fixed-coupon bonds, excluding convert-

ible, set-up, and preferred securities. CW
8/1/2012 8/8/2012 8/15/2012 8/22/2012 8/29/2012
370
380
390
400
(Basis points)
Data as of Sept. 11, 2012.
Source: Standard & Poors Global Fixed Income Research.
Chart 1 Auto Spreads
9/4/2012 9/10/2012 9/7/2012
190
200
210
220
230
240
(Basis points)
580
590
600
610
620
630
640
650
(Basis points)
Data as of Sept. 11, 2012.
Source: Standard & Poors Global Fixed Income Research.
Investment grade (left scale) Speculative grade (right scale)
Chart 2 Standard & Poors Composite Credit Spreads (Sept. 4 to Sept. 11, 2012)
120
130
140
150
160
170
180
190
(Basis points)
480
490
500
510
520
530
540
550
(Basis points)
Data as of Sept. 11, 2012. CDSCredit default swap.
Sources: Standard & Poors Global Fixed Income Research and Markit Group Ltd.
Investment grade (left scale) Speculative grade (right scale)
9/4/2012 9/10/2012 9/7/2012
Chart 3 CDS Index Spreads (Sept. 4 to Sept. 11, 2012)
Diane Vazza
New York (1) 212-438-2760
Gregg Moskowitz
New York (1) 212-438-1838
Auto Sector
W
hen we upgraded Hyundai
Motor Co. (HMC) and its sub-
sidiary Kia Motors Corp. to
BBB+ from BBB in March, we expected
them to maintain sound financial risk pro-
files in 2012 owing to their strong market
positions and profitability. And they have:
In the first half of this year, both companies
produced adjusted debt ratios well below
our expectations and made record oper-
ating profits. However, Standard & Poors
Ratings Services believes it may become
harder for these companies to keep these
improvements going. Here, we answer fre-
quently asked questions about these com-
panies performance and the potential
implications for their credit quality.
Q. What were Standard & Poors expec-
tations for HMC and Kia this year?
A. In March, we expected ratios of
adjusted debt to EBITDA for both compa-
nies to remain below 1.5x for 2012. In the
first half of this year, both companies pro-
duced adjusted debt to EBITDA below 1x.
They also had consecutive quarters of
record operating profits. HMCs oper-
ating profit for the first half of the year
increased 34% year on year, while Kias
increased 25%. Operating profit margins
for both companies were exceptional for
global automakers and comparable with
those of luxury car makers.
Sales have also been healthy. HMC and
Kia sold 4.6 million units in the first eight
months of 2012, putting them on track to
meet their combined global sales goal of 7
million units this year (see chart 1).
However, we believe the companies
are likely to fall short of our expectations
for their share of the global auto market
in 2012. We expect them to attain a
combined market share of 8.8%, up from
8.7% in 2011 and 8.1% in 2010 but down
from our previous expectation of 9%. In
the U.S., the companies combined share
even declined to 8.6% in August 2012
and 9.5% in July 2012 from 9.3% and
9.9%, respectively, a year earlier.
Q. What could threaten HMC and Kias
current strong market shares?
A. In our view, the decline in HMC and
Kias combined share of the U.S. market is
a good indicator of their prospects glob-
ally. We believe that decline was partly
due to a drop in exports from Korea after
a series of labor strikes, which were
recently resolved. However, we attribute
the decline of HMC and Kias combined
U.S. market share this year more to:
Their inability to increase supply

to match a sharper-than-expected
recovery in U.S. auto sales, which
increased 14% year on year in the first
seven months of 2012;
Their strategy to increase profitability

rather than market share and to avoid
aggressively expanding capacity; and
A significant recovery in production

among Japanese automakers.
We expect these factors to continue to
affect their market share over the next one
to two years. Thus during the period, we see
a high likelihood that the companies
market shares will continue to decline grad-
ually from their recent peaks (see chart 2).
We believe new additions to HMC and
Kias capacity will not be sufficient to
meet growth in global demand. Therefore,
we expect their combined market share to
be flat at 8.8% in 2013 and to decline to
How Sustainable Are
Hyundai Motor And
Kias Gains In Market
Share And Profitability?
Credit FAQ
8.4% in 2014. We think the companies will
add a total of less than 1 million units of
annual capacity between 2012 and
2014or around 4% per yearunder-
shooting our expectation in line with the
6% to 9% annual growth in global demand
that consultant LMC Automotive Ltd.
Estimates (see chart 3).
We believe HMC and Kia have some
flexibility to increase existing capacity
modestly through further automation
and a change in shift-work systems.
However, considering global competi-
tors plans to add new capacity, we dont
think the extra gains HMC and Kia could
make through such measures would be
enough to enable them to hold onto their
current combined global market share.
HMC and Kia have inventory levels well
below the industry average of two months,
partly owing to the labor strikes. Reduced
inventory can reflect good sales perform-
ance. In theory, this can lead to higher
average sales prices and less need to offer
incentives to buyers, resulting in stronger
profitability and operating cash flow.
However, we believe HMC and Kias low
inventories are more likely to reduce their
market shares because they could lengthen
the delay for buyers to obtain new cars.
They could also put the companies at a dis-
advantage when demand for cars improves
and competitors begin to market their
models aggressively. In the U.S., in partic-
ular, the higher inventories and sales incen-
tives of Japanese and U.S. automakers are
testing HMC and Kias sales and marketing.
Q. What could threaten HMC and Kias
current strong profitability?
A. We see several obstacles to HMC
and Kias ability to continue the prof-
itability improvements theyve made in
the past three years. Profitability could
erode gradually over the next one to two
years from the historical highs the com-
panies achieved in the first half of this
year, owing to:
Rising costs, including for labor and

