CORPORATES CREDIT OPINION 3 January 2018 Update RATINGS Valeo S.A. Domicile Paris, France Long Term Rating Baa2 Type LT Issuer Rating - Fgn Curr Outlook Stable Please see the ratings section at the end of this report for more information. The ratings and outlook shown reflect information as of the publication date. Contacts Matthias Heck +49.69.7073.0720 VP-Senior Analyst [email protected]Falk Frey +49.69.7073.0712 Senior Vice President [email protected]Matthias Hellstern +49.69.7073.0745 MD-Corporate Finance [email protected]CLIENT SERVICES Americas 1-212-553-1653 Asia Pacific 852-3551-3077 Japan 81-3-5408-4100 EMEA 44-20-7772-5454 Valeo S.A. Semi-annual update Summary Valeo’s Baa2 rating reflects as positives its: (a) size and scale as a Tier 1 automotive supplier with revenues in 2017 of around €18 billion; (b) long-standing relationships with the global original equipment manufacturers (OEMs); (c) high product diversity operating across four core reporting segments; (d) positive exposure to the long-term forces affecting the automotive industry; (e) high rate of innovation with products launched within the last 3 years accounting for over 42% of orders in 1H2017; and (f) balanced financial policy, as reflected by gross debt/EBITDA (Moody's adjusted) of 2.9x per LTM 06/2017. The rating also reflects as negatives its: (a) exposure to the cyclicality of automotive production which faces headwinds in 2017; (b) exposure to volatile raw material costs; and (c) low profitability, with an EBITA margin (Moody's adjusted) of 5.8% per June 2017 albeit at a level that is average for the industry. Exhibit 1 Leverage Compared with Rating Triggers Valeo S.A. 0 500 1,000 1,500 2,000 2,500 2009 2010 2011 2012 2013 2014 2015 2016 LTM 2017e 2018e Cash on balance ( m) 0.0x 0.5x 1.0x 1.5x 2.0x 2.5x 2009 2010 2011 2012 2013 2014 2015 2016 LTM 6/2017 2017e 2018e 2019e Expected range for Baa2: 1.5-2.0x net debt / EBITDA (Moody's adjusted) Source: Moody's Financial Metrics™ Credit Strengths » High innovation rate underpins future revenue growth » Well positioned to manage long-term disruptive trends » Increasing aftermarket sales » Strong liquidity, supported by continuously high cash balance Credit Challenges » Exposure to the cyclicality of automotive production
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CORPORATES
CREDIT OPINION3 January 2018
Update
RATINGS
Valeo S.A.Domicile Paris, France
Long Term Rating Baa2
Type LT Issuer Rating - FgnCurr
Outlook Stable
Please see the ratings section at the end of this reportfor more information. The ratings and outlook shownreflect information as of the publication date.
SummaryValeo’s Baa2 rating reflects as positives its: (a) size and scale as a Tier 1 automotive supplierwith revenues in 2017 of around €18 billion; (b) long-standing relationships with the globaloriginal equipment manufacturers (OEMs); (c) high product diversity operating acrossfour core reporting segments; (d) positive exposure to the long-term forces affecting theautomotive industry; (e) high rate of innovation with products launched within the last 3years accounting for over 42% of orders in 1H2017; and (f) balanced financial policy, asreflected by gross debt/EBITDA (Moody's adjusted) of 2.9x per LTM 06/2017.
The rating also reflects as negatives its: (a) exposure to the cyclicality of automotiveproduction which faces headwinds in 2017; (b) exposure to volatile raw material costs; and(c) low profitability, with an EBITA margin (Moody's adjusted) of 5.8% per June 2017 albeit ata level that is average for the industry.
» Exposure to disruptive trends in the industry, but product portfolio to partly offset this
» High R&D expenses
Rating OutlookThe stable outlook reflects our expectation that Valeo will be able to sustain: (a) EBITA margins well above 5.5%; (b) positive levels ofFree Cash Flow (FCF) generation; (c) net leverage well below 2x net debt / EBITDA (and gross debt / EBITDA well below 3x); and (iv)retained cash flow (RCF) / net debt above 35%.
