A Key Regional Player in the Making: Initiating Coverage with a Buy Rating

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1 Latin American Equity Research Mexico City, December 4, 2007 MEXICHEM Company Report Mexico Chemicals * Employed by a non-us affiliate of Santander Investment Securities, Inc. and is not registered/qualified as a research analyst under NASD rules. BUY A Key Regional Player in the Making: Initiating Coverage with a Buy Rating Luis Miranda*, CFA Christian Audi Diego Laresgoiti* Mexico: Banco Santander S.A. NY: Santander Investment Securities Inc. Mexico: Banco Santander S.A. (5255) (212) (5255) lmiranda@santander.com.mx caudi@schny.com dlaresgoiti@santander.com.mx (11/30/07) CURRENT PRICE: US$3.70/M$40.40 TARGET PRICE: US$4.75/M$53.00 Initiation of Coverage Rating: Buy Price Target: M$53.00 (US$4.75) YE2008 EBITDA Estimates (US$): million million million Company Statistics Bloomberg MEXCHEM* 52-Week Range (US$) E P/E Rel to IPC (x) E P/E Rel to Chemicals (x) 0.7 IPC (US$) 2,730 3-Yr CAGR (06-09E) 30% Market Capitalization (US$ Mn) 2,031 Float (%) 28 3-Mth Avg Daily Vol (US$000) 2,680 Shares Outst - Mn Net Debt/Equity (x) 1.2 Book Value per Share (US$) 1.22 Estimates and Valuation Ratios E 2008E 2009E Net Earn (M$ Mn) 1,146 1,868 2,349 2,582 Current EPS Net Earn (US$ Mn) Current EPS P/E (x) P/Sales (x) P/CE (x) FV/EBITDA (x) FV/Sales (x) FCF Yield (%) NM NM NM 3.0 Div per Share (US$) Div Yield (%) NM not meaningful. Sources: Bloomberg, Company reports, and Santander Investment estimates. Investment Thesis: We are initiating coverage on Mexichem, the leading manufacturer of PVC and PVC pipes in Latam and owner of the largest fluorite mine in the world, with a Buy rating and a year-end 2008 target price of US$4.75 or M$53.00, implying a total return of 30% in U.S. dollar terms from current levels. The reasons for our positive view on Mexichem are as follows: Mexichem has been able to successfully implement its strategy to add value to its raw materials: salt, chlorine and fluorite, in our view. Furthermore, it has become a regional consolidator in Latam in the chlorine-vinyl chain and pipe systems business. This has led to a CAGR of 37% in sales and 46% in EBITDA in the period. We believe, given the company s stated strategy to deliver, on average, a 20% yearly increase in sales and EBITDA, via organic growth and through acquisitions, especially in the chlorine-vinyl chain and pipe systems division, growth will continue to be attractive. We estimate EBITDA and net income growth of 21% and 24% in 2008, on top of our estimated 77% growth in EBITDA in 2007 and 65% in net income. Although the company has exposure to commodity products, its strategy to add value to its production chains has led to 70% exposure to the construction and infrastructure markets, which we believe will have higher-than-average growth in the region in the coming years. We also believe that the company s policy of investing in businesses that deliver returns of at least 22% in U.S. dollar terms will continue to allow it to deliver ROE and ROIC above its WACC, therefore generating attractive returns for shareholders. For 2007, we estimate adjusted ROE and ROIC of 20% and 18%, respectively. Valuation. The stock is currently trading at a FV/EBITDA for 2008 of 6.0 times and 5.4 times for 2009, and a P/E multiple of 9.5 times 2008E and 8.7 times our 2009 estimate. This represents a discount to a sample of Latam peers in terms of P/E and a premium in term of FV/EBITDA, offering more attractive growth rates in terms of EBITDA and net income compared with its peers. Main risks include: (1) overpaying for acquisitions; (2) an economic slowdown in Latam; (3) exposure to commodity prices; (4) slower-than-expected growth in construction; (5) diversification in other non-related business; and (6) exposure to different currencies.

2 A Key Regional Player in the Making; Initiating Coverage with a Buy Rating Mexichem is a leading producer of PVC products and pipes, as well as metallurgic and acid grades of fluorite. The company is a market leader in the PVC pipe business in Latam and has the largest fluorite mine in the world. The company operates three business units: (1) the chlorine-vinyl chain (51% of sales in 2007E); (2) fluorite chain (8% of sales); and (3) pipe systems (41% of sales). Approximately 70% of sales is related to the construction and infrastructure industries. Mexichem has a presence in 14 countries throughout Latin America. Management has the objective of increasing sales and EBITDA by 20% per year on average, via organic growth and acquisitions, investing in projects that it expects to deliver a 20% rate of return. MEXICHEM AT A GLANCE Mexichem is a key petrochemical player in Latam, with exposure to the chlorine-vinyl (CV), fluorite and pipe systems businesses. The main products in the chlorine-vinyl chain are caustic soda used in manufacturing industrial and consumer products and chlorine for the production of VCM (monomer for the production of PVC). The company owns the largest fluorite mine in the world and produces different grades, including hydrogen fluoride acid for the production of coolants and fluoropolymers. The company acquired Amanco in 2007, and with this acquisition Mexichem became the leading manufacturer of PVC pipes in Latam. We estimate that during 2007, the company will have sales of US$2.1 billion and EBITDA of US$385 million. Figure 1 summarizes the company s sales mix and geographical exposure. Figure 1. Mexichem s Sales Breakdown by Product and Region (2007 Estimates) PVC 31% Compounds 12% Fluorite 4% Export, 13% Foreign, 42% South America, 18% HF 4% Chlorine 3% Caustic Soda 4% Others, 2% Asia, 2% Europe, 4% Pipes 40% Derivatives 2% Domestic, 45% Ctrl America, 6% North America, 11% Sources: Company Reports and Santander Investment Estimates. The company s strategy includes adding value to its key raw materials, maintaining low production costs, maintaining a leading position in markets with attractive long-term outlooks and maintaining attractive returns on capital. We believe that management has been able to deliver on the implementation of its strategy in businesses in which they have a competitive advantage. In our view this has enabled Mexichem to become an industry consolidator in the region. The implementation of this strategy has led to a CAGR in sales, EBITDA and net income of 37%, 46% and 54%, respectively, in dollar terms. The company is controlled by Grupo Kaluz (Del Valle Family), holding 52% stake in the company, while other family members outside the controlling group hold 20% and free float is 28%. 2