utilities;
Weak domestic demand for vehicles;
Rising sales of imported cars in

Koreas market;
A slow improvement in product

quality; and
A peak in their launch cycle for new

models, which could leave the companies
vulnerable to increasing competition.
In our view, the unstable domestic
labor market has always had the poten-
tial to add to HMC and Kias costs,
posing a major danger to their ability to
sustainably improve profitability. Labor
strikes halt production, which lowers
operating rates, leading to higher overall
production costs. Furthermore, getting
employees back to work almost always
involves higher labor costs. Also, the
strong domestic labor union could try to
block further automation and overseas
expansion over concerns that the com-
panies would lay off workers to try to
lower overall production costs and fur-
ther improve profitability.
After three years without a major
strike, HMC and Kias domestic labor
relations have been less stable recently.
An unfavorable court ruling reducing the
companies hiring of cheaper nonregular
workers and long strikes at both HMC
and Kia this year illustrate potential risks
in the companies domestic labor rela-
tions. We believe the more favorable
work shift systems and pay rise that
management agreed on following the
strikes are likely to gradually dilute the
companies cost advantage.
Weak demand for new cars in Korea
and rising sales of imported vehicles
also raise our concerns about HMC and
Kias profitability. The companies
domestic sales declined 5% and 7%,
respectively, year on year in the first
eight months of 2012. Sales of imported
cars rose 20% during the same period.
By our estimate, sales in the domestic
market account for more than 20% of
the companies combined profits and
have long been a stable source of
returns. The companies dominate the
market in Korea, with more than 80% of
total sales, and they have a more prof-
itable product portfolio there than in
other markets, although domestic sales
account for less than 20% of total rev-
enue (see chart 4).
Because of gains their competitors
have made in product quality, a slow-
down in HMC and Kias own improve-
ments in this area could also threaten
2012
sales forecast
2012
Jan.-to-Aug.
annualized sales
0
1,000
2,000
3,000
4,000
5,000
(Thousands of units)
Sources: Standard & Poors, Company data.
Chart 1 HMC And Kia Sales
Forecast And
Annualized Sales
Toyota Honda Nissan HMC Kia HMC and Kia
0
5
10
15
20
25
30
35
(Year-on-year change, %)
Note: Red line shows total year-on-year change of U.S. car and light-truck units sold.
Sources: Standard & Poors, Automotive News Data Center.
Chart 2 Change In U.S. Unit Sales Of Cars And Light Trucks
(August 2012 Year-To-Date)
their higher profitability. HMC and Kias
Initial Quality Study (IQS) scores
renowned indicators of product quality
in the auto industryunderperformed
the industry in 2011 and 2012. By con-
trast, HMC and Kia sharply improved
and outperformed the industry in earlier
years. Their underperformance on IQS
tests mostly related to audio, entertain-
ment, and navi gati on equi pment
whi ch are not consi dered core to
product qual i ty but are becomi ng
increasingly important.
Moreover, HMC and Kias launch
cycle for new models peaked last year,
and updates that major competitors
have launched this year seriously chal-
lenge their existing lineups. In our view,
a relative lack of new models is likely to
make HMC and Kia vulnerable to a wide
range of new offerings and higher incen-
tives from competitors.
Q. What are the implications for HMC
and Kias credit quality?
A. In our view, obstacles to HMC and
Kias ability to maintain their current
market shares and profitability are
unlikely to significantly affect the com-
panies credit quality over the next one
to two years. We think these difficulties
could only gradually erode market
shares and profitability; however, they
have the potential to become material in
years to come if the companies do not
address them properly.
Sooner or later, we expect HMC and
Kia to employ their high cash holdings
and robust operating cash flow to counter
the expected loss of market share. If
these companies add capacity in the U.S
over the next two years and improve flex-
ibility through automation and changes to
work shift systems, we believe the deteri-
oration in their combined market share
over the next two years could be even
more gradual than we have factored into
our current expectations.
We believe the companies potential
i nvestments to counter the l oss of
market share are unlikely to dent either
companys financial risk profile signifi-
cantly. Even allowing for some erosion,
we bel i eve the compani es wi l l be
strong enough to justify the current rat-
ings. For example, we believe adjusted
debt-to-EBITA ratios for both compa-
ni es wi l l remai n bel ow 1. 5xour
downgrade triggereven after incorpo-
rating assumptions for investments in
new capacity and automation and
changes in work shift systems. Without
those assumptions, we believe theyll
remain below 1x.
However, we believe challenges to
their strong profitability are a more sig-
nificant threat to credit quality than chal-
lenges to their market share. In our view,
such tests of their profitability are rela-
tively difficult to address in the short
term, and challenges such as unstable
labor relations and weak domestic
market conditions are further beyond
their control. Still, after past improve-
ments in areas such as fuel efficiency
and design, along with their continued
efforts to raise quality and keep costs
down, the companies now-better brands
will likely limit the possibility of a
sudden, significant fall in profitability. CW
2012e 2013f 2014f
0
1
2
3
4
5
6
7
8
9
10
Sources: Standard & Poor's, LMC Automotive.
Industry total HMC and Kia
Chart 3 Growth Rate Forecast For Global Light Vehicle Sales
A
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Sources: Standard & Poors, Korea Automotive Research Institute.
Total change (right scale) HMC (left scale) Kia (left scale) Others (left scale)
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Chart 4 Change In Korean Monthly Auto Sales
Sangyun Han
Hong Kong (852) 2533-3526
Osamu Kobayashi
Tokyo (81) 3-4550-8494
Hyundai Motor
SPECIAL REPORT
FEATURES
W
ith car and light-truck sales volumes in Western Europe
set to decline for the fifth consecutive year by as much
as 7% in 2012, Peugeot S.A. (BB/Negative/B), Fiat SpA
(BB-/Stable/B), and Renault S.A. (BB+/Stable/B) will have to
swerve carefully to avoid more potholes ahead. Weak demand,
along with high operating leverage and fierce price competition in
small car segments could put the brakes on results and hamper
free operating cash flow. And in the case of Peugeot, it may
continue to bear on credit quality.
Europes Speculative-Grade Volume
Carmakers Are Still Rolling, But
Driving Conditions Are Becoming
More Precarious
Overview
With car and light-truck sales volumes in Western Europe set to decline for the
fifth consecutive year by as much as 7%, we expect the three main southern
European manufacturersPeugeot, Fiat, and Renaultto continue to face
operational difficulties in the coming quarters.
For the rest of 2012 and the first half of 2013, we anticipate that the lower
volumes, high operating leverage, and fierce price competition in the small car
segments will squeeze profits. They may also hamper these companies ability to
generate positive free operating cash flow. In the case of Peugeot, we believe
credit quality remains vulnerable.
While these three volume carmakers are
struggling, several of their upmarket
German competitorsBMW AG (A/Sta-
ble/A-1), Daimler AG (A-/Stable/A-2), and
Volkswagen AG (A-/Positive/A-2)are still
largely profitable. Their plants are running at
high capacity because of strong overseas
sales and a strong premium segment, and all
three companies currently harbor solid
investment-grade ratings. We have excluded
VW, as an investment-grade credit, from this
peer review, which compares and contrasts
the performance of Europes three specula-
tive-grade volume makersFiat, Peugeot,
and Renaultagainst our key rating factors.
While VW does produce for the mass
market like Fiat, Peugeot, and Renault,
we see it in a different class. Since its
integration of Porsche AG this year, half
of its earnings now come from premium
vehicles. In addition, the company has
greater geographic diversity and com-
mands premium prices even for its main
volume brand. Its gaining market share
globally as well as in several European
countries. In our view, VWs credit
quality is therefore less vulnerable to
European volume declines.
We characterize the car manufacturing
industry as highly cyclical for volume
and luxury makers alike. When assessing
a carmakers credit quality, we bench-
mark it against several key credit fac-
tors. These feed into our view of a com-
panys business risk and financial risk,
reflecting an ability to withstand cyclical
swings in demand and operating cash
flow and face up to capital expenditure
needs and new operational challenges.
We therefore believe the performance
and ratings of Fiat, Peugeot, and Renault
this year and next will depend on their
ability to:
Find growth and, more importantly,

profitability outside of historical
Western European markets;
Address plant under utilization in