Factors that Could Lead to an UpgradePositive rating pressure could arise if Valeo achieved on a sustainable basis
» EBITA margins in the high single-digits in percentage terms,
» Net leverage below 1.5x net debt/EBITDA (Moody's adjusted),
» Further improvement in FCF generation,
» RCF/net debt ratio above 40%, and
» continuation of a balanced financial policy.
Factors that Could Lead to a DowngradeNegative rating pressure could arise if
» EBITA margins fell below 5.5%,
» Materially negative FCF was generated,
» Leverage increased towards 2.0x net debt/EBITDA and/or 3.0x gross debt/EBITDA, or
Capital Structure: Net Debt / Net Capitalization 45.1% 37.8% 33.9% 46.1% 45.8%
[1] All ratios are based on 'Adjusted' financial data and incorporate Moody's Global Standard Adjustments for Non-Financial CorporationsSource: Moody's Financial Metrics™
ProfileHeadquartered in Paris, Valeo S.A. is one of the leading global suppliers of automotive components for new cars and light vehicles(original equipment or OE) and the aftermarket (around 10% of group revenues). In 2016, Valeo generated revenues of €16.5 billion.
This publication does not announce a credit rating action. For any credit ratings referenced in this publication, please see the ratings tab on the issuer/entity page onwww.moodys.com for the most updated credit rating action information and rating history.
2 3 January 2018 Valeo S.A.: Semi-annual update
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Valeo has four business divisions: (i) Comfort and Driving Assistance Systems (20% of 2016 group revenues); (ii) Powertrain Systems(24%); (iii) Thermal Systems (28%); and (iv) Visibility Systems (28%). The group's product range consists of clutches, electrical systems,switching and driver interface modules; sensors for driving assistance; air-conditioning systems and modules; heating and coolingproducts; filters; windshield wipers; and lighting systems.
Detailed Credit ConsiderationsExposure to the cyclicality of automotive productionValeo, like most global auto suppliers, has a strong reliance on the production rates of light vehicles by the various OEMs. In 2017,the global production of passenger cars increased by around 1.3% to reach 94 million cars (according to Moody's data). While thedeveloped markets of Europe grew by a more muted 2%, growth in Asia was notably higher. In particular, production in China grewby 5.6% (according to Moody's data). In contrast, North American markets declined by around 3.6%, after relatively strong growth in2014 and 2015 and stable volumes 2016.
Exhibit 3
Global production increased by 1.3% in 2017 driven by most regions but notably higher in China (Moody's data)
K Units Unit Sales 2013 Unit Sales 2014 Unit Sales 2015 Unit Sales 2016
Total 84,285 87,341 89,102 92,794 94,000 1.3% 95,400 1.5%
See Moody's 2018 Outlook for Automotive manufacturers and parts suppliersSource: LMC, US Bureau of Economic Analysis, ACEA, Chinese Association of Automobile Manufacturers and estimates of Moody's Investors Service
As a consequence of this speed of growth, Valeo (along with many of the other automotive suppliers) is looking to increase its exposureto Asian customers. While in 2007, Asia represented only 12% of OEM sales (with China at 3%), the region had increased in 1H2017 to29% of Valeo's OEM sales (with 15% coming from China).
At its Capital Markets Day in February 2017, Valeo estimated that global vehicle production would increase by an average 2.3% perannum between 2016 and 2021 with Asia accounting for 65% of the increase. Within this, Valeo estimated that China would accountfor 46% while the rest of Asia would account for 19%. This is arguably a stronger rate of growth than we estimate in our industry sectoroutlook, published in December 2017 where we estimate that global light vehicle sales will grow by 1.5% in 2018, roughly the samegrowth rate as the industry delivered in 2017. While we expect China and Japan to grow above the global average, we anticipate thatWestern Europe will grow very modestly by 1.0% and the United States may decline by another 0.6% in 2018.
Well positioned to manage long-term disruptive trendsWe believe that Valeo has positive exposure to three long-term disruptive trends currently facing the automotive industry: (a) theelectrification of the powertrain and the shift towards hybrid and fully electric vehicles; (b) autonomous driving; and (c) the increasingconnectivity of a car both with passengers and also with its surroundings.