3 INVESTMENT THESIS We see Mexichem as an industry consolidator that will continue to deliver attractive growth rates given its leadership in the attractive markets where it competes, while the stock offers an attractive valuation in our view. We address the main points of our investment thesis below. STRATEGY SUGGESTS PROFITABLE GROWTH WILL CONTINUE We believe Mexichem can deliver an EBITDA growth of 21% in Mexichem s management aims to achieve an average of 20% growth in sales and a 20% EBITDA margin per year. A key element of the strategy is to achieve organic growth and implement acquisitions with projects that deliver a 22% return. In our view, management has been able to implement its strategy, delivering CAGR in EBITDA of 46% in in U.S. dollar terms. We believe that in 2008, the company will be able to deliver a healthy 21% growth in EBITDA, driven by synergies generated from recent acquisitions (Amanco and Petco), as well as ongoing operating efficiencies on the fluorite business driven by internally developed technological processes, which have allowed the company to add value to the fluorite. Management has recently expressed that they will continue evaluating different acquisition projects in the CV chain and in the pipe systems business, which will allow them to continue growing at attractive rates. Figure 2. Mexichem CAGR & 2008E (Change in U.S. Dollars) 60% 50% 46% 54% 40% 37% 30% 20% 23% 21% 24% 10% 0% Revenues EBITDA Net Income CAGR E We expect Mexichem s ROE and ROIC to continue to generate value for shareholders. Sources: Company Reports and Santander Investment Estimates. Growth is leveraged by a strict investment policy. Management s strategy of investing in projects or acquisitions that deliver a minimum return of 22% in U.S. dollar terms has allowed the company to post what we believe are attractive rates of return, generating value for shareholders compared to its WACC. We estimate that during 2008 we will see some decline in the profitability of the company as we foresee a decline in margins in the chlorine-vinyl chain, which represents 52% of sales in 2007E. We still estimate that the company will be able to deliver attractive returns, significantly above the WACC, thus creating value for shareholders. Figure 3. Mexichem ROE, ROIC and WACC ( E) E ROE 24.9% 29.0% 31.3% 22.0% ROE Adjusted* 19.6% 24.5% 17.5% 18.2% ROIC 18.9% 23.1% 20.4% 15.8% WACC 10.6% 10.1% 8.1% 8.4% Source: Santander Investment historicals and forecasts. * Adjusted for FX and Monetary gains. U.S. investors inquiries should be directed to Santander Investment Securities Inc. at (212) /(212)

4 A Key Regional Player in the Making; Initiating Coverage with a Buy Rating LEADERSHIP IN ATTRACTIVE MARKETS Exposure to the construction industry is close to 70% of sales. We believe that Mexichem s presence in the construction infrastructure markets is a strong positive for the company in the medium term. Almost 70% of the company s total revenue is related to the construction industry, which is expected to post strong numbers. In Mexico, it has been identified by the Calderon Administration as a main contributor to economic growth. Our economists expect an average construction growth of 5.5% through the period, which surpasses the 3.6% expected growth of the GDP in Mexico. For the period in Brazil, our economists expect an average growth of 5.5% in construction, versus an estimated average growth of 4.3% in GDP. Figure 4. Santander s Construction and GDP Projections for Mexico and Brazil 2008E 2009E 2010E GDP Construction GDP Construction GDP Construction Mexico 3.4% 5.1% 3.6% 5.6% 3.8% 5.9% Brazil 4.7% 5.1% 4.0% 5.9% NA NA NA not available. Source: Santander Investment estimates. The growth in construction is also leveraged on pending demand for new homes in Latam. Brazil and Mexico have the highest deficits in terms of housing in the region, with deficits of 6.7 million and 4.3 million homes, respectively. Therefore, we would expect these deficits to diminish in the future, given governmental support programs and declining or relatively stable interest rates. Figure 5. Housing Deficit in Latam (Millions of Houses) Brazil Mexico Venezuela Colombia Argentina Peru Ecuador Chile Sources: Company Reports and Santander Investments Estimates. Pent-up housing demand and low penetration in the sanitation sector should drive demand. We believe that an increase in the use of PVC pipes will boost demand. The PVC per capita consumption in Latam countries is significantly lower than in other regions of the world, as shown in Figure 6. In the U.S., PVC per capita consumption was 21.1 kg in 2004 versus 3.7 kg in Mexico and 3.9 kg in Brazil. In our view, this should drive future growth, spurred by demand in the construction and infrastructure sectors, low penetration of sanitation systems in Latam (estimates suggest a penetration of only 48%), and higher per capita income. In our opinion, the effect of substitution from copper pipes and fittings to PVC, due to the high cost of copper, will also foster growth. 4

