Grupo Simec

Moat: 2/5

Understandability: 2/5

Balance Sheet Health: 4/5

A diversified Mexican steel producer and distributor, primarily operating in Mexico and the United States, with recent expansion into Brazil; it produces and sells a wide range of steel products.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Grupo Simec S.A.B. de C.V. (“SIM” or “the Company”), is a steel producer that operates across Mexico, the United States and now Brazil. The company manufactures and distributes a wide range of structural steel products including special bar quality (SBQ) steel, steel sections, and wire rods. Their main end-users include the automobile and construction industries. SIM has a unique value proposition since they are able to procure scrap from the US at relatively cheap prices, while selling their products mostly in Mexico, Brazil and some parts of the US.

Business Overview

SIM operates primarily through its Steel Segment, responsible for manufacturing and distributing steel products. The revenue sources are highly dependent on the price of steel, the current demand and their volume in shipments.

Here’s a more granular breakdown:

Geographic Distribution: The vast majority of SIM’s revenues comes from Mexico, followed by the US and Brazil, showcasing a strong reliance on the Mexican market. In 2022, Mexico represented approximately 74%, US 19% and Brazil 7% in Sales. Recent expansion into Brazil is a good opportunity for the future if they manage to perform their operations without disruptions or further risks.
Product Mix: The company manufactures a range of products, including SBQ bars, merchant bar, structurals, wire rod, and rebar. They primarily target the automotive, construction and industrial markets. There is a heavy reliance on standard steel products, making the company quite commoditized.

Industry Landscape

The steel industry is highly cyclical, with demand and prices fluctuating in sync with the broader economy. As a result, companies in the industry are subjected to significant variability in revenues and profits.

Cyclicality: Steel is a highly cyclical industry, with periods of high demand followed by periods of low demand. This is largely due to the nature of the product as a commodity, prices are prone to huge swings, and economic crises will disproportionately affect their earnings.
Competition: The steel industry is highly competitive, with many large, and small players all trying to fight for market share. This increases pressure on prices, and margins.

Financial Analysis

Revenue: SIM has historically shown substantial and consistent increases in revenues, but also high volatility depending on the market price of steel and global demand. 2022 Net sales totaled Ps. 54,269.3 Million, up from Ps. 41,139.2 Million in 2021, which in turn was up from Ps. 35,620.0 Million in 2020. Sales volumes have increased as well.
Gross Profit: As seen in exhibits, the company’s gross profits has varied across segments due to price volatility and operating costs. In 2022, the gross profit was Ps. 14,417.3 Million, up from Ps. 11,152.7 Million in 2021 and Ps. 7,378.9 Million in 2020, showing a significant improvement as sales grew, albeit costs have increased as well.
Net Income: Net income increased from a loss of Ps. 593 million in 2020 to a positive income of Ps. 3,533 million in 2021 and a stunning result of Ps. 9,434 million in 2022. This huge variance is a direct effect of an increase in average selling prices and a recovery in global demand for steel, showing a strong dependency on external factors for high earnings. However, management is clearly stating that it intends to use the proceeds to continue to improve profitability and invest in growth.
ROIC: Return on Invested Capital has been very volatile during the last three years. It rose rapidly in 2021 and 2022, but is projected to remain below its current value in the coming years. This indicates the lack of a true moat since the company’s financials are very dependent on the overall economic environment.
Free Cash Flow: As free cash flow figures come out, you need to understand that 2021 and 2022 have been a peak in cash flows, and a return to normal levels is highly likely with a decrease in these.

Moat Analysis

Based on my analysis, I am assigning SIM a Moat Rating of 2 / 5. While SIM has several advantages it faces a huge risk in the commoditized environment it operates within.

Economies of scale: The Company benefits from large, modernized and efficient facilities, with integrated production processes in Mexico, the US and Brazil.
Geographic advantages: They have a distribution and logistics network centered in the Mexican market, and a cheap source of scrap in the United States.
Vertical integration: The company produces not only steel but also a wide range of steel finished products. The company also invests in its mining operations to provide raw materials for its plants.

