(Adds share/bond market reaction, background)
By Nick Tattersall
FRANKFURT, June 26 (Reuters) - Credit rating agency Fitch said on Thursday it had assigned an A+ senior unsecured rating and an F1 short-term rating to German carmaker Volkswagen , but said the long-term outlook was negative.
"The outlook reflects the expected reduction in cash generation during the upcoming model replacement phase and an unfavourable hedging position," Fitch said in a statement.
Fellow rating agency Moody's on Monday cut VW's outlook to negative, citing concerns about its cashflow as it prepares to launch updated versions of its two most important cars -- the Golf hatchback and larger Passat saloon.
VW's profits tumbled by more than two thirds in the first quarter of this year, hammered by a weak dollar and spending on new models, but Chief Executive Bernd Pischetsrieder has said he expects new products to "reverse the picture" in 2004.
The company recently lifted its hedging rate to cover 40 percent of its exposure to the U.S. dollar, Japanese yen and British pound, but it still hedges much less than rivals.
Costs from its massive product overhaul -- it is launching an updated model somewhere in the world every three weeks this year -- has been slicing away at profits, while sliding sales of the ageing cars it is replacing have seen it lose market share.
Fitch said VW would have to claw back those losses and translate them into a substantial improvement in operating margins and cash flow generation to maintain the rating.
Chief Financial Officer-designate Hans-Dieter Poetsch told a German newspaper on Thursday that while VW would sell more cars in 2004 than this year, markets would need to pick up for it to achieve record sales, which peaked at 5.16 million cars in 2000.
PRICING PRESSURE
Volkswagen bonds fell slightly in value after the rating announcement. A trader said the 4.875 percent bond due May 2013 was yielding around 118 basis points above government benchmarks at around 1200 GMT, or about two basis points more on the day.
"VW spreads are trading wider than we'd expect for single-A rated name. There's a lot of supply -- if you want a VW bond, you have plenty to choose from," the trader said.
VW stock was up 1.7 percent to 34.80 euros in afternoon Frankfurt trade, joining a sector rally in Germany as the dollar firmed against the euro after the U.S. Federal Reserve cut interest rates by 1/4 percentage point.
Fitch also noted that VW faced heavy price competition due to the downturn in its main markets -- Europe and the United States -- a trend which tends to affect mass-market players more than their luxury peers.
Pischetsrieder told a conference earlier this week he was determined to stick to a sales policy that supported the prices of used VW cars, and noted that the company had been introducing premium products, traditionally more immune to pricing pressure.
Fitch also said that a potential increase in VW's stake in truckmaker Scania would be a threat to the group's liquidity base.
Sweden's Volvo has to sell its 45-percent stake in Scania for regulatory reasons by early next year, and Pischetsrieder has said VW is keeping its options open on whether to sell off its existing stake in Scania or buy more. (Additional reporting by Bei Bei She in London)