5 Figure 6. PVC per Capita Consumption Comparison (Kilograms) US Western Europe Northern Asia China Total World Colombia Brazil Mexico Argentina Venezuela Sources: Company Reports and Santander Investments Estimates. As a consequence of the aforementioned industry drivers, industry estimates suggest that PVC demand in less developed countries such as those in which Mexichem operates is set to outperform developed countries. Mexichem expects a CAGR in plastic pipe demand of 6.8%, which compares favorably with the CAGR of 3.3% for the U.S. economy. Mexichem is a key planner in the markets in which it competes. This attractive demand should benefit Mexichem, as the company is in an excellent position in the markets where it competes. Figure 7 summarizes the company s market position by product and region. We believe that this strong market position will allow the company to extract further synergies via the integration of operations in the region, as well as the implementation of best practices in the different business units. In fact, management has stated that most of the synergies associated with the two most recent acquisitions, Amanco and Petco, will be in reorganization and purchases of raw materials. Figure 7. Mexichem Market Position by Product Country Product Mkt share Position Country Product Mkt Share Position Colombia PVC 80% 1st Ecuador PVC Pipes 66% 1st Mexico PVC 56% 1st El Salvador PVC Pipes 56% 1st Mexico Chlorine 70% 1st Colombia PVC Pipes 55% 1st Mexico Compounds 36% 1st Honduras PVC Pipes 51% 1st Mexico Alkali 54% 1st Panama PVC Pipes 48% 1st Guatemala PVC Pipes 37% 1st World Fluorine 17% 1st Venezuela PVC Pipes 37% 1st World Hydrofluoride 55% 1st Argentina PVC Pipes 31% 1st Mexico PVC Pipes 20% 1st Peru PVC Pipes 17% 1st Brazil PVC Pipes 21% 2nd Costa Rica PVC Pipes 42% 2nd Nicaragua PVC Pipes 40% 2nd Source: Company Reports. U.S. investors inquiries should be directed to Santander Investment Securities Inc. at (212) /(212)

6 A Key Regional Player in the Making; Initiating Coverage with a Buy Rating We believe valuation is appealing considering the company s growth outlook. ATTRACTIVE VALUATION We believe that Mexichem s valuation is appealing in terms of PE and FV/EBITDA. Mexichem is currently trading at 6.0 times our 2008 estimated FV/EBITDA multiple and 5.4 times our 2009 estimate. The company is trading at 9.5 times our 2008 estimate and 8.7 times our 2009 estimate of P/E multiple. As shown in figure 8, the company shows impressive discounts in its trades to a number of North American chemical and petrochemical companies. Mexichem is trading at a 51% discount considering 2008 P/E average and a 32% discount versus the 2008 FV/EBITDA average for our universe. Compared with its Latam peers, while the company is trading at very attractive discounts to P/E multiple (37% discount in 2008), it is trading at a premium in relation to the FV/EBITDA multiple. Our Latam universe includes Braskem and Ultrapar from Brazil and Solvay Indupa from Argentina. We believe that Braskem and Solvay are the two most closely comparable companies as they have a higher exposure to chemical-petrochemical products. In fact, Solvay has a very similar exposure to petrochemical products (PVC). Based on our 2008 estimates and FV/EBITDA multiple, Mexichem trades at a 39% premium to the average of our Latam universe. Although this could cause concern given our Buy rating on the stock, we believe that the premium is warranted since Mexichem s expected growth is stronger than any of its peers. For 2008, we estimate that Mexichem will deliver a net income growth of 24% in U.S. dollar terms, versus the expected declines of 48% for Braskem and 29% for Solvay. In terms of EBITDA, we estimate 21% growth for Mexichem, versus the expected declines of 1% for Braskem and 11% for Solvay. We believe that in the medium term the company will be able to continue to deliver attractive growth rates, leveraging on its acquisition. In fact management recently confirmed that it plans to continue acquiring companies in the chlorine-vinyl chain and pipe systems business. Figure 8. Mexichem s Multiple Valuation vs. Peers, E Price (US$) P/E FV/EBITDA Ticker Company Curr. Target Rating E 2008E E 2008E LYO Lyondell x 15.8x 13.5x 5.3x 6.2x 6.0x ROH Rohm Haas x 15.0x 13.0x 7.9x 7.9x 7.3x GGC Georgia Gulf x NA 44.5x 8.0x 7.6x 6.3x FUL HB Fuller x 15.7x 14.5x 8.3x 8.1x 7.4x AVY Avery Dennison x 14.8x 13.1x 11.8x 11.8x 9.8x CBY Cabot Corp x 14.6x 16.2x 10.3x 6.9x 7.1x DOW Dow Chemical x 11.1x 11.9x 5.8x 6.4x 6.6x DD Du Pont x 14.4x 13.5x 9.5x 8.2x 7.5x POT Potash Corp x 36.3x 25.3x 14.8x 20.2x 15.6x EMN Eastman Chem. Co x 13.3x 13.0x 5.6x 5.9x 5.7x North America Average 18.9x 16.8x 17.8x 8.7x 8.9x 7.9x INDU Solvay Indupa* Hold 8.1x 10.4x 14.6x 2.4x 3.7x 4.1x BAK Braskem Hold 41.3x 8.8x 17.1x 4.9x 3.9x 3.3x UGPA4 Ultrapar Buy 14.5x 23.9x 9.7x 8.7x 5.9x 4.3x Latam Average 21.3x 14.4x 13.8x 5.3x 4.5x 3.9x Mx Mexichem Buy 7.7x 9.5x 8.7x 4.3x 6.0x 5.4x Mexichem Premium/-Discount to North America -59% -43% -51% -51% -33% -32% Mexichem Premium/-Discount to Latam -64% -34% -37% -19% 33% 39% *Note: 2007 Target Price. NA not available. Source: Santander Investment Estimates. DCF Model. We are using our DCF model to estimate our target price. We used an estimated risk-free rate of 5.80% for year-end 2008 and an equity risk premium of 5.5 times. We used a beta of 0.90 versus the IPC index and a low debt-to-total-capitalization ratio of 40%. Based on these figures, we calculated a cost of equity of 10.75% and an after-tax cost of debt of 5.90%, for a WACC of 8.81%. We used a growth rate in perpetuity of 1.5% per year (a very conservative growth rate in our view given the company s track record). 6