However, despite these strengths, the following factors affect their competitive advantages:

Commoditized product: Steel products are largely commodities, making it very difficult for companies to compete on any basis other than price.
High cyclicality: The market is highly cyclical and therefore even if they have a strong competitive advantage the economic situation will negatively affect the financials in certain periods.
Low switching costs: The switching cost for buyers is practically nil, so if a better alternative enters the market, the customer will have no problem switching to a new supplier.
Limited pricing power: In commodity industries, companies have limited influence over pricing, making it difficult to gain an extra edge over competitors.

Legitimate Moat Risks and Resilience

While SIM has some strengths, it faces significant risks that can impair their moat and overall business resilience.

Economic Downturns: A global recession would significantly reduce demand for steel, resulting in decreased revenues and profit margins.
Intense Competition: Increased competition might lead to price wars, eroding profit margins.
Commodity Price Volatility: Fluctuations in raw material and steel prices may impact profit margins.
Regulation Changes: Trade policies and environmental regulations might affect operations and raise costs.
Operational Risks: Events such as facility breakdowns, supply-chain issues and labor disputes could disrupt production and delivery.

SIM’s resilience is only fair, due to its vulnerability to external factors. While they seem equipped to handle operational issues (they have demonstrated that throughout the COVID pandemic) and seem to have very effective managers, the dependence on external factors can create huge financial challenges if prices decline significantly.

Understandability Analysis

Based on my analysis, I rate SIM’s business with a Understandability Rating of 2/5. The business model is complex, but there are some simplified aspects that make it somewhat easy to understand.

Complexity of Operations: The business itself is quite complex. It involves several steps in the production and distribution process, as well as various financial instruments to secure funding and cover costs of operations.
Accounting: The accounting can be difficult to analyze due to the effects of foreign currency and derivatives, as well as the various adjustments that are needed to get the company in line with accounting standards.
Management structure: The organization structure includes an independent management that has all the required skills to run a good company.
Cyclical nature: the company’s business is heavily influenced by the overall economic situation, which includes interest rates and demand. Therefore it is hard to consistently forecast earnings since it may vary considerably year-over-year.

Balance Sheet Health Analysis

Based on my analysis, I am giving SIM a Balance Sheet Health rating of 4/5. While there is some reliance on short-term debt, the company has enough assets to weather most economic downturns.

Debt Level: The company has been lowering its debt levels considerably, and has managed to amass a lot of cash during 2022. Their long term debt is reasonable as well, and they have managed to extend their debt maturities, so they are not overly exposed.
Current Ratio: The company’s current assets to current liabilities is very solid at around 3 times. This is a strong indicator that they can meet their short-term requirements.
Cash Position: The company has greatly improved its cash position during 2022, giving it a strong balance sheet.
Debt Maturities: The company has stretched its debt maturities to the long-term, thus reducing risk.

Recent Concerns and Management’s Response

The most recent earnings calls have focused on the huge earnings and cash flows, as well as the plan to use such cash.

Management has stressed that the current performance is not expected to stay, and that is not indicative of future performance.
Management has also stated they are planning to return to their historic debt-to-equity ratios by using the large free cash flows in repaying debt.
Management also stated they plan to invest in new production facilities, and new technologies to reduce costs of operations, but those plans are still very early stage.
There has been a discussion on when management will begin returning excess cash to shareholders through dividends or buybacks, but they have not yet given any specifics.

Overall management has stated their plans and how they will use the excess capital generated in 2022 and 2021. They have also been transparent about issues affecting the balance sheets, like pension obligations, currency and more. Management has repeatedly communicated its intentions to shareholders, giving them some stability.

It is important to note that since the company is based in Mexico, there can be significant political risks, as evidenced by the trade war of the mid 2010s and the election of populist leaders in Mexico. It is essential to follow what the Mexican government decides to do regarding international agreements.

That said, the financial situation of the company has been very healthy during the past couple years, but is expected to decline to historical averages. There is uncertainty on when the company will increase dividends, and when acquisitions may come into play.