Western Europe and manage a still-
high cost base, while defending
market share against non-European
players;
Maintain credit ratios that are com-

mensurate with our ratings, and
Break even in terms of free operating

cash f low (FOCF) on a sustainable
basis.
The three companies ability to
achieve these objectives depends on the
strength of their business fundamen-
talsthat we analyze as part of our busi-
ness risk assessmentand their degree
of financial f lexibility to ride out the
downturn and implement measures to
re-establish profitability and preserve
cash flow (that we study as part of our
financial risk assessment). We see all
three companies as having on average
fair business risk, as our criteria define
this term. However, their financial risk
ranges from intermediate to aggres-
sive (see table 1).
Ratings History And
Current Outlooks
Following several negative rating actions
since the 2008 downturn, our ratings on
the three carmakers are all in the BB
category, with Renault at the higher end
(see table 2). Fiat and Renault have stable
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Note: Data for all carmakers is for the consolidated group. Europe includes Eastern Europe, Russia, and Turkey.
e--Estimate.
2009 2010 2011 2012e
Chart 1 Non-Commercial Light Vehicle Market Share In Europe
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e--Estimate.
2009 2010 2011 2012e
Chart 2 Non-Commercial Light Vehicle Market Share Worldwide
outlooks, and we expect the companies
to maintain credit ratios commensurate
with their current ratings despite the
negative operating conditions (see the
Appendix for our outlooks on the three com-
panies). Our negative outlook on Peugeot
ref lects the possibility that we could
lower the ratings if car sales continue to
decline, its rate of cash flow depletion
does not recover, and if turbulent capital
markets and political risk hamper the
carmakers announced restructuring.
Before the 2008 to 2009 economic
downturn, Standard & Poors ratings on
all three automakers were investment
grade (BBB- or higher). Those two
years were exceptionally difficult: For all
three companies, operating income
turned negative and cash flow started to
burn following major swings in working
capital. By August 2009, our ratings on
all three companies had fallen into the
speculative-grade category. Since then,
lackluster demand in Europe plus the
carmakers limited diversification and
relatively high costs have continued to
hurt credit quality, particularly for Fiat
and Peugeot.
We Assess Business Risk As Fair,
Mainly Because Of Industry
Cyclicality, Weak Demand In
Europe, And Low Profitability
We assess business risk as fair for Fiat,
Peugeot, and Renault (see 2008 Corporate
Criteria: Analytical Methodology, published
April 15, 2008 on Ratings Direct, on the
Global Credit Portal). According to the cri-
teria, we assess several factors to deter-
mine a companys business risk profile,
primarily: 1. industry risk, 2. competitive
position, and 3. profitability. In our view,
the most important factors weighing on
the three carmakers today are reces-
sionary conditions in Europe and weak
profitability (see table 3).
1.
Industry Risk: The
Automotive Volume
Industry Presents Higher
Risk Than Other Industries
The credit risk profile of the global volume
automaker industry is higher than that of
other industries. One reason is cyclicality of
demand arising from economic conditions,
which greatly influence a consumers deci-
sion to purchase a vehicle. Expectations
about fuel prices, changing tastes, and per-
ceptions about quality and reliability also
factor into the decision. In addition, even
though the price tags on autos are big, car-
makers have limited pricing power but face
significant fixed costs, resulting in lever-
aged and capital-intensive operations.
Furthermore, the industry is highly labor-
and capital-intensive. Carmakers must deal
with powerful labor groups, make large
investments to design and manufacture
autos, and cope with an increasing level of
regulation, particularly on emissions.
These risks have been all the more
apparent for volume makers, compared
with those of manufacturers focusing on
the higher-margin and less-cyclical pre-
mium and truck segments. They are
especially heightened for Fiat, Peugeot,
and Renault because recessionary condi-
tions and austerity measures in Europe
have sapped consumer confidence and
demand for big-ticket purchases.
Amid recessionary conditions in
Europe, we project a 6.4% drop in
demand for light vehicles in 2012
The latest macroeconomic indicators sug-
gest that most European economies are
moving further into recession and that the
core countries of the European Economic
and Monetary Union (EMU or eurozone) are
increasingly vulnerable. Standard & Poors
economists now forecast GDP growth in the
eurozone of -0.6% in 2012 and 0.4% in 2013
according to their baseline scenario. They
also see a 40% chance of European
economies sinking into a genuine double-dip
Corporate credit rating Business risk profile Financial risk profile
Renault S.A. BB+/Stable/B Fair Intermediate
Peugeot S.A. BB/Negative/B Fair Significant
Fiat SpA BB-/Stable/B Fair Aggressive
Table 1 | Business Risk And Financial Risk Assessments For Renault,
Peugeot, And Fiat
Peugeot S.A. Renault S.A. Fiat SpA
Current ratings BB/Negative/B BB+/Stable/B BB-/Stable/B
Rating action date
and change (if any)
4/1/2012 BB-/Stable/B
2/1/2012 BB+/Negative/B BB/Watch Neg/B
2/1/2011 BB/Negative/B
11/1/2010 BB+/Stable/B
10/1/2010 BB/Watch Pos/B
9/1/2010 BB+/Stable/B
4/1/2010 BB+/Watch Neg/B
8/1/2009 BB+/Negative/B BB+/Negative/B
6/1/2009 BBB-/Watch Neg/A-3 BB/Stable/B
3/1/2009 BBB-/Negative/A-3 BBB-/Negative/A-3 BB+/Watch Neg/B
2/1/2009 BBB+/Watch Neg/A-2 BBB/Watch Neg/A-3
1/1/2009 BBB-/Watch Neg/A-3
10/1/2008 BBB+/Negative/A-2 BBB/Negative/A-3 BBB-/Negative/A-3
7/1/2008 BBB+Negative/A-2
4/1/2008 BBB+/Stable/A-2 BBB+Stable/A-2 BBB-/Stable/A-3
Table 2 | Ratings History For Peugeot S.A., Renault S.A., And Fiat SpA Since
April 2008
recession in 2013 consistent with their alter-
native scenario (see The Curse Of The Three
Ds: Triple Deleveraging Drags Europe Deeper
Into Recession, published July 30, 2012).
In such an environment, we expect
demand for light vehicles (passenger
cars and light trucks) in Europe to fall-
6.4% this year and grow an anemic 0.4%
next year, with Italy (-15%/-2%), France
(-10%/2%), and Spain (-6%/-3%) the
weakest, the U.K. (-1%/1%) remaining
very sluggish, and Germany about flat
(1%/0.7%). We base our expectations on
detailed forecasts by LMC Automotive
Ltd. (see table 4).
2.
The Carmakers Relatively
Large Product Ranges Are
Positive For Our Assessment Of
Their Competitive Position
We regard a large number of models and
brands as a supporting factor in our
assessment of credit quality. This factor
mitigates vulnerability to model
changeover costs, for instance in case of
an unsuccessful model replacement,
while supporting a companys competi-
tive position in different end markets.
The three companies produce a diverse
range of vehicles, from small cars to
those in the higher-priced upper seg-
ments (see table 5). That said, they gen-
erate the bulk of their sales in the A to C
segments (in automotive industry parl-
ance, these refer to the length and luxury
of the car, running from A, the shortest
and most basic, to E, the longest and
most luxurious) and have limited pres-
ence in the premium segment, unlike VW.
The German carmaker is also a volume
producer but has a strong premium seg-
ment following the consolidation of
Porsche, and before that of the Audi,
Lamborghini, and Bentley brands. This
factor alone accounts for a fair portion of
the difference in the operating margin for
the core automotive operations of VW on
the one hand at 7% in 2011, and those of
Peugeot, Renault, and Fiat on the other