7 Figure 9. Mexichem DCF Model, 2007E-2018E (U.S. Dollars in Millions) 2007E 08E 09E 10E 11E 12E 13E 14E 15E 16E 17E 18E Perp. EBIT Tax Tax Rate 28% 28% 28% 28% 28% 28% 28% 28% 28% 28% 28% 28% NOPLAT D&A Working Capital (242) (188) (94) (53) (61) (81) (81) (91) (91) (91) (91) (91) - Capex (600) (300) (250) (150) (150) (140) (140) (140) (140 (140 (140 (140) - FCF to Firm (543) (125) Perpetuity Growth 1.50 Perpetuity Value - - 4,193 FCF (to Firm) + Perp ,802 Net Present Value 3,431 - (Net Debt+Min.) 834 Estimated Market Cap. 2,597 Premium/Discount -22% Fair Value (US$) 4.73 Fair Value (M$) Sources: Company reports and Santander Investment estimate. We are setting a year-end 2008 target price for Mexichem of M$53.00 (or US$4.75) per share. Our target price implies a total upside potential of 30% in U.S. dollar terms, including an estimated 1.9% dividend yield. Our dividend yield is based on a dividend policy payout of 10% of EBITDA. Given that our expected return compares favorably to the expected cost of equity of 17% for Mexico, we are initiating coverage of the stock with a Buy rating. MANAGEMENT Management s track record. We believe that, over the last five years, Mexichem s management has demonstrated ability in implementing its value added-growth-consolidation strategy, while maintaining a profitable operation. We recognize management s commitment to openly share growth objectives and potential synergies of recent acquisitions. Furthermore, in our opinion, the divestiture of the distribution chain (Dermet), one year after it was acquired, illustrates management s proactive approach to identifying issues and correcting operations that do not fit within the portfolio. Positives Clear strategy and implementation. Strong profitability. Market leader with exposure to attractive industries. Low-cost producer due to vertical integration. Compelling valuation. Concerns Cyclical commodity exposure. Acquisition and execution risk. Raw materials and energy risk. Exposure to different countries and currencies. Low (but increasing) liquidity. Competent management team. U.S. investors inquiries should be directed to Santander Investment Securities Inc. at (212) /(212)

8 A Key Regional Player in the Making; Initiating Coverage with a Buy Rating EARNINGS OUTLOOK We estimate that during 2008, Mexichem will continue to benefit from the acquisition of Amanco and from higher profitability in the fluorite chain business, due to the use of the fluorine purifier in the HF plant. We believe that these two factors will strengthen the company s overall integration on its chlorine-vinyl and fluorite chains. During 2007, Mexichem will report an unusually high growth rate due to the consolidation of Amanco and Petco. We estimate that sales will reach US$2.1 billion: a 97% increase as compared with We foresee that the consolidation of Amanco and higher profitability in the fluorine chain business, due to the increase in capacity in the concentrated grade, will lead to a 77% growth in EBITDA, thus allowing the company to reduce its imports and improve profitability. We estimate sales growth of 23% in 2008, as a result of the consolidation of Amanco and Petco and better prices in the fluorite chain. At the EBITDA level, we estimate 21% growth in 2008, partially driven by consolidations and better profitability in the fluorite operations. Overall, we expect that synergies in the CV chain will partially offset weaker prices of PVC, as expected by CMAI. Figure 10. Mexichem Consolidated Estimates, E (U.S. Dollars in Millions) E 2008E 2009E 06/05 07E/06 08E/06E 09E/07E Sales 1,078 2,122 2,618 2,727 37% 97% 23% 4% Operating Profit % 74% 20% 4% Operating Margin 16.2% 14.3% 13.9% 13.9% EBITDA % 77% 21% 8% EBITDA Margin 20.2% 18.1% 17.8% 18.4% Net Profit % 65% 24% 7% Sources: Company reports and Santander Investment estimates. In Figure 11, we show our estimates by division. We should highlight three events that during 2007 had a strong impact on Mexichem s results. First, the acquisition of Amanco, which created the pipe systems (fluid conduction) division and second, the acquisition of Petco, a PVC resin manufacturer, both which began to be consolidated in 2Q07, and the latter boosted the sales and profits of the chlorine-vinyl chain. Finally, we point out the spin-off of the distribution chain (Dermet), which was consolidated in Mexichem s results until 1Q07. The main highlights by division are: Chlorine vinyl chain (51% of sales 2007E). We estimate sales and EBITDA growth of 15% and 2%, in 2008, respectively in U.S. dollar terms. The solid top line growth is driven by the consolidation of Petco, while the modest EBITDA growth is attributable to the lower prices of PVC expected in 2008, mainly driven by an expected increase in supply from Asia, particularly in China. Flourine chain (8% of sales). We estimate sales and EBITDA growth in 2008 of 2% and 6%, respectively in dollar terms versus 2008, mainly driven by a better sales mix, with higher average prices, due to a higher use in-house manufactured concentrated fluorine for the production of HF. Fluid conduction chain (41% of sales). We estimate that this division will be the main driver for growth in 2008, with estimated sales and EITDA growth of 37% and 55% in U.S. dollar terms, respectively versus The growth will be driven by the consolidation and improvement in operations and marketing practices, which should allow the company to increase the use ot its capacity of its plants. We also believe that this division will be benefit from synergies with the CV chain, as Mexichem produces the main raw material for the pipes. 8

9 Figure 11. Mexichem s Estimates Breakdown by Division, E (U.S. Dollars in Millions) Mexichem Total E 2008E 2009E 06/05 07E/06 08E/07E 09E/08E Sales 1,078 2,122 2,618 2, % 96.9% 23.4% 4.1% Operating Margin 16.2% 14.3% 13.9% 13.9% (123) (185) (45) 4 EBITDA % 76.5% 20.9% 7.6% EBITDA Margin 20.2% 18.1% 17.8% 18.4% (229) (209) (37) 60 Chlorine-Vinyl Sales 733 1,043 1,199 1, % 42.3% 15.0% 1.2% EBITDA % 29.9% 1.5% 5.7% EBITDA Margin 20.8% 19.0% 16.8% 17.5% (73) (182) (222) 75 Fluorine Chain Sales % 14.4% 1.9% 4.1% EBITDA % 13.7% 5.5% 7.5% EBITDA Margin 45.1% 44.9% 46.5% 48.0% 874 (24) Pipe Systems Sales ,233 1,320 NA NA 37.4% 7.0% EBITDA NA NA 55.4% 8.5% EBITDA Margin NA 13.3% 15.0% 15.2% NA NA NA not available. Sources: Company reports and Santander Investment estimates. The following table shows the most recent macroeconomic estimates released by our economic team in Mexico. Figure 12. Mexico Select Economic Projections, E E 2007E 2008E Real GDP (%) 4.2% 2.8% 4.8% 3.3% 3.8% CPI Inflation (%) 5.2% 3.3% 4.1% 3.7% 3.5% US$ Exchange Rate (Year-End) US$ Exchange Rate (Average) Interest Rate (Year-End) 8.5% 8.2% 7.0% 7.3% 7.0% Interest Rate (Average) 6.8% 9.2% 7.2% 7.2% 7.1% Fiscal Balance (% of GDP) -0.3% -0.2% 0.0% 0.0% 0.0% Current Account Balance (% of GDP) -1.1% -0.7% -0.3% -1.5% -0.8% International Reserves (US$ Bn) Total External Debt (% of GDP) 20.6% 16.8% 13.2% 13.0% 12.4% Source: Santander Investment historical and forecasts. U.S. investors inquiries should be directed to Santander Investment Securities Inc. at (212) /(212)

