Business Context and Reporting Period
Company: GRUPO SIMEC, S.A.B. De C.V. (Grupo Simec)
Filing Type: Form 20-F (Annual Report)
Reporting Period: Fiscal year ended December 31, 2010
Accounting Standards: Mexican Financial Reporting Standards (MFRS) with reconciliations to U.S. GAAP.
Business Overview: Grupo Simec is a diversified manufacturer, processor, and distributor of Special Bar Quality (SBQ) steel and structural steel products. Operations are conducted in Mexico, the United States, and Canada. The company operates 12 facilities with a combined crude steel installed capacity of 4.5 million tons. The company is controlled by Industrias CH, S.A.B. de C.V., which owns approximately 84% of the shares.
Key Financial Metrics (Year Ended Dec 31, 2010)
| Metric | Amount (Mexican Pesos) | Amount (U.S. Dollars) |
|---|---|---|
| Net Sales | Ps. 24,576 million | US$ 1,989 million |
| Gross Margin | Ps. 4,047 million | US$ 328 million |
| Operating Income | Ps. 1,085 million | US$ 88 million |
| Net Income (Consolidated) | Ps. 605 million | US$ 49 million |
| Net Income (Controlling Interest) | Ps. 904 million | US$ 73 million |
| Adjusted EBITDA | Ps. 2,182 million | US$ 177 million |
| Cash from Operating Activities | Ps. 2,227 million | US$ 180 million |
| Total Assets | Ps. 27,121 million | US$ 2,195 million |
| Total Liabilities | Ps. 6,663 million | US$ 539 million |
| Stockholders' Equity | Ps. 20,458 million | US$ 1,656 million |
| Cash and Cash Equivalents | Ps. 3,385 million | US$ 274 million |
Note: U.S. Dollar amounts are translated at the rate of Ps. 12.3571 per US$1.00 (Dec 31, 2010 rate).
Material Changes vs. Prior Period (2009)
- Revenue Recovery: Net sales increased 28% to Ps. 24.6 billion from Ps. 19.2 billion in 2009, driven by a 10% increase in shipments (2.24 million tons vs. 2.04 million tons) and a 16% increase in average selling prices.
- Profitability Turnaround: The company returned to profitability, recording a net income of Ps. 605 million compared to a net loss of Ps. 1.175 billion in 2009. The 2009 loss was heavily impacted by a Ps. 2.368 billion impairment of intangible assets (goodwill and trademarks) related to the Grupo San acquisition.
- Segment Performance:
- Mexico Segment: Generated Ps. 1.2 billion in net income, driven by strong performance in structural steel and rebar.
- U.S. Segment (Republic): Recorded a net loss of Ps. 600 million, though operating losses narrowed significantly compared to 2009 due to increased volume and prices in the SBQ market.
- Cost Structure: Direct cost of sales increased 19% to Ps. 20.5 billion, primarily due to higher raw material costs (scrap metal prices rose ~34% in 2010) and increased volume. Gross margin improved to 16.5% of sales from 10.4% in 2009.
Guidance, Outlook, Risks, and Unusual Items
Management Commentary and Outlook
- Market Recovery: Management notes a recovery in the automotive and construction sectors, which are key end-markets. Sales to the automotive sector increased 40% in 2010.
- Capital Expenditures: Estimated capital expenditures for 2011 are approximately Ps. 258 million (US$20.8 million), focused on efficiency improvements in Mexico and Republic facilities.
- Raw Materials: The company faces volatility in scrap metal and energy prices. While they attempt to pass costs to customers, time lags can compress margins.
Material Risks and Contingencies
- Internal Control Weaknesses: The company and its auditors identified material weaknesses in internal controls over financial reporting for 2010. Issues included insufficient segregation of duties, lack of an integrated consolidation system (reliance on Excel), and management override of controls at the SimRep subsidiary. Remedial measures were adopted in September 2010, but the auditor issued an adverse opinion on internal controls.
- Environmental Liabilities: Significant environmental remediation liabilities exist, particularly at the Pacific Steel facility in California (soil contamination) and Republic facilities. A reserve of Ps. 38.3 million (US$3.1 million) was recorded as of Dec 31, 2010.
- Legal Proceedings:
- OSHA Violations: In Nov 2010, the company was cited for safety violations at the Lorain, Ohio facility. A tentative settlement of Ps. 700,000 (US$60,000) was negotiated in March 2011.
- Customer Dispute: A pricing dispute with American Axle & Manufacturing Inc. was settled in Sept 2010 for US$2.4 million.
- Concentration Risk: Sales to the ten largest U.S. customers accounted for 38.6% of U.S. revenues in 2010. The automotive industry accounts for a significant portion of SBQ sales.
- Accounting Changes: The company is required to adopt International Financial Reporting Standards (IFRS) for fiscal years beginning Jan 1, 2012.
Investor Verification Checklist
- Internal Control Remediation: Verify the effectiveness of the remedial measures adopted to address the material weaknesses in internal controls, specifically regarding the consolidation process and segregation of duties.
- Environmental Reserves: Review the adequacy of the environmental reserve (Ps. 38.3 million) against potential future remediation costs, particularly for the Pacific Steel site in California.
- Raw Material Hedging: Assess the effectiveness of natural gas swap contracts in mitigating energy cost volatility.
- Goodwill Valuation: Monitor the assumptions used in the goodwill impairment testing for the Grupo San reporting unit, given the sensitivity to construction market recovery.
- Related Party Transactions: Review the terms of loans and transactions with Industrias CH and its affiliates, which represent a significant portion of related party balances.