(ranging from 4% to-0.2% in 2011).
Renault still sells most of its products in
the small and medium auto segments. The
group has gradually reduced its reliance on
the Clio model group, and boasts solid
market positions in several countries in the
entry segment through its Dacia brand.
Through its two brands, Peugeot and
Citroen, Peugeot currently covers most
segments with a diversified mix that
has, unti l recentl y, gradual l y been
moving upmarket, with some innova-
tive positioning in niche markets. We
believe that the companys recently
announced restructuring plans may
2009 2010 2011 1H2012
(4)
(3)
(2)
(1)
0
1
2
3
4
5
(% sales)
Renault S.A. Peugeot S.A. Fiat SpA
Chart 4 Group Operating Margin For Renault, Peugeot, And Fiat
2006 2007 2008 2009 2010 2011 2012e
0
10
20
30
40
50
60
(%)
Adjusted funds from operations to debt
eEstimate.
Renault Peugeot Fiat
Chart 5 Standard & Poors Base-Case Forecasts For Renault, Peugeot, and Fiat
2009 2010 2011 1H2012
(5)
(4)
(3)
(2)
(1)
0
1
2
3
4
5
(% sales)
Chart 3 Operating Margin For The Auto Divisions Of Renault, Peugeot, And Fiat
Key credit factor Renault S.A. Peugeot S.A. Fiat SpA
The ability to extend or Renault boasts a solid market position Peugeot is the second-largest player The group lags somewhat behind
protect retail market share in the small and midsize auto segments, in Europe after Volkswagen in market its direct competitors in market share
in key markets by offering and in the entry segment through share. In Europe, the group has in Europe (7.1%). This weakness is
high-quality products Dacia. Selective expansion in recently suffered some market share lessened by the groups leading position
desired by customers. emerging countries (Mediterranean loss, to 11.4% at the end of first-half in Brazil (20% market share) and by its
countries, Latin America, and 2012 from 12.7% in 2010. Outside expansion in the U.S. following the
Russia) has been sustained while Europe, Peugeot has heavily invested June 2011 consolidation of Chrysler.
fierce competition has slightly eroded in China, Russia, and Latin America
the groups market share in Europe. with moderate success in volume gains
Alliance with Nissan is beneficial but so far no positive impact
to Renault in terms of joint and whatsoever on earnings.
R&D spending, market coverage,
and model launch.
Frequency of model Renault has demonstrated a sound The companys positive product mix Managements decision to limit
replacement; ability to overall capacity to anticipate market has evolved in recent years, gradually investments in new models, though
meet shifts, often rapid, trends. The group has gradually moving upmarket. Recently announced beneficial for cash flow in the near term,
in consumer preferences reduced its reliance on the Megane restructuring plans may erode may undermine the groups model
and perceptions. and Clio models, adding new model Peugeots market positions in the diversity and competitive position in the
families to its product range. coming quarters. longer term. Limited success for
Particularly successful have been Chryslers revamped products in
the value models sold under the Europe so far.
Dacia brand like the Logan-Sandero
family and the Duster family.
Ability to limit sales Intense price competition in the Intense price competition from Consolidated revenues are fast
incentives because of brand European volume market continues European peers and increasingly by declining in Europe and notably in
loyalty and success in to hamper sales and profitability. Asian competitors continues to Italya market that experienced a
differentiating product depress sales in Europe. We see a test double-digit percentage decline in the
on the basis of quality, style, to the carmakers ability to retain any first half of 2012. However, they are
or other consumer-driven premium pricing ability on any supported by Chryslers robust
measures. model in the coming quarters. performance in the U.S. and sustained
flows from Latin America, Fiats luxury
segment (Ferrari), and auto parts.
Ability to generate So far, the group has reported low but After a rebound in 2010 and the first While they are negative in Europe,
consistent profits in key stable profits in most geographies and half of 2011, the group has been consolidated earnings are supported by
portions of the product segments, with above-average earnings generating losses from its core Chryslers recently robust operating
lineup (retail and fleet) from its captive finance operations. automotive operations since the performance in the U.S. and sustained
under most volume scenarios, We expect declining sales in Europe second half of 2011, largely because flow of earnings from Latin America,
along with prospects for to weigh on the groups overall of its strong dependence on the highly Fiats luxury segment (Ferrari) and auto
break-even results or profitability in the coming quarters. competitive and mature European parts. Excess capacity continues to be
better during a significant volume market. We note that the an ongoing issue for Fiats European
market slump. group, so far, has failed to translate operations.
higher revenues outside its historical
markets into profits.
Production capacity utilization With a global capacity utilization rate During first-half 2012, the group Fiat reported very low capacity
across the companys of 87% in 2011, Renault compares reported a European capacity utilization utilization rates across its manufacturing
manufacturing footprint, positively with direct peers in the rate of 76%, an historical low for plants. Reported plant utilization in
in light of a typically high European volume market. Renault the group. Italy was as low as 50% in 2011, while
industry operating leverage. has moved faster in moving production in Brazil and in the U.S. the group
out of high-cost Western Europe, reported rates of 92% and 114%. The
to Romania, Turkey, Brazil, or group seems focused on improving
Morocco, for example. these rates.
The extent of brand, Renault has been able to achieve Average brand and geographic The group benefits from moderate
geographic, and product some product diversification through diversification. The group has two geographic and brand diversification.
line diversification. its three brands: Renault, Dacia, and brands: Peugeot and Citroen, which The agreement with Chrysler further
Renault Samsung Motors. As for both target the same market segments. supports the overall groups geographic
geographic diversity, Renault is still Geographic diversification is too limited, and segment diversity. The American
very reliant on Western Europe, with 73% of the groups revenues brand supports the groups strong
which accounted for approximately generated in Europe. Some benefits positioning in the light truck and
58% of unit sales and 65% of stem from the consolidation of minivan markets.
revenues in 2011. Faurecia (auto parts) and its wholly
owned captive finance subsidiary.
The scale, profitability, and Renault owns 100% of RCI Banque Peugeot owns 100% of Banque PSA Nonconsolidated and 50%-owned FGA
funding efficiency of vehicle (BBB/Stable/A-2), which provides Finance (BBB-/Negative/A-3), which Capital SpA (BBB-/Negative/A-3) is not
finance capabilities, through financing for Renault dealers and retail provides financing for the carmakers really adding to business diversity.
a captive unit or partnerships, customers in Renaults and some of dealers and retail customers in its major
because of significant reliance Nissans major markets. RCI Banque auto markets. The bank represents a
on financing availability for provides Renault with a substantial, substantial, relatively stable source of
the vehicle distribution and relatively stable source of earnings and earnings and cash flow for the carmaker.
sales process. cash flow that is not directly tied to
the auto industrys cyclicality.