10 A Key Regional Player in the Making; Initiating Coverage with a Buy Rating RISKS TO INVESTMENT THESIS We have identified the following issues that could affect Mexichem s operations: Expensive acquisitions and integrations. Mexichem is a company that, based on its strategy, we expect to grow organically and via acquisitions. In fact management has a strategic objective of a 20% growth in EBITDA per annum, but organically, we believe the growth would be between 6%-8%. Therefore, acquisitions play an important role in the company s future. Therefore, the price paid for and implied valuations of any acquisitions is an important concern, in our view. However, we believe that this risk is partially limited, given the company s explicit corporate guidance, where a new project or acquisition should meet the IRR objective of at least 22% in U.S. dollar terms. Also, depending of the size of an acquisition, the company could report extraordinary charges, which could have an important effect on quarterly results and YoY and QoQ comparisons. Economic slowdown. Although the company s sales are relatively well diversified, sales in the domestic market continue to represent 45% of sales and exposure to the U.S. economy represents 11% of consolidated sales. Although our economic scenario is based on a 2% growth rate in the U.S. economy for 2008, we believe that the company will be able to deliver a healthier growth, driven by a more favorable sales mix across its business divisions and synergies that management will extract from acquisitions, mainly Amanco and Petco. Mexichem remains a commodity-exposed company. Almost 60% of Mexichem sales are related to chemical products, which have a cyclical component. Although 41% are related to PVC pipes (pipe systems division), which is a less cyclical business, given its strong correlation to construction, we believe that the company remains a high commodity exposure business. We must highlight that the company has a high component of value-added products or a high integration on its operations. Nevertheless, the chemical component on its sales remains high in our opinion, and could have a negative effect in prices and costs. Slower-than-expected growth in the construction industry. We estimate that 60% of the company s total revenues are related to the construction industry. The outlook for this industry, including housing and infrastructure, remains attractive. However, a lower-thanexpected growth or deterioration in the outlook, could lead to a lower-than-expected demand and a negative sentiment towards the stock. Diversification into other related business. In the past, the company entered into the distribution of chemical products via Dermet and some acquisitions. However, management recognized that the business was completely different from the other operations and spun-off via a dividend this operation in 1Q07. In our view, Mexichem s management is capable and has proven to be able to deliver on its objectives. However, a diversification that its not clearly related to their current business, would be taken negatively by the market, in our opinion. Exposure to different currencies. Mexichem has 45% of its revenues generated in Mexico, but 42% in other countries, and exports represent 13% of sales. Also, the company has production facilities in different countries within Mexico, Central and South America. Therefore, the appreciation/depreciation of different currencies could have an effect on the company s results via FX losses and variations in production costs. 10

11 FINANCIAL STATEMENTS Figure 13. Mexichem Income Statement, Balance Sheet, and CF, E (U.S. Dollars in Millions) Income Statement 2006 % 2007E % 2008E % 2009E % Sales 1, % 2, % 2, % 2, % Cost of Sales % 1, % 1, % 1, % Gross Profit % % 1, % 1, % Oper. and Adm. Expenses % % % 1, % Operating Profit % % % % Depreciation % % % % EBITDA % % % % Financing Costs % 4 0.2% % % Interest Paid % % % % Interest Earned 2 0.2% 6 0.3% 2 0.1% 2 0.1% Monetary Gain/Loss (0) 0.0% % 9 0.3% 7 0.2% FX Gain/Loss 2 0.2% % 0 0.0% 0 0.0% Other Financial Operations (3) -0.3% % - 0.0% - 0.0% Profit before Taxes % % % % Tax Provision % % % % Profit after Taxes % % % % Subsidiaries 0 0.0% (0) 0.0% - 0.0% - 0.0% Extraordinary Items - 0.0% - 0.0% - 0.0% - 0.0% Minority Interest (0) 0.0% 2 0.1% 3 0.1% 4 0.1% Net Profit % % % % Balance Sheet E 2008E 2009E Assets % 2, % 2, % 2, % Short-Term Assets % % % 1, % Cash and Equivalents % % % % Accounts Receivable % % % % Inventories % % % % Other Short-Term Assets 2 0.2% - 0.0% - 0.0% - 0.0% Long-Term Assets % 1, % 1, % 2, % Fixed Assets % % % 1, % Deferred Assets % % % % Other Assets % % % % Liabilities % 1, % 1, % 1, % Short-T. Liabilities % % % % Suppliers % % % % Short-Term Loans % % % % Other ST Liabilities % % % % Long-Term Loans % % % % Deferred Liabilities % % % % Other Liabilities - 0.0% - 0.0% 0 0.0% (0) 0.0% Majority Net Worth % % 1, % 1, % Net Worth % % 1, % 1, % Minority Interest % 6 0.7% 8 0.7% 9 0.7% Cash Flow E 2008E 2009E Net Majority Earnings D&A and Non-Cahs Items Change in Working Capital (50) (242) (188) (94) Capital Increase / Dividends (89) 186 (36) (43) Change in Debt Capex (250) (600) (300) (250) Net Cash Flow (18) 106 (102) 24 Previous Cash Closing Cash Sources: Company reports and Santander Investment estimates. U.S. investors inquiries should be directed to Santander Investment Securities Inc. at (212) /(212)

