Durante El 1T98 Ahmsa Reportó Decrementos En Las Ventas Y En La Utilidad Operativa De 6

LONG TERM BUY

Alfa’s 2Q99 sales dropped 1.2%, due mainly to real price decreases in peso terms in all divisions, which were partially offset by consolidated volume growth of 6.5%. Alfa’s steel and petrochemical divisions experienced difficulties at the operating level due to pricing pressures as a result of the Asian crisis, higher exports, and the inflation/devaluation effect. However, this was partially offset by higher total volumes, and lower raw material and energy costs. As a result, gross margin fell 1.6 pp (due mainly to Alpek). Overall, operating income and cash flow decreased 15.6% and 10.6% in the quarter. The company reported a net financial gain of Ps 41 million compared to a loss last year due mainly to non-cash FX gains, and lower net interest expense. On the non-consolidated subsidiary line, Alfa reported a loss of Ps 270 million, which corresponded mainly to losses in Sidor and Onexa of Ps 195 million and Ps 47 million respectively. Operations at Onexa continue to improve through volume growth, and should continue a positive tendency as LD prices recently increased. On the other hand, Sidor’s results have been affected by the economic slowdown in Venezuela, although perspectives seem to be improving. Alfa’s long-term outlook remains positive, supported by its participation in growth-oriented markets, focus on higher value added products and cost efficiencies, and experienced management. We are bullish with Hylsamex as steel prices are rebounding all around the world. However, Alpek continues to experience pricing pressures in certain product lines, and could take longer to recover. As a result, we reiterate our LONG-TERM BUY recommendation, even though from a valuation standpoint Alfa looks attractive.

Operating Results

In Hylsamex, total revenue dropped 4.4% in the quarter due mainly to real price decreases resulting from worldwide pricing pressures in 2H98, higher exports and the inflation/devaluation effect. This was partially offset by an increase of 11.3% in total volume. Domestic volume rose 5.3% in the quarter due to strong domestic demand, to lower steel imports, and to Ahmsa not oversupplying the market at very low prices. This was partially offset by higher intercompany transfers between Hylsa and Galvak. Without considering the growth in internal transfers, domestic volumes would have grown 12.0%. Export volume skyrocketed by almost 72% in the quarter. We believe this was due to growth in the US economy, and to the application of anti-dumping tariffs on some countries by the US, in which Mexico was not included. The drop in operating income was due mainly to the lower sales prices. This was partially offset by a reduction in energy, DRI and scrap costs (for detailed information on Hylsamex, please check our quarterly).

In Alpek, 2Q99 sales and operating income declined by almost 9% and 33% respectively. This resulted from a 13% reduction in real prices in peso terms which was partially offset by volume growth of 5%. In addition, start up costs related to the nylon expansions and to wage hikes also affected operating results. Exports were higher in dollar terms due mainly to a recovery in Asian markets (triggering demand), and lower supply of certain product lines as some foreign plants were shutdown for maintenance/operational problems. In general terms, prices continued to be pressured during the quarter, except in PTA. In addition, the dumping situation continues in the domestic fiber market, even though the authorities have implemented procedures. The pricing pressures in most products, coupled with an increase in low margin exports, led to an important decline of 4.5 pp in EBITDA margin.

In Sigma, total volume grew approximately 11% in the quarter (meat, cheese, yogurt, and prepared meals volumes increased 6%, 27%, 39%, and 4% respectively). However, price increases tended to be lower than inflation as sales rose only 3.4%. Even so, gross margin improved 2.1 pp due mainly to a reduction in raw material prices and to larger volumes. Operating expenses rose 7.9% due to increased volumes. Overall, EBITDA rose 13.7% (for detailed information on Sigma, please check Scott Kolb’s quarterly).

In Versax, overall volume grew by over 14% during the quarter. Nemak increased volumes by 28%, reaching 1.33 million cylinder heads in 2Q99. Total Home posted good operating results in the quarter due to the contribution from its fourth store which began operations in 1Q99. Construction of Nemak’s fifth plant for the production of aluminum blocks continues advancing, and is expected to begin operations in 3Q00. In addition, the company was awarded new contracts by Opel Generation III (Europe-400,000 units) and Ford Jaguar (140,000 units) to produce cylinder heads. The Ford contract begins in late 2001, and Opel’s in mid 2002.

Financing Activities

Alfa reported Ps 41 million in net financial gains compared to a loss last year, due mainly to non-cash FX gains and lower net interest expense, which was partially offset by lower monetary gains. We were pleased to see that the company decreased its net debt by approximately US$178 million compared to 1Q99. Although the company’s ratios continue at high levels, with leverage (total liabilities/equity) at 125%, and net debt to equity at 88%, we are comforted with debt coverage of 2.8x. In addition, Hylsamex is planning to reduce its debt during 1999, which will also benefit Alfa on a consolidated level.

It is important to note that an important part of the capital expenditure plan for the 1998-2000 period was completed in 1998. Thus, Alfa’s cash requirements in the coming years will be significantly lower, and it should now be able to reap the benefits of these investments.

Outlook

The long-term perspectives remain positive for Alfa, as it participates in growth-oriented markets, invests to modernize and expand capacities, concentrates on producing more value-added products, and diversifies geographically. Thus, we expect all these factors to enhance the company’s competitive position, as well as shareholder value. Steel prices are rebounding worldwide, and the Mexican steel market has recently accepted two price hikes of 10% each in March and June. All this, combined with strong domestic demand will improve Hylsamex operating results in the near future. However, we believe Alpek’s results could take longer to recover as pricing pressures continue in fibers (due to dumping practices), and in polypropylene (due to capacity increases by US producers). As a result, we believe Alfa’s operating results will probably begin to improve until 4Q99/1Q00. Thus, we reiterate our LONG-TERM BUY recommendation.

Sumant Vasal:

The information contained herein has been obtained from sources that we believe to be reliable, but we make no representation as to its accuracy or completeness. Neither CASA DE BOLSA BANORTE, S.A. DE C.V. nor AFIN SECURITIES INTERNATIONAL accepts any liability for any losses arising from any use of this report or its contents.

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