SIM

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, 2008
Accounting Standards: Mexican Financial Reporting Standards (MFRS), with reconciliations to U.S. GAAP provided.
Business Overview: Grupo Simec is a diversified manufacturer, processor, and distributor of Special Bar Quality (SBQ) steel and structural steel products with operations in Mexico, the United States, and Canada. The company operates 12 facilities with a combined annual crude steel capacity of 4.5 million tons.

Key Financial Metrics (2008)

Note: U.S. Dollar amounts are translated at the rate of Ps. 13.5383 per $1.00 (December 31, 2008 rate).

Material Changes vs. Prior Period

• Revenue Growth: Net sales increased 46% to Ps. 35.2 billion in 2008 compared to Ps. 24.1 billion in 2007. This was driven by a 9% increase in shipment volume (to 2.92 million tons) and a 34% increase in average selling prices.
• Acquisition Impact: The significant increase in sales and volume includes the consolidation of Grupo San (Corporación Aceros DM), acquired in May 2008 for approximately Ps. 8.73 billion. Grupo San contributed Ps. 2.53 billion in sales and 261,000 tons of shipments for the period.
• Profitability: Operating income increased 43% to Ps. 3.1 billion. Gross profit rose 49% to Ps. 5.4 billion. However, gross margin remained flat at 15% of net sales due to rising raw material costs.
• Cost Pressures: Direct cost of sales increased 45%, primarily due to a 34% rise in raw material costs (scrap, iron ore, alloys) and energy prices.
• Financial Expenses: The company recorded a net financial expense of Ps. 175 million in 2008, compared to financial income of Ps. 41 million in 2007. This shift was largely due to a Ps. 254 million foreign exchange loss resulting from the 25% devaluation of the peso against the dollar.
• Cash Flow: Cash provided by operating activities decreased to Ps. 1.85 billion in 2008 from Ps. 2.35 billion in 2007. Investing activities used Ps. 9.0 billion, primarily for the Grupo San acquisition.

Guidance, Outlook, and Risks

• Economic Outlook: Management notes a sharp reduction in economic activity starting in Q4 2008 due to the global financial crisis. In Q1 2009, net sales decreased 33% and steel prices fell approximately 25% compared to Q4 2008.
• Capital Expenditures: Estimated capital expenditures for 2009 are approximately $35.2 million (Ps. 476.5 million).
• Key Risks:
  • Raw Material Volatility: Significant fluctuations in scrap, iron ore, and energy prices impact margins. The company may not be able to pass these costs to customers immediately.
  • Customer Concentration: U.S. sales are concentrated; U.S. Steel accounted for ~20% of U.S. revenues and ~11% of consolidated revenues in 2008. The top 10 U.S. customers accounted for 54% of U.S. revenues.
  • Internal Controls: The company and its auditors identified a material weakness in internal controls over financial reporting related to the financial statement closing process, deferred taxes, and business acquisitions due to rapid growth and the Grupo San integration.
  • Environmental Liabilities: Ongoing remediation costs at U.S. facilities (Pacific Steel) and potential future environmental compliance costs.
  • Political/Social Risks: Risks related to crime, drug trafficking, and political instability in Mexico.

Investor Verification Checklist

• Internal Control Remediation: Verify the status of remediation efforts for the identified material weakness in internal controls over financial reporting.
• Grupo San Integration: Assess the realization of synergies and the financial performance of the newly acquired Grupo San facilities post-acquisition.
• Raw Material Hedging: Review the effectiveness of natural gas swap contracts and strategies to mitigate scrap and iron ore price volatility.
• Currency Exposure: Monitor the impact of peso devaluation on U.S. dollar-denominated debt and the translation of U.S. subsidiary earnings.
• Customer Concentration: Track the financial health of major U.S. customers, particularly U.S. Steel and automotive manufacturers, given the recessionary environment.
• Environmental Reserves: Confirm the adequacy of reserves for environmental remediation at U.S. facilities, specifically the Pacific Steel site in California.