Table 3 | Key Credit Factors For Renault, Peugeot, And Fiat
however erode its market positions in
the coming quarters.
Fiats sales are more skewed than its
peers toward mini and small cars.
However, the companys relatively broad
family of brands and models and steady
earnings contribution of its luxury, high-
performance brands (Maserati and
Ferrari) support credit quality, in our view.
The three companies benefit from
favorable environmental positioning.
Peugeots average CO2 emissions per unit
were 128 grams per kilometer (g/km) in
2011, while Renault is well on track to
meet its target of 120 g/km by 2013. Fiat
reported a best-in-class result of 125
g/km for full-year 2011. These measures
compare positively with those of German
car manufacturers and meet the EU
requirement of 120 g/km by 2012. (More
precisely, automakers are to achieve 130
g/km, with an additional 10g/km coming
from complementar y measures, for
example the use of biofuels.)
The three companies continue to
feature what we consider to be
average brand positioning and good
market shares in their core markets
We usually view strong market shares in
fewer countries as more advantageous,
from a credit standpoint, than weaker
market shares in more countries. In this
regard, the three southern European players
are relatively well positioned: Peugeot ranks
No. 2 in market share in Europe, with
Renault and Fiat following. However, in
Europe, their market share distribution is
skewed toward France, Italy, and Spain, the
three national car markets that are currently
suffering the most (see chart 1).
Partly for the same reason, all three
companies have seen their European
market share slowly but steadily decline in
the past few years. Another factor is fierce
competition from Asian players entering
the European market (like Hyundai-Kia)
and more surprisingly, market share gains
by VW even in the most difficult countries
like Italy and France.
Outside Europe, Fiat holds some solid
market positions in Brazil (above 20%) and
Argentina (10%), and meaningful ones in the
U.S. through Chrysler. Renault has gained
solid traction in some Mediterranean and
Eastern European countries such as
Morocco, Algeria, Turkey, and Romania.
Peugeot is present in Latin America, China,
and Russia, but with relatively limited
market shares at this stage, which we see as
a relative weakness.
Globally, Renault ranks as the 11th-
largest automaker by market share (third
when combined with Nissan), while Fiat
(including Chrysler) is No. 7 and Peugeot
is No. 9 (see chart 2).
3.
Capacity To Find
Profitability Outside
Domestic Markets Still Lags
Best Industry Performers
Since the Western European car market is
likely to be depressed through 2013, we
are monitoring the three carmakers
capacity to generate earnings outside their
historical markets as a key factor to sup-
porting operating performance and
overall credit quality in the next two years.
Based on available information (the
three carmakers dont consistently dis-
close earnings by region), we believe
that Fiats earnings benefit the most of
the three from running profitable oper-
ations outside of its home market (see
table 6). Fiats strong operating per-
for mance i n Brazi l and i n the U. S.
through Chrysler supports its overall
profitability despite the steep losses
generated in Europe. However, Fiats
overall geographic diversification faces
two main constraints: small exposure
to the large and growing Asian automo-
bile market, which represented about
2006 2007 2008 2009 2010 2011 2012e
(6)
(5)
(4)
(3)
(2)
(1)
0
1
2
3
4
5
(Mil. )
Unadjusted free operating cash flow
eEstimate.
2006 2007 2008 2009 2010 2011 2012e
0
2
4
6
8
10
12
14
(%)
Adjusted debt to EBITDA
eEstimate.
3% of reported revenues (including
Chrysler) in 2011; and a strong depend-
ence on a f ew mar kets, wi th Ital y,
Brazil, and U.S., accounting for more
than 80% of revenues.
We view Renault as less diversified than
Fiat. However, Renault has increased its
presence in developing countries in recent
years, particularly in Russia, Latin America
(Brazil and Argentina primarily), and sev-
eral countries in the Euro-Mediterranean
such as Romania, Turkey, Algeria, and
Morocco, which are offering growth poten-
tial. In addition, Renault is generating
profits in most markets where it is active,
in particular the entry segment with Dacia.
The main weaknesses regarding diversifi-
cation are, in our view, lack of a presence
in North America, with the exception of
Mexico, or in Japan, and its marginal posi-
tion in China. The groups presence in Asia
is primarily limited to the highly competi-
tive South Korean market.
Peugeot benefits the least of the three
from diverse sources of earnings genera-
tion. The group generates more than 70%
of its revenues in Western Europe.
Moreover, except for its 50% joint venture
with the Chinese company Dongfeng,
which is contributing to equity earnings,
other regions outside Western Europe are
not yet generating positive earnings for
the group. The group so far has also failed
to translate growing revenues in Russia
and Latin America (primarily Brazil and
Argentina) into better earnings.
Overcapacity and high operational
leverage continue to weigh on
operating performance
We regard plant underutilization as a par-
ticularly acute problem in Europe for mass
market makers. European automakers did
not cut capacity during the last downturn,
unlike those in the U.S. following the 2009
government sponsored bailouts, where
plant closures and asset disposals laid the
foundation for better profitability. Overall,
the three companies earnings perform-
ances remain lackluster.
In analyzing operating efficiency for the
three automakers, we believe that the most
relevant factors are the size and location of
production, reported capacity utilization
rates, and the actual achievement of
improved earnings from cost reductions
and efficiency gains.
We believe that Renault is better posi-
tioned than the other two carmakers
regarding cost management and capacity
utilization. The measures it has been
taking since 2008 have allowed it to adjust
its production footprint to its expectations
for changes in sales volumes and the
regions where it is targeting growth.
Peugeot S.A. Renault S.A. Fiat SpA
Brands as percentage of total auto production (%)
Citroen 40.2 Renault 61.2 Fiat 46.8
Peugeot 59.8 Dacia 30.1 Dodge 23.6
Samsung 8.6 Jeep 14.3
Chrysler 6.9
Alfa Romeo 3.2
Lancia 2.5
Iveco 2.4
Ferrari 0.2
Maserati 0.1
Top five models as percentage of total auto production (%)
Peugeot 19.7 Renault 17.8 Fiat Uno 7.3
206/207/208 Clio
Peugeot 8.2 Dacia 10.8 Fiat Punto/ 7.1
306/307/308 Logan Grande Punto
Citroen C4 8.2 Dacia 10.2 Dodge Ram Light 5.0
Sandero Duty Pickup
Citroen C3 7.0 Renault 9.2 Fiat 500 5.0
Megane
Citroen Berlingo 4.8 Dacia 6.6 Fiat New Panda 4.9
Duster
Total top five best sellers (%)
47.8 54.6 29.2
Source: LMC Automotive Ltd., data as of 2011.
Table 5 | Brands And Model Diversity For Peugeot, Renault, And Fiat
(000s units) 2010 % change 2011e % change 2012e % change 2013f % change
North America 13,930 10.4 15,230 9.3 17,116 12.4 17,917 4.7
Mercosur
(Brazil and
Argentina) 4,042 13.7 4,376 8.3 4,222 (3.5) 4,589 8.7
Western Europe 14,430 (3.7) 14,375 (0.4) 13,453 (6.4) 13,510 0.4
Eastern Europe
(including Russia,
Turkey, Ukraine) 3,756 17.0 4,633 23.3 4,803 3.7 5,166 7.6
Japan 4,896 7.4 4,149 (15.3) 5,030 21.2 4,630 (8.0)
Asia-Pacific 24,019 30.6 25,162 4.8 27,371 8.8 30,949 13.1
Other 7,358 11.5 7,548 2.6 7,844 3.9 8,468 8.0
World 72,431 13.3 75,473 4.2 79,840 5.8 85,228 6.7
Table 4 | Standard & Poors Expectations For Light Vehicle
Demand Worldwide
Peugeot repor t ed a record l ow
capacity utilization rate of 76% as of
June 2012. The concentration of the
groups capaci ty i n Europe, where
about 80% of its workforce is located,
greatly exposes the carmaker to poten-