In recent research, we estimated that alternative fuel vehicles (AFVs) such as hybrids and electric cars could account for between15-25% of total production by 2025. This high level of growth is driven by a combination of: (a) the increasing severity of carbonemissions regulations and; (b) the decreasing cost of lithium ion batteries. Together these factors are promoting an increase in salesof cars with some level of electrification in the powertrain. We believe that Valeo is well placed to benefit from this trend, particularlygiven its leading position for 48-volt (48V) “mild hybrids.” In its 2017 Capital Markets Day, Valeo estimated that for such vehicles itsaverage content per car is around threefold of that with a traditional internal combustion engine (ICE). For higher powered hybrids(such as plug-in hybrids) and electric vehicles, the content is greater still. We also think Valeo is well positioned to benefit from its JointVenture with Siemens founded in 2016, which will see the latter contribute its expertise for electric motors and inverters.
Through Valeo’s Comfort & Driving Assistance (CDA) Systems division, we believe the group is also well placed to benefit from thetrend towards increasingly autonomous and connected vehicles. The company has a broad portfolio of products (e.g., sensors, cameras,lasers and control units) which are found in increasing quantities in autonomous vehicles. While the time horizons for the variousstages of autonomous cars (level 1 = some driver assistance; level 5 = full autonomy) are uncertain, the company also believes that itsaverage content per vehicle would be considerably higher in those scenarios than is implied from its financial performance in 2017.
High innovation rate underpins future revenue growthLike many European auto suppliers, Valeo invests significantly in research & development (R&D) activities per year. In 2016, thisamounted to €1.6 billion (9.7% of sales), a 59% increase since 2012 (where it was €1 billion and represented 8.6% of sales). Of this€1.6 billion, around €456 million were funded directly by Valeo’s customers (predominantly the OEMs) and through subsidies/grantsand around €437 million were capitalized as capital expenditure. Within the profit & loss account, therefore, 5.8% of revenues areshown as net R&D expenses, which was slightly above that of the industry average.
While the high level of R&D has a negative impact on both profitability and cash flow, it is nevertheless intrinsic to the sector andis somewhat required by companies in order to generate future orders and profitability. Indeed, Valeo’s financial policy is illustratedthrough its “virtuous circle” whereby innovation through R&D underpins future orders, which in turn provides earnings growth andheadroom to undertake acquisitions. In this respect, the company said that in the first half of 2017 its order intake increased by 16%to €14.9 billion (1.8x of original equipment sales) in addition to €3.0 billion related to the Valeo Siemens JV. This high order intakewill underpin revenue growth in excess of automotive production in the next 2-3 years. Furthermore, Valeo aims to maintain R&Dexpenses around 6% of sales to drive continuing innovation. In the first half of 2017, products that were developed within the prior 3years amounted to 42% of the group’s order intake.
Increasing global presence and aftermarket provide diversification benefitsGiven the growth of its sales to OEM customers in recent years, Valeo’s aftermarket business has declined slightly (in relativeterms) and now reflects 10% of total group revenue (as per first nine months of 2017). Nevertheless, the company believes thatits aftermarket sales will significantly increase in excess of 10% per year to 2021 to reach around €2.8 billion of sales. This reflectsa combination of: (a) previous OEM sales which drives the demand for replacement products; and (b) the acquisition of FTE andIchikoh. From a credit perspective, such a strategy – if successfully executed – would be credit positive because we generally expectthat aftermarket sales are less sensitive to the economic cycle than for the OEM segment. As a consequence, a higher proportion ofaftermarket sales (as a percentage of the total group) would lower the volatility of Valeo’s cash flows over time.
Strong credit metrics and committed to an investment-grade rating
Source: Moody's Financial Metrics. All figures & ratios calculates using Moody's estimates & standard adjustments. FYE = Financial Year-End. LTM = Last Twelve Months.