12 A Key Regional Player in the Making; Initiating Coverage with a Buy Rating Figure 14. Mexichem Income Statement, Balance Sheet, and CF, E (Millions of Mexican Pesos) Income Statement 2006 % 2007E % 2008E % 2009E % Sales 12, % 23, % 29, % 31, % Cost of Sales 8, % 14, % 15, % 15, % Gross Profit 3, % 8, % 14, % 16, % Oper. and Adm. Expenses 1, % 5, % 10, % 12, % Operating Profit 1, % 3, % 4, % 4, % Depreciation % % 1, % 1, % EBITDA 2, % 4, % 5, % 5, % Financing Costs % % % % Interest Paid % % % % Interest Earned % % % % Monetary Gain/Loss (5) 0.0% % % % FX Gain/Loss % % 3 0.0% 3 0.0% Other Financial Operations % (186) -0.8% - 0.0% - 0.0% Profit before Taxes 1, % 2, % 3, % 3, % Tax Provision % % % 1, % Profit after Taxes 1, % 1, % 2, % 2, % Subsidiaries 5 0.0% 0 0.0% - 0.0% - 0.0% Extraordinary Items - 0.0% - 0.0% - 0.0% - 0.0% Minority Interest (0) 0.0% % % % Net Profit 1, % 1, % 2, % 2, % Balance Sheet 2006E 2007E 2008E 2009E Assets 10, % 25, % 27, % 30, % Short-Term Assets 4, % 10, % 11, % 12, % Cash and Equivalents % 1, % % % Accounts Receivable 2, % 6, % 7, % 8, % Inventories 1, % 2, % 2, % 2, % Other Short-Term Assets % - 0.0% - 0.0% - 0.0% Long-Term Assets 8, % 19, % 21, % 23, % Fixed Assets 4, % 8, % 10, % 11, % Deferred Assets 1, % 4, % 5, % 5, % Other Assets 1, % 6, % 6, % 6, % Liabilities 5, % 15, % 15, % 15, % Short-T. Liabilities 3, % 7, % 7, % 6, % Suppliers 2, % 3, % 3, % 2, % Short-Term Loans % 2, % 2, % 2, % Other ST Liabilities % 1, % 1, % 1, % Long-Term Loans 1, % 7, % 7, % 7, % Deferred Liabilities % % % % Other Liabilities - 0.0% (0) 0.0% - 0.0% 0 0.0% Majority Net Worth 4, % 9, % 12, % 15, % Net Worth 4, % 9, % 12, % 15, % Minority Interest % % % % Cash Flow 2006E 2007E 2008E 2009E Net Majority Earnings 1,146 1,868 2,349 2,582 D&A and Non-Cahs Items 499 1,216 1,239 1,474 Change in Working Capital 545 2,614 2,106 1,071 Capital Increase / Dividends (993) 2,053 (406) (500) Change in Debt 292 7, Capex (2,804) (6,632) (3,384) (2,896) Net Cash Flow (1,315) 8,960 2,001 1,788 Previous Cash , Closing Cash 446 1, Sources: Company reports and Santander Investment estimates. 12

13 APPENDIX I: COMPANY DESCRIPTION Mexichem is a group of chemical & petrochemical companies focused on the manufacturing transformation and marketing of petrochemical products in the chlorine-vinyl and fluorine chains. The company has three business units: (1) vinyl-chlorine-pvc chain; (2) fluorine chain; and (3) pipe systems. In 2005, the company divested its iron cable and wire business to focus on the petrochemical division. The company s most important products have a large market in dynamic sectors in Latam (construction, housing, potable water, and urban sewage systems) as well as in the United States. Recently the company changed its business profile, with the spin-off of its distribution chain (Dermet) and the acquisition of Amanco and Petco manufacturers of PVC pipe. Figure 15 shows the company s key milestones. Figure 15. Mexichem Time-Line Highlights Cables Mexicanos SA. is founded Holding group, Grupo Industrial Camesa SA. (GICSA) is created and the shares are listed in the Mexican Bolsa Acquires fluorite producer Compañia Minera las Cuevas SA Camesa s outstanding debt is capitalized Grupo Empresarial Privado Mexicano SA (GEPM) is created. This group holds 50.4% stake in Quimica Pennwalt Plastic division merges with GEPM Grupo Empresarial Kaluz SA. gains control of the company Camesa increases its stake from 50.4% to 93.79% through its subsidiary of the French company Total Acquires 100% of the shares of Quimica Fluor SA January: acquires 100% of the shares of Grupo Primex SA June: sells its steel division for US$135 million September: change of the registered name from Grupo Industrial Camesa SA. to Mexichem SA, consolidating as a company in the chemical and petrochemical sector October: primary and secondary offering, increasing the float to 28%. Mexichem issued M$854 million. The company priced the shares at M$ November: Acquires 69% of Dermet (Mexican Distribution Company) March: Mexichem purchases all the shares of Bayshore (U.S. company in the plastic industry) Pochteca and Dermet merged May: expansion of San Luis Mine (floating capacity doubled), and fluorite purifier starts operations in Matamoros Spin-off of chemical distribution business (Dermet) The company acquired the control of PETCO (Petroquimica Colombiana), a company that produces PVC resins, as well as the shares of Grupo Amanco, a leading industrial conglomerate in Latin America in the production and sale of solution for fluids conduction April: public offering of 58.8 million shares increasing share count from 490 to million, thus the float increased to 31.5% from 28.2%. Resources used to finance the acquisition of Petco and Amanco. Offering price of M$29.00per share. Sources: Company reports and Santander Investment. U.S. investors inquiries should be directed to Santander Investment Securities Inc. at (212) /(212)