tial decreases in home market demand.
Fiat is in a somewhat similar situation
in Europe. We are seeing substantial
overcapacity in the groups European
mass market and especially in Italy,
where capacity utilization was as low as
50% for the companys fiscal year ended
Dec. 31, 2011.
Weak profitability is the main
constraint on business risk for all
three carmakers
We are monitoring the profitability of all
three carmakers, which is the primary
constraint for their business risk and the
ratings. Because of falling European sales,
the operating margin of all three compa-
nies declined during the first half of 2012.
We do not expect the trend to reverse on
a full-year basis (see charts 3 and 4).
We regard Peugeots profi tabi l i ty
measures as the weakest of all three
companies. The groups core automo-
tive operations have been reporting
increasingly negative operating mar-
gins since mid-year 2011. It broke even
at the end of June 2012 thanks only to
its auto parts subsidiary Faurecia and
captive fi nance enti ty Banque PSA
Finance (BPF; BBB-/Negative/A-3). In
our view, it will be quite an achieve-
ment for the group to break even for
full-year 2012 on a consolidated basis.
We regard the groups capaci ty to
restore profitability in its automotive
operations in the near to medium term
as key for overall credit quality.
Renaults profitability measures,
although better than Peugeots, remain at
the lower end among European carmakers
and lower than those of Asian peers.
Fiat continues to report an operating
profit in its auto segment and on a
group level. Although this supports
credit quality, the group remains unable
to maintain positive operating results in
Europe. Overall profitability depends
on sustained success in Brazil and con-
tinued improvement at its Chr ysler
unit, whose contribution accounted for
some 90% of total group operating
income in first-half 2012. This contri-
bution is not mirrored by similar cash
movements between the two compa-
nies (documentary restrictions limit
intragroup cash flow transfer between
Chrysler and Fiat with Chryslers cash
remai ni ng l argely ri ng-fenced from
Fiats at this stage).
Strategic alliances support
can creditworthiness
Standard & Poors views the three car-
makers alliances with global automakers
as somewhat supportive of credit
quality. The benefits are obviously higher
after an alliance has an established track
record of several years, broad scope
(from joint procurement, shared logistics,
to common research and development
(R&D), and shared production plat-
forms), and a visible effect on consoli-
dated results through cost savings.
Renaults alliance with Nissan dating
back to 1999, in our view, is a substantial
indirect advantage for the company. The
collaboration between the two groups
has resulted in a substantial sharing of
Revenues Automotive 97%; Automotive: 71.2%; Automotive (FGA
breakdown RCI Banque Faurecia (equipment): and Chrysler) 75.7%;
by business (captive finance) 3% 23.5%; Gefco Luxury (Ferrari,
(transportation Maserati) 4.2%; Fiat
and logistic): 2.4%; Power Train (engine
Banque PSA Finance and transmissions) 6.5%;
(captive finance): Teksid (metallurgical
2.6%; Other: 0.2% products) 1.4%; Comau
(production systems)
2.1%; Magneti Marelli
(auto components) 8.6%
Automotive revenues
(mil. and % of total)
Europe 27,408 64.3 43,836 73.2 17,007 28.5
North America 5,210 12.2 0 0.0 21,423 36.0
South America 5,495 9.2 9,860 16.6
Asia 5,060 11.9 2,833 4.7 1,557 2.6
Other 4,950 11.6 7,748 12.9 9,712 16.3
Total revenues 42,628 100.0 59,912 100.0 59,559 100.0
Automotive wholesale
units and % of total
Western Europe 1,455,241 57.1 1,950,600 57.8 1,136,279 28.0
Eastern Europe 411,955 16.2 222,767 6.6 218,044 5.4
North America 23,171 0.9 5,546 0.2 1,659,250 40.9
South America 392,903 15.4 314,726 9.3 904,291 22.3
Asia 156,005 6.1 432,407 12.8 128,646 3.2
Other 108,120 4.2 445,856 13.2 11,882 0.3
Total 2,547,395 100.0 3,371,902 100.0 4,058,392 100.0
Automotive market share (%)
Western Europe 10.1 13.6 7.9
Eastern Europe 8.8 4.7 3.8
North America 0.0 0.0 10.9
Latin America 7.2 5.8 16.7
Asia 0.0 1.4 0.4
Global share 3.4 4.5 5.4
Market share and unit sales data from LMC Automotive Ltd. as of 2011.
Table 6 | Sales, Revenue, And Market Share For Renault, Peugeot, And Fiat
the huge costs that carmakers incur in
developing new products and technolo-
gies. In 2011, the Renault-Nissan Alliance
spent 5.2 billion on R&Dwith Renault
paying 2 billion and Nissan the rest. In
addition, Renault and Nissans opera-
tional integration covers the develop-
ment of certai n model s, the use of
common platforms and components,
the manuf acturi ng of products i n
shared facilities, and the pooling of
spare parts procurement.
Although Fiats alliance with Chrysler
began only in 2009, the full consolidation
of Chrysler since June 2011 brings with it
substantial advantages. Chryslers strong
position in the U.S. market adds substan-
tial diversity to the integrated groups
geographic footprint, while the American
brands in the light truck segment comple-
ment Fiats existing product mix.
Peugeot S.A. (BB/Negative/B)
The negative outlook on Peugeot (PSA) captures the risk that
the company might be unable to meaningfully reduce the
level of cash flow burn in 2013 from the current unsustain-
ably high level and a risk of ongoing reduction in car sales.
While so far PSA has shown good progress in executing its
disposal strategy, the outlook also reflects the risks that tur-
bulent capital markets and political risk may hamper the exe-
cution of PSAs announced restructuring and disposal plans.
Furthermore, there is uncertainty whether in 2013 PSAs
key markets will halt their decline and how competitively PSA
will be positioned in these markets.
We would lower the rating if PSA was unable to maintain
its ratio of FFO to adjusted debt at about 20% throughout
2012 to 2013the level we see as commensurate with the
companys BB rating. An additional revenue decline in 2013,
coupled with a further gross margin weakening, could cause
this ratio to fall below our target. A downgrade could also
occur if asset disposals are not forthcoming in 2012 to 2013.
In our base-case scenario of anemic car market growth in
Europe in 2013, any marked improvement in PSAs credit
ratios would likely only stem from further progress in its asset
streamlining, including divestments and plant closures, as
well as a conservative approach to capex, dividends, and
working capital management.
We could revise the outlook to stable if we saw clear evidence
of improving credit ratios, specifically FFO to adjusted debt well
above 20% over the medium term, which will partly depend on
sufficiently supportive industry conditions, but also on PSAs
demonstrated ability to restore profitability and reduce debt.
(See: Research Update: French Carmaker Peugeot Downgraded
To BB On Rapid Cash Burn And Mounting Operational Challenges;
Outlook Negative, published July 25, 2012.)
Renault S.A. (BB+/Stable/B)
The stable outlook reflects our opinion that Renault will likely
maintain credit ratios that we consider to be commensurate
with its BB+ rating, such as adjusted FFO to debt of about
25% over the next two years, even under a conservative credit
scenario. In our base case for 2012, we expect Renaults
adjusted FFO to debt to exceed this level. However, we see
the need for a cyclical company, such as Renault, to maintain
a buffer to be able to withstand large swings in demand and
operating cash flow, as has been the case in the past, and to
face new operational challenges. As such, we expect FFO to
debt in the 20% to 30% range and debt to EBITDA of less than
4x even in the most difficult years. Volume carmakers are sub-
ject to cyclicality and therefore our target credit ratios incor-
porate a buffer upward and downward to enable us to rate
through the cycle.
