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Ternium S.A. 2019 Financial Summary

Business Context and Reporting Period

This Form 6-K filing presents the consolidated financial statements of Ternium S.A., a global steel manufacturer, for the fiscal year ended December 31, 2019. The report was filed with the SEC on February 18, 2020. Ternium operates primarily in Latin America and the United States, with reportable segments in Steel and Mining. The financial statements are prepared in accordance with IFRS, with the functional currency for most subsidiaries being the U.S. dollar, except for Argentine subsidiaries which were subject to hyperinflation accounting (IAS 29) during the period.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Decline: Net sales decreased by approximately 11% to $10.19 billion, driven by lower volumes and pricing in the steel segment.
• Profitability Compression: Operating income fell significantly by 59% to $864.6 million. Gross margin contracted from 26% in 2018 to 17% in 2019 due to higher raw material costs and lower selling prices.
• Foreign Exchange Impact: The Argentine peso devalued by 37.1% in 2019. While inflation adjustments provided a positive impact of $118 million in the income statement, currency translation adjustments resulted in a negative impact of $43 million in other comprehensive income.
• Debt Reduction: Despite an increase in total borrowings on the balance sheet (partly due to IFRS 16 lease liabilities), the company made significant prepayments on the syndicated facility used to finance the 2017 acquisition of Ternium Brasil, reducing the outstanding principal on that specific facility to $400 million.
• Capital Expenditures: Investing cash outflows increased to $1.2 billion, primarily due to capital expenditures of $1.05 billion, compared to $520 million in 2018.

Outlook, Risks, and Contingencies

• Accounting Changes: The company adopted IFRS 16 "Leases" on January 1, 2019, recognizing right-of-use assets and lease liabilities of approximately $280 million. Additionally, Ternium Argentina changed its functional currency from the Argentine peso to the U.S. dollar effective January 1, 2020, to reduce earnings volatility.
• Legal Contingencies:
  • Usiminas Tender Offer: Ongoing litigation regarding a potential tender offer for Usiminas shares. The Superior Court of Justice in Brazil declared the appeal admissible in September 2019; no provision has been recorded as management believes claims are groundless.
  • Class Action: A putative class action was filed in the U.S. regarding the "Notebooks Case" involving former and current executives. Management believes it has meritorious defenses.
  • Tax Matters: Significant tax contingencies exist in Brazil regarding ICMS tax credits and deferral benefits related to the Ternium Brasil acquisition. Provisions of approximately $509 million (net of indemnification assets) were recorded as of year-end.
• Commitments: The company has significant off-balance sheet commitments, including long-term supply contracts for iron ore, natural gas, and electricity, with outstanding values totaling hundreds of millions of dollars.

Investor Verification Checklist

• Margin Sustainability: Verify the outlook for steel prices versus raw material costs to assess if the 17% gross margin is sustainable or if further compression is expected.
• Argentina Exposure: Confirm the impact of the functional currency change for Ternium Argentina on future earnings volatility and the status of hyperinflation accounting adjustments.
• Debt Covenants: Review compliance with financial covenants (leverage ratios) on the major syndicated facilities, particularly given the reduced operating income.
• Legal Reserves: Monitor the status of the Usiminas tender offer litigation and the Brazilian ICMS tax disputes, as adverse outcomes could require significant additional provisions.
• Capital Allocation: Assess the return on the increased capital expenditures ($1.05 billion) and the timeline for the new capacity to contribute to earnings.