14 A Key Regional Player in the Making; Initiating Coverage with a Buy Rating CHLORINE-VINYL CHAIN: 51% OF SALES This is Mexichem s core production chain, which generated 68% of 2006 consolidated revenues and 69% of EBITDA This process begins with salt, which produces chlorine and caustic soda by electrolysis, The products derived from this process have a wide range of uses including in several industries such as, plastics, fertilizers and construction, among others. The main use of chlorine is the production of PVC, which is used in wide range of products but its main applications are in the construction sector, mainly for pipes. Among the products derived from PVC are window frames, pipes for fluid transport, etc. Regarding price projections for PVC, CMAI (Chemical Market Associates Inc.) forecasts a decline in prices due to an expected excess of capacity, mainly in Asia. Nevertheless, we believe that here could be upside risk given that the higher energy prices and the strong demand from China and India and the local demand for Mexichem s products should remain high as they are key inputs for the housing and chemical industries, which are expected to grow at a strong pace. Figure 16. Chlorine Vinyl Chain Prices, Current and Projections (Jan 1999 = 100) ESTIMATES J-99 J-99 N-99 A-00 S-00 F-01 J-01 D-01 M-02 O-02 M-03 A-03 J-04 J-04 N-04 A-05 S-05 F-06 J-06 D-06 M-07 O-07 M-08 A-08 J-09 J-09 N-09 PVC VC Source: Santander Investment Estimates and CMAI. The PVC chain is divided into two processes: Chlorine soda production and the vinyl process. In the chlorine soda process, the company has five operating plants, four in Mexico and one in Colombia, with a total capacity of more than 2.38 millions of tons a year. The plants located in Mexico includes 1) Cloro de Tehuantepec (produces chlorine soda and has a total capacity of 576,000 tons), 2) Pennwalt (which includes two production facilities: Santa Clara and El Salto), 3) Union Minera del Sur (salt producer with 1.2 tons per year of total capacity), and in Colombia, Mexichem operates a facility located in Cajicá focused on the production of chlorine and caustic soda. This plant has 22,260 tons per year of total capacity. In the vinyl process, chlorine is processed with ethylene to produce VCM (vinyl chloride monomer) which is polymerized and transformed to PVC resins. In the PVC business, the company has four production facilities: 1) Altamira (produces PVC resins, total capacity of 450,000 tons a year including compounds); 2) Tlaxcala (produces PVC resins and compounds, total capacity of 66,000 tons); 3) Bayshore (USbased company involved in the PVC production, total capacity of 42,500 tons); and 4) Petroquimica Colombiana (Petco), which is based in Cartagena, Colombia and has a total capacity of 390,000 tons per year. The following chart shows the vinyl-chlorine chain process. 14

15 Figure 17. Chlorine Vinyl Production Process Sources: Company Reports and Santander Investment Estimates. FLUORINE CHAIN: 8% OF SALES Fluorite, fluorspar or calcium fluoride is a mineral with three principal types of industrial use depending on its purity. Metallurgical-grade fluorite, the lowest, has traditionally been used as a flux to lower the melting point of raw materials in steel and cement production, to aid the removal of impurities, and later in the production of aluminum. Ceramic-grade fluorite, intermediate grade, is used in the manufacture of opalescent glass, enamels and cooking utensils. The highest grade, acid-grade fluorite, is used in the manufacture of hydrofluoric acid. Hydrofluoric acid is the primary feedstock for the manufacture of virtually all organic and inorganic fluorine-containing compounds, including fluoropolymers and perfluorocarbons. It is also used on scale removal in the production of stainless steel. Mexichem has the world s largest fluorspar mine Compañia Minera las Cuevas and competes in the world market primarily with Chinese manufacturers. Global demand for fluorspar, especially highly purified fluorspar, which is used in manufacturing refrigerants, continues to rise. Mexichem s principal competitors in the fluorine chain are: Honeywell, Dupont, Arkema and Chinese producers as a country. Regarding Fluorite mining and processing, Mexichem s plant, Compañia Minera las Cuevas, is the world s largest fluorite mine, accounting for 17% of world production. We believe this is a competitive advantage,as it gives the company the necessary scale to become a low-cost producer. This business unit represented 15% of the 2006 total sales and 33% of the EBITDA. This chain produces two end products: hydrofluoric acid (HF) and sulfuric acid. The former is used in the manufacture of the refrigerant gas used in air conditioners, refrigerators and freezers. It is also used in the production of salts such as lithium for batteries, sodium to produce tooth paste, among others. Sulfuric acid is mainly used for the production of HF. According to the Mexichem estimates as of 2006, 7% of the fluorite total production was sent to the production of hydrofluoric acid (HF), which is the other end product derived from this chain and has a higher price. The company expects that for 2007 this number rise to 17%. Regarding hydrofluoric acid, Mexichem is the second largest producer of HF in the world. Total installed capacity reached the 120,000 tons which according to the company 98% of the production is exported to the U.S. Figure 18, summarizes the fluorine chain process. U.S. investors inquiries should be directed to Santander Investment Securities Inc. at (212) /(212)

16 A Key Regional Player in the Making; Initiating Coverage with a Buy Rating Figure 18. Fluorine Chain Process Sources: Company Reports and Santander Investment estimates. There is some potential risk of lower prices due to higher demand, nevertheless, we believe the risk is limited. There have been some comments regarding a potential increase of supply of fluorite from China, which has 49% of fluorspar worldwide production. Nevertheless, this supply is very fragmented and lacks economies of scale. Mexichem management estimates that we would have to add up the production of 1,500 mines in China in order to match the capacity of Las Cuevas. Therefore, we believe that Mexichem economies of scale and high productivity, limit the risk of competition from imports. PIPE SYSTEMS BUSINESS: 41% OF SALES (2007E) This chain is relatively new, as it started as a business unit in February 2007, when the company acquired the Brazilian company, Amanco, a regional leader in the production and distribution of PVC pipes. This chain involves the production of water pipes as well as fluid conduction solutions. Amanco sells its products in 29 different countries, grouped in five geographical regions: Brazil, Central American region, Andean region, Colombia and Mexico. Recently, the company expanded its operations through the acquisition of the Colombian company PAVCO. Mexichem was forced by the Colombian Antitrust Commission to divest one of its PVC production facilities located in Colombian city of Barranquilla. Nevertheless, the company maintained its brands. This division has 18 production plants distributed in 14 different countries (all of them in North America), with a total production capacity of 360,500 tons per year. 16

