SIM

Business Context and Reporting Period

Company: GRUPO SIMEC, S.A.B. De C.V.
Filing Type: Form 20-F (Annual Report)
Reporting Period: Fiscal year ended December 31, 2017
Accounting Standards: International Financial Reporting Standards (IFRS)
Business Overview: Grupo Simec is a diversified manufacturer, processor, and distributor of Special Bar Quality (SBQ) steel and structural steel products. Operations are conducted across three primary segments: Mexico (approx. 58% of sales), the United States/Canada (approx. 30% of sales), and Brazil (approx. 11% of sales). The company operates 13 facilities with a combined crude steel capacity of 4.6 million tons.

Key Financial Metrics (2017)

Note: USD translations are based on the exchange rate of Ps. 19.7354 per USD 1.00 as of December 31, 2017.

Material Changes vs. Prior Period

• Revenue Growth: Net sales increased 4% to Ps. 28.7 billion, driven by a 4% increase in average selling price per ton and a slight volume increase (0.3%).
• Profitability Decline: Net income decreased significantly by 60% to Ps. 1.7 billion. This was primarily due to a foreign exchange loss of Ps. 654 million in 2017, compared to a gain of Ps. 1.775 billion in 2016, resulting from the appreciation of the Mexican peso against the U.S. dollar.
• Segment Performance:
  • Mexico: Net income dropped to Ps. 925 million from Ps. 3.46 billion, largely due to foreign exchange losses.
  • USA: Net income collapsed to Ps. 6 million from Ps. 2.93 billion. Margins were compressed as selling prices lagged behind rising raw material costs, and the segment lacked the significant one-time income from asset transfers recorded in 2016.
  • Brazil: Net income fell to Ps. 59 million from Ps. 731 million, driven by a reduction in foreign exchange gains.
• Operational Volume: Total shipments increased slightly to 2.091 million tons. Mexico shipments decreased 7%, while non-Mexico shipments increased 17%.

Guidance, Outlook, and Risks

Management Commentary and Outlook

• Capital Expenditures: Estimated 2018 capital expenditures are approximately Ps. 1.16 billion, focused on Mexican facilities. A major new mini-mill in Tlaxcala (600,000 tons capacity) is scheduled to begin operations in May 2018.
• Strategic Focus: Management aims to improve cost structures, focus on high-margin products, and pursue strategic growth opportunities. The U.S. segment is tackling cost curves to restore profitability.
• Trend Information: Q1 2018 net sales increased 17% compared to Q4 2017, with sales volume up 12% and prices up 4.4%.

Material Risks and Contingencies

• Internal Controls: The company and its auditors identified material weaknesses in internal controls over financial reporting for the seventh consecutive year (2011–2017). Issues include lack of segregation of duties, insufficient accounting resources, lack of a unified ERP system, and inadequate IT controls. The auditor issued an adverse opinion on internal controls for 2017.
• Regulatory and Legal:
  • SEC Inquiry: The SEC is conducting an informal inquiry regarding the company's internal controls. The company is cooperating and implementing remediation.
  • Environmental: Ongoing environmental remediation liabilities exist, particularly at the Pacific Steel facility in California (RCRA soil disposal) and Republic facilities. A reserve of Ps. 53.3 million is maintained.
  • Tax Audits: Tax authorities in Mexico, the U.S., Canada, and Brazil have the right to review prior years. An Ohio sales tax assessment of ~$2.45 million is being appealed.
• Market Risks:
  • Currency: Significant exposure to fluctuations in the Mexican peso and Brazilian real against the U.S. dollar.
  • Trade Policy: Potential impact of U.S. tariffs on steel (Section 232) and renegotiation of NAFTA.
  • Raw Materials: Volatility in scrap metal and energy prices. Scrap prices increased ~31% in 2017.

Investor Verification Checklist

• Internal Control Remediation: Verify the progress of remediation plans for the recurring material weaknesses in internal controls, specifically regarding the lack of a unified ERP system and segregation of duties.
• U.S. Segment Profitability: Monitor the U.S. segment's ability to pass on raw material cost increases to customers and restore margins, given the sharp decline in 2017 net income.
• Foreign Exchange Exposure: Assess the impact of peso appreciation on future earnings, as 2017 results were heavily impacted by FX losses compared to 2016 gains.
• Capital Project Execution: Track the timeline and budget adherence for the new Tlaxcala mini-mill and the Mexicali rolling mill reconstruction.
• Legal and Tax Reserves: Review the status of the Ohio tax appeal and the California environmental remediation costs to ensure reserves are adequate.