We could lower the ratings if Renaults industrial operating
performance weakens markedly, resulting in FFO to debt
below 20%. This could happen, for instance, if Renaults oper-
ating margin contracts by some 150 basis points versus the
recent level or if the company fails to maintain positive FOCF
in its automotive division over more than a year or so.
We could raise the ratings if the operating margin of
Renaults core automotive operations structurally improves
toward the mid-single digits, including through periods of soft
demand, and becomes fully commensurate with the 5% con-
solidated operating margin target set by Renault for 2013.
Further reduction of Renaults dependence on the European
market would also be beneficial, in our view.
(See: Research Update: French Automaker Renault Upgraded
To BB+ On Completion Of Sale Of Volvo B Shares; Off Watch;
Outlook Stable, published Nov. 3, 2010.)
Fiat SpA (BB-/Stable/B)
The stable outlook reflects our view that European activities will
remain weak over the next 12 months. However, we also believe
that cash flow from Brazilian and luxury car operations, efforts
to control costs, and substantial excess liquidity will enable Fiat
to weather a difficult period in the European auto market.
Under our base case, we expect the consolidated group to
maintain FFO to net adjusted debt in the 12% to 20% range
and net debt to EBITDA of 4.5x to 5x. We view these ratios as
appropriate for the current rating.
We could take a negative rating action if an even more
severe than expected deterioration in European performance,
or significant weakening of Brazilian operations, causes the
liquidity position to worsen or credit ratios to drop below
levels we view as commensurate with the BB- rating. We cur-
rently see no upgrade potential for the rating.
(See: Research Update: Fiat Downgraded To BB- On Weak
European Performance And Rising Consolidated Net Debt;
Outlook Stable, published April 26, 2012.)
Appendix: Standard & Poors Outlooks On Renault, Peugeot, And Fiat
Peugeot for the moment is reaping
fewer operational benefits than the other
two companies from its March 2012
alliance with General Motors Co. (GM;
BB+/Stable/). We dont foresee sizable
benefits from joint procurement, shared
logistics, and common R&D before 2015.
Nevertheless, we consider that financial
support, such as the recent equity increase
subscribed by GM, has helped Peugeot sta-
bilize debt levels in the near term.
Financial Risk Hinges On Their
Degree Of Financial Flexibility
While we classify business risk for all
three companies as fair, our assess-
ment of financial risk runs from inter-
mediate for Renault, significant for
Peugeot, to aggressive for Fiat. This
varies with the amount of debt they
carry and their capacity to generate cash
flow. However, we expect all of the com-
panies credit ratios to come under some
pressure in the coming quarters because
of weak operating performance.
To assess a companys financial risk,
Standard & Poors reviews factors such
as f i nanci al pol i cy, cash f l ow ade-
quacy, capital structure, and liquidity
on a historical and forward-looking
basis. Our evaluation also includes a
review of accounting policies and any
documentar y restri cti ons that may
limit intragroup cash f low transfer.
(This is particularly relevant for Fiat,
which cannot access Chryslers cash,
according to a 2009 deal where the
Italian carmaker promised to maintain
a firewall as a condition of U.S. and
Canadian governments bailouts of the
American carmaker.)
Financial flexibility is crucial for the
ratings on all three carmakers
We believe that our measures of cash
flow adequacy such as adjusted funds
from operations (FFO) to debt and
adjusted debt to EBITDA will tend to
weaken in the near to medium term. For
that reason, financial flexibility is crucial
to maintaining the ratings at their cur-
rent level. Although we believe that
Renault and Fiat have a buffer, Peugeot
does not, which accounts for our nega-
tive outlook.
We believe that Renault has more
financial flexibility than the other two
carmakers. For full-year 2012, we fore-
cast a decline in Renaults adjusted
ratio of FFO to debt to about 40% from
current levels and adjusted debt to
EBITDA to exceed 2x, which we still
view as comfortable for the ratings (see
charts 5 and 6).
Peugeots credit metrics declined
sharply last year and in the first half of
2012, on the back of cash burn in its
automotive operations. In our view, the
companys ability to stabilize debt this
year and next will rely primarily on one-
off corporate measures like divestments
or the recent equity increase subscribed
by GM. In our base-case scenario, we
anticipate that Peugeot will at best main-
tain its adjusted ratio of FFO at about
20% by year-end 2013.
We see Fiat as the most leveraged of
the trio. At the end of 2011, the group
had about 26 billion in net debt,
including Standard & Poors adjustments
for operating leases, pension deficits,
and the deconsolidation of finance liabil-
ities. Although this large debt burden is
weighing on the groups financial flexi-
bility, we anticipate that Fiat will be able
to keep its credit metrics from declining.
In our base-case scenario for Fiat, we
expect the consolidated group to main-
tain adjusted FFO to debt in the 12% to
20% range and adjusted debt to EBITDA
at about 4.5x to 5x, which we see as
commensurate for the current ratings.
Cash flow volatility is the
main risk for all three companies
in the coming quarters
In the current bearish environment for
the European volume auto industry, in
our view their maintenance of at least
neutral FOCF is key to protecting finan-
cial stability. During the last downturn in
2009, FOCF turned deeply negative for
the three companies, mainly because of
significant swings in working capital
requirements, partly because of growing
inventories of unsold vehicles.
We believe Renault is better able to
generate cash flow than the other two
companies (see chart 7). Since 2008,
FOCF has consistently improved and we
understand that positive cash flow gen-
eration for automotive is a key target for
management as part of Renaults
strategic plan. Despite an increase in
inventories in the first half of 2012, we
anticipate that FOCF will at least break
even for full-year 2012.
We anticipate that Fiats FOCF will be
close to breakeven in 2012, with support
from the strong performance of Chrysler
in the U.S. and by the groups cash flow-
generative Brazilian operations, despite
heavy capital expenditure spending.
Peugeot reported largely negative
FOCF of about a negative 2 billion in
full-year 2011 and an additional negative
1 billion in first-half 2012. In light of
deteriorating conditions in its core mar-
kets, we do not expect the carmaker to be
able to generate breakeven FOCF before
2014. In our base case, we foresee the
company generating negative FOCF,
purely from operations, of about 2 billion
this year, with only a marginal improve-
ment in 2013, when the restructuring
measures it recently announced kick in.
Liquidity is still adequate
for the three carmakers
We view all three automakers liquidity
as adequate under our criteria (see
Standard & Poors Standardizes Liquidity
Descriptors For Global Corporate Issuers,
July 2, 2010). We focus on bank lines and
cash balances as the main sources of liq-
uidity. While automakers may be able to
extract cash from working capital when
production is increasing, because they
receive cash faster than they need to pay
it to their suppliers, the reverse is typi-
cally true when production falls, and
these outflows can be massive. We will
continue to closely monitor liquidity
levels and trends for these carmakers
over the coming quarters. CW
Eric Tanguy
Paris (33) 1-4420-6715
Barbara Castellano
Milan (39) 02-72111-253
Jan Plantagie
Frankfurt (49) 69-33-999-131
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CreditWeek