Valeo's credit metrics are generally commensurate with the current rating in absolute terms as well as in comparison to its peers. At theend of June 2017, net debt / EBITDA amounted to 1.6x (vs. guidance to maintain the rating of 1.5x-2.0x) while gross debt / EBITDA was2.9x (vs. guidance of less than 3x). The difference reflects the company’s sizeable cash balance, which amounted to €2.3 billion at theend of June 2017 and reflects the company’s strong historical free cash flow generation. Nevertheless, since 2015, Valeo’s credit metrics
4 3 January 2018 Valeo S.A.: Semi-annual update
MOODY'S INVESTORS SERVICE CORPORATES
have weaken somewhat and this reflects predominantly the acquisitions made by the group. We therefore expect a further increase innet leverage towards 2.0x at the end of 2017.
The acquisition of FTE, a producer of clutch and gear actuators based in Germany, was Valeo's only major transaction in 2017. Theacquisition was closed in 4Q2017 for an enterprise value of €819 million and was financed with cash on balance. While we expectthe company will continue to make medium sized acquisitions going forwards, we nevertheless believe that the issuer will maintaina balanced financial policy, commensurate with its existing rating. In this respect, we also note the group’s public commitment tomaintaining an investment grade rating and also its recent track record for stronger FCF generation.
Valeo has also operated a reverse factoring programm since 2014. Under the programme, which is reported as part of the group's tradepayables, Valeo pre-approves invoices from suppliers to a financial institution (“factor”). This supports Valeo's suppliers and enablesthem to factor their receivables. Despite its growing volume, we understand that Valeo's reverse factoring programme is still relativelysmall compared to its total trade payables of €4.2 billion as per June 2017 and has no material impact on the group's credit metrics ona Moody's adjusted basis.
Liquidity AnalysisMoody's considers Valeo's liquidity position to be strong and reflects a combination of: (a) cash on the balance sheet of €2.3 billion; (b)annual funds from operations (FFO) of around €1.4 billion; and (c) full availability under the company’s committed credit lines of €1.2billion. While those lines contain a financial covenant, we anticipate that headroom against it will be ample.
The above mentioned sources of liquidity comfortably exceed expected cash outflows, which mainly comprise (a) capex, (b) debtrepayments, and (c) M&A-related outflows for the Kapec JV and the acquisition of FTE.
Exhibit 5
Liquidity Development 3Q2017 to 2Q2018E walk-forwardValeo S.A.
*Short-term debt and current maturities of long-term debt** Working cash of ~ €0.5 billion is a Moody's standard assumption equivalent to 3% of group revenueSource: This represents Moody's forward view; not the view of the issuer; and unless noted in the text, does not incorporate significant acquisitions and divestitures.
Rating Methodology and Scorecard FactorsMoody's rating methodology for the automotive supplier industry points to Baa3 for Valeo driven by a temporary increase in gross andnet debt which also leads to slightly lower retained cash flow to net debt as a result of recent acquisitions. While scale of the businessis shown as a key strength of the credit, the grid points to profitability weakness. The actual rating assigned is one notch above theindication received from the grid reflecting the company's focus on innovation and the success in growing the business above themarket. the rating also reflects Valeo's continuously high cash balance which is not reflected in the gross leverage calculation.
b) Retained Cash Flow / Net Debt 38.8% Baa 33% - 40% Baa
c) Debt / EBITDA 2.9x Ba 2.5x - 3x Ba
d) Capital Structure: Net Debt / Net Capitalization 45.1% Ba 40% - 45% Ba
Rating:
a) Indicated Rating from Grid Baa3 Baa3
b) Actual Rating Assigned Baa2
Current
LTM 6/30/2017
Moody's 12-18 Month Forward View
As of 12/28/2017 [3]
[1] All ratios are based on 'Adjusted' financial data and incorporate Moody's Global Standard Adjustments for Non-Financial Corporations. [2] As of 6/30/2017; [3] This represents Moody'sforward view; not the view of the issuer; and unless noted in the text, does not incorporate significant acquisitions and divestitures.Source: Moody's Financial Metrics™
Ratings
Exhibit 7Category Moody's RatingVALEO S.A.
Outlook StableIssuer Rating Baa2Senior Unsecured -Dom Curr Baa2Subordinate MTN -Dom Curr (P)Baa3Commercial Paper -Dom Curr P-2
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