17 Figure 19. Amanco s Sales Breakdown by Region Colombia (18%) Mexico Brazil Andean (11%) CAR (23%) Sources: Company Reports and Santander Investment Estimates. The key driver for this division is economic growth in the regions. The regions where the company operates are expected to post attractive GDP growth. For 2007, according to the Santander economic team, Mexichem s markets should grow on average 6.3% and 5.3% for 2007 and 2008, respectively. For 2009, our team estimates that Mexichem s main markets should growth 4.9% on average. U.S. investors inquiries should be directed to Santander Investment Securities Inc. at (212) /(212)

18 A Key Regional Player in the Making; Initiating Coverage with a Buy Rating IMPORTANT DISCLOSURES Mexichem 12-Month Relative Performance (U.S. Dollars) MEXICHEM IPC Nov-06 Dec-06 Jan-07 Feb-07 Mar-07 Apr-07 May-07 Jun-07 Jul-07 Aug-07 Sep-07 Oct-07 Oct-07 Nov-07 Sources: Bloomberg and Santander Investment. 18

19 Key to Investment Codes IMPORTANT DISCLOSURES Rating Definition % of Companies Covered with This Rating % of Companies Provided Investment Banking Services in the Past 12 Months Buy Expected to outperform the local market benchmark by more than 5.0% % 78.95% Hold Expected to perform within a range of 5.0% above or below the local market benchmark % 21.05% Underperform/Sell Expected to underperform the local market benchmark by more than 5.0%. 8.86% The numbers above reflect our Latin American universe as of Thursday, November 15, For a discussion, if applicable, of the valuation methods used to determine the price targets included in this report and the risks to achieving these targets, please refer to the latest published research on these stocks. Research is available through your sales representative and other electronic systems. Target prices are 2007 year-end unless otherwise specified. Recommendations are based on a total return basis (expected share price appreciation + prospective dividend yield) unless otherwise specified. Stock price charts and rating histories for companies discussed in this report are also available by written request to Santander Investment Securities Inc., 45 East 53 rd Street, 17 th Floor (Attn: Research Disclosures), New York, NY USA. Ratings are established when the firm sets a target price and/or when maintaining or reiterating the rating. Ratings may not coincide with the above methodology due to price volatility. Management reserves the right to maintain or to modify ratings on any specific stock and will disclose this in the report when it occurs. Valuation methodologies vary from stock to stock, analyst to analyst, and country to country. Any investment in Latin American equities is, by its nature, risky. A full discussion of valuation methodology and risks related to achieving the target price of the subject security is included in the body of this report. The benchmark used for local market performance is the country risk of each country plus the 1-year U.S. Treasury yield plus 5.5% of equity risk premium, unless otherwise specified. The benchmark plus or minus the 5.0% differential used to determine the rating is time adjusted to make it comparable with the total return of the stock over the same period. For additional information about our rating methodology, please call (212) This report has been prepared by Santander Investment Securities Inc. ( SIS ) (a subsidiary of Santander Investment I S.A which is wholly owned by Banco Santander, S.A. ("Santander"), on behalf of itself and its affiliates (collectively, Grupo Santander) and is provided for information purposes only. This document must not be considered as an offer to sell or a solicitation of an offer to buy any relevant securities (i.e., securities mentioned herein or of the same issuer and/or options, warrants, or rights with respect to or interests in any such securities). Any decision by the recipient to buy or to sell should be based on publicly available information on the related security and, where appropriate, should take into account the content of the related prospectus filed with and available from the entity governing the related market and the company issuing the security. This report is issued in Spain by Santander Central Hispano Bolsa, Sociedad de Valores, S.A. (SCH Bolsa), and in the United Kingdom by Banco Santander, S.A., London Branch (Santander London), which is regulated by the Financial Services Authority in the conduct of investment business in the UK. This report is not being issued to private customers. SIS, Santander London, and SCH Bolsa are members of Grupo Santander. The following analysts hereby certify that their views about the companies and their securities discussed in this report are accurately expressed, that their recommendations reflect solely and exclusively their personal opinions, and that such opinions were prepared in an independent and autonomous manner, including as regards the institution to which they are linked, and that they have not received and will not receive direct or indirect compensation in exchange for expressing specific recommendations or views in this report, since their compensation and the compensation system applying to Grupo Santander and any of its affiliates is not pegged to the pricing of any of the securities issued by the companies evaluated in the report, or to the income arising from the businesses and financial transactions carried out by Grupo Santander and any of its affiliates: Luis Miranda, Christian Audi, and Diego Laresgoiti. Grupo Santander receives non-investment banking revenue from the subject companies, with the exception of Solvay Indupa. Within the past 12 months, Grupo Santander has received compensation for investment banking services from Braskem. In the next three months, Grupo Santander expects to receive or intends to seek compensation for investment banking services from Mexichem. The information contained herein has been compiled from sources believed to be reliable, but, although all reasonable care has been taken to ensure that the information contained herein is not untrue or misleading, we make no representation that it is accurate or complete and it should not be relied upon as such. All opinions and estimates included herein constitute our judgment as at the date of this report and are subject to change without notice. Any U.S. recipient of this report (other than a registered broker-dealer or a bank acting in a broker-dealer capacity) that would like to effect any transaction in any security discussed herein should contact and place orders in the United States with SIS, which, without in any way limiting the foregoing, accepts responsibility (solely for purposes of and within the meaning of Rule 15a-6 under the U.S. Securities Exchange Act of 1934) for this report and its dissemination in the United States by Santander Investment Securities Inc. All Rights Reserved. 2007