The Global Authority On Credit Quality | September 26, 2012

We expect the eurozone economies to remain depressed, and although the

The company sustains debt to

Pretax automotive profit to reach the

Liquidity at the automotive parent

Automotive-related operating free

The company successfully manages

Ford Credit continues to be profitable

AA or A category BMW, Toyota,

BBB categor y Hyundai-Kia and

BB+ or BB rated Ford, GM,

BB- and lower-rated Aston Martin,

France-based Compagnie Generale

U.S.-based Goodyear Tire & Rubber

Ger many-based Continental AG

U.S.-based Cooper Tire & Rubber Co.

Labor (including mostly unionized

Large manufacturing plants with

The U.S. automakersGM, Ford, and Chryslerhave returned to profitability in

Losses in Europe that seem likely to

GMs plan for substantial changes to

Fords performance in North America

We believe Ford will act with increasing

We could raise the rating to invest-

Losses in Europe that seem likely to

Fords plans to offer lump sum pay-

Our expectation that Chryslers prof-

Chryslers ef forts to improve con-

Fiats ownership (now 58.5%), the

The companys substantial scale, with

A recent, but in our view, sustainable,

Reliance on the light-truck segment in

Difficult conditions in Europe, with

Significant geographic and product

Automotive margins that are in the

The companys global scale, with 2011

A growing track record of profitability

Reliance on the light truck segment in

Difficult conditions in Europe, with

Geographic diversity that provides at

Automotive margins that are in the

Heavy reliance on the light-truck seg-

Limited geographic diversity;

The companys shorter track record of

EBITDA margins that are currently

The benefits of Fiat ownershipbut

Global production overcapacity;

High operating leverage (high fixed

Highly cyclical and volatile end-

Making expensive products but having

The industrys labor-intensive nature, and

The 2007 health care deal with the

The companies have reduced debt

GM and Chrysler have reduced debt

Automotive-related FOCF of about

Prospects for debt to EBITDA of

Automotive EBIT profit margins in the

Liquidity at the automotive parent

GMs continuing ability to cope suc-

GM Financials continuing profitability.

Ford sustai ns debt to EBITDA at

Automotive-related operating free cash

Pretax automotive profit margins in