Business Context and Reporting Period
Company: Ternium S.A.
Filing Type: Form 20-F (Annual Report)
Reporting Period: Fiscal year ended December 31, 2005
Jurisdiction: Grand Duchy of Luxembourg (Holding Company)
Accounting Standards: International Financial Reporting Standards (IFRS), with U.S. GAAP reconciliations provided.
Ternium is a leading steel producer in the Americas, operating through subsidiaries in Argentina (Siderar), Venezuela (Sidor), and Mexico (Hylsamex). The 2005 reporting period was significantly impacted by a major corporate reorganization and two strategic acquisitions: Amazonia (controlling Sidor) was consolidated starting February 15, 2005, and Hylsamex was consolidated starting August 22, 2005. These events rendered year-over-year comparisons with 2004 and 2003 non-comparable on a like-for-like basis.
Key Financial Metrics (IFRS Basis)
| Metric (in thousands USD) | 2005 | 2004 | 2003 |
|---|---|---|---|
| Net Sales | 4,447,680 | 1,598,925 | 1,056,566 |
| Gross Profit | 1,976,836 | 633,921 | 384,846 |
| Operating Income | 1,392,161 | 514,171 | 264,782 |
| Net Income (Total) | 1,072,813 | 748,175 | 356,551 |
| Attributable to Equity Holders | 704,406 | 457,339 | 218,215 |
| Basic EPS (Equity Holders) | $0.58 | $0.39 | $0.19 |
| Total Assets | 8,659,981 | 2,646,630 | 2,186,888 |
| Total Liabilities | 5,084,062 | 874,779 | 934,803 |
| Cash and Cash Equivalents | 765,630 | 194,875 | 129,020 |
| Total Borrowings | 2,916,277 | 123,006 | 364,152 |
Note: U.S. GAAP Net Income for 2005 was $559.3 million compared to $704.4 million under IFRS.
Material Changes vs. Prior Period
- Revenue Surge: Net sales increased 178% to $4.45 billion, driven primarily by the consolidation of Amazonia and Hylsamex, which contributed approximately $2.59 billion in combined sales.
- Profitability: Net income attributable to equity holders rose 54% to $704.4 million. This was bolstered by a non-recurring gain of $188.4 million from the conversion of Amazonia's convertible debt into equity.
- Debt Expansion: Total borrowings increased dramatically from $123 million in 2004 to $2.92 billion in 2005. This reflects the financing of the Hylsamex acquisition (approx. $2.2 billion in new debt) and the consolidation of Amazonia's debt.
- Financial Expenses: Net financial income turned into a net expense of $310.7 million (compared to $202.3 million income in 2004). This was due to higher interest costs on new debt and a $265.2 million financial loss resulting from the change in accounting treatment of Sidor's excess cash payments following consolidation.
- Asset Base: Total assets more than tripled to $8.66 billion, including $399.7 million in goodwill recorded from the Hylsamex acquisition.
Guidance, Outlook, and Risks
Management Commentary & Outlook: Management expects to continue integrating operations to achieve synergies and reduce costs. The company plans to shift its sales mix toward higher-margin value-added products. Capital expenditures for the next five years are estimated at approximately $1.55 billion to modernize facilities and expand capacity.
Key Risks and Contingencies:
- Country Risk: Significant exposure to economic and political instability in Argentina (energy shortages, inflation, exchange controls), Venezuela (government intervention, currency controls via CADIVI, labor disputes), and Mexico (political transition, natural gas price volatility).
- Raw Material Costs: Vulnerability to price fluctuations in iron ore, coal, and energy. Notably, Sidor's iron ore costs increased from ~$19 to ~$31 per ton in 2006 due to contract renegotiations with the Venezuelan state-owned supplier.
- Debt Covenants: Credit agreements related to the Hylsamex acquisition restrict dividend payments until 2010 and impose financial maintenance covenants.
- Goodwill Impairment: The $399.7 million goodwill from the Hylsamex acquisition is subject to annual impairment testing; a decline in value could result in significant non-cash charges.
- Legal Proceedings: Sidor faces potential exposure of $102.1 million regarding a dispute with PDVSA Gas over pricing, though management considers the likelihood of loss remote.
Investor Verification Checklist
- Acquisition Integration: Verify the realization of synergies and cost savings from the integration of Hylsamex and Amazonia, as projected by management.
- Debt Service Capacity: Assess the company's ability to service the $2.9 billion debt load, particularly given the variable interest rate exposure (91% of total borrowings).
- Dividend Restrictions: Confirm the impact of debt covenants prohibiting dividends until 2010 and the specific conditions required to lift these restrictions.
- Regulatory Environment: Monitor developments in Argentina regarding natural gas supply restrictions and in Venezuela regarding currency controls (CADIVI) and government intervention in pricing.
- Goodwill Valuation: Review future impairment tests for the $399.7 million Hylsamex goodwill, especially if steel prices or operational performance decline.
- IFRS vs. GAAP Reconciliation: Understand the significant differences between IFRS and U.S. GAAP net income ($704M vs. $559M) to ensure accurate valuation comparisons.