1Q05 Results Were Strong Overall and Better than Expected; Some Flags in Sigma

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1 Latin American Equity Research Mexico, April 21, Earnings Comment Mexico Conglomerates ALFA (US$4.71) (ALFAA) STRONG BUY TARGET PRICE: US$6.15 1Q05 Results Were Strong Overall and Better than Expected; Some Flags in Sigma Luis Miranda, CFA (5255) News/Analysis: Alfa reported 1Q05 results on April 20 after the market closed. Overall, results were strong and better than expected. On the positive side, we highlight the very strong numbers for Alpek and Nemak, with the latter benefiting from the consolidation of Rautenbach. On the negative side, Sigma s operating margin was affected by higher raw material costs, a structural change in the sales mix, and non-recurring expenses related to the acquisition of New Zealand Milk de Mexico. Alfa s revenue of M$16.7 billion in 1Q05 was 24% higher YoY in real peso terms, 4% higher than our estimate, and 9% higher than consensus. EBITDA of M$2.2 billion was 27% higher YoY, 12% higher than our estimate, and 14% higher than consensus. The operating margin of 9.7% was 80 bps higher than our estimate, mainly because of very strong numbers at Alpek. By division, Alpek (petrochemicals, 53% of sales) reported sales and EBITDA growth of 24% and 35% in real terms, respectively, versus 1Q04. This was driven by a 29% increase in prices, partially offset by a 4% decline in volume that was largely due to maintenance at the polypropylene plant. Nemak (autoparts, 21% of sales) posted top-line growth of 19% versus 1Q04 in real terms, most of which stemmed from the consolidation of the recently acquired European company Rautenbach, which was consolidated for all of 1Q05. EBITDA rose 3% YoY, mainly due to the ramping up of some projects. Sigma (food, 24% of revenues) recorded revenue growth of 27% in 1Q05 versus 1Q04, spurred by volume growth of 23% and a 5% price increase. Nevertheless, the operating margin was 8.4%, 330 bps lower YoY and 240 bps lower than expected, because of the aforementioned factors. Management did not disclose the magnitude of the non-recurring charges. However, we believe that the weak operating margin raises a red flag in regard to Sigma; therefore, we believe the operating performance of this division is a key variable to follow closely. Consolidated net income was 34% higher than expected, mainly due to higher operating results. Consolidated net debt of M$1.23 billion was up 12% YoY, on the back of acquisitions and investments in working capital. Net/Net: This was a strong first quarter for Alfa, in our opinion, and we believe the report could have a positive effect on the stock price. Despite the new concerns about Sigma, overall results were better than our estimates and consensus. We believe that Alpek will continue to post strong numbers in the medium term and that the company s top line should benefit from organic growth and acquisitions at Sigma and Nemak. The main challenge, in our view, will be an improvement in Sigma s profitability and evidence of synergies. Valuation and Risks to Investment Thesis: Our target price is based on a FV/EBITDA multiple of 6.1 times, in line with the company s average in the period (prior to its period of high leverage and weak results), and it is also adjusted for the expected spin-off. The main risks to our investment thesis include: (1) higher-than-expected margin pressure on Alpek and Sigma due to higher cost of raw materials; (2) high exposure to U.S. OEMs; and (3) lower-than-expected economic growth in the U.S. and Mexico. Alfa First-Quarter 2005 Results U.S. Dollars in Millions a Mexican Pesos as of March 2005 in Millions a Sales Op Prof Op Marg EBITDA Net Inc EPS Sales Op Prof Op Marg EBITDA Net Inc EPS 1Q05 1, % ,708 1, % 2,235 1, SI Est 1, % ,009 1, % 1,990 1, Cons 1, % ,326 1, % 1, Q04 1, % ,456 1, % 1,948 1, % Ch Q/Q 3.6% 20.4% % -26.4% -26.4% 1.5% 18.0% % -27.9% -27.3% 1Q04 1, % ,516 1, % 1, % Ch Y/Y 27.9% 38.8% % NM NM 23.6% 34.1% % NM NM a Except per share/adr amounts. NM Not meaningful. Sources: Company reports and Santander Investment estimates.

2 Alfa: 1Q05 Results Valuation Summary (U.S. Dollars in Millions a ) Current Price US$4.71 Target Price US$6.15 Bloomberg ALFAA MM 52-Week Range (US$) US$3.09-US$ E P/E Rel to (Index) (x) E P/E Rel to (Sector) (x) 1.66 Market Capitalization (US$ Mn) US$2,736 Float (%) 35% 3-Mth Avg Daily Vol (US$ Million) 8.3 Shares Outst (ADR xx:1) 581 Net Debt/Equity (x) 0.6 Book Value per ADR (US$) Month Share Price Performance Relative to the IPC (In U.S. Dollar Terms) A-04 J-04 A-04 S-04 N-04 J-05 F-05 A-05 EPS EBITDA FV/ CE Div Div (Local) US$ P/E per ADR EBITDA per ADR P/CE per ADR Yield (%) % % 2005E % 2006E % a Except per share amounts. NA Not available. NM Not meaningful. Sources: Company reports, Economatica, Bloomberg, and Santander Investment estimates Alfa Operating Highlights by Division (U. S. Dollars in Millions) ALFA Sales Operating Margin EBITDA Division 1Q04 4Q04 1Q05 1Q04 4Q04 1Q05 1Q04 4Q04 1Q05 Alepk % 7.3% 9.6% Sigma % 11.6% 8.4% Nemak % 8.0% 7.7% Total 1,159 1,431 1, % 8.4% 9.7% Sources: Company reports, Alpek (53% of sales). The petrochemical division posted sales growth of 24% in real peso terms versus 1Q04 and 28% in dollar terms. This was driven by a 29% increase in prices in peso terms versus 1Q04 and 6% versus 4Q04, which was partially offset by a 4% decline in volume versus 1Q04 and 8% decline versus 4Q04. The volume decline is attributable to lower output of polypropylene due to maintenance as well as a weak month of March due to the Easter holiday (this year in March versus April in 2004). The latter is naturally true for all the divisions. Operating margin in 1Q05 of 9.6% was 120 bps higher than expected and 220 bps higher YoY, as prices of feedstock have stabilized and price increases implemented during the quarter have been accepted by consumers. During 1Q05, Alpek posted EBITDA of US$101 million, the highest level since 2Q97 and US$7 million above our estimate. The three business units, raw materials for polyester, nylon fibers, and plastic-chemicals, posted sequential increases in EBITDA of 16%, 54%, and 6%, respectively. We believe the short-term outlook for this division remains attractive. Although volatility in oil-related products is expected to remain, demand seems to be stable and prices of feedstock have stopped increasing, which should allow the division to continue reporting attractive numbers, at least in the short term. The company should also benefit from higher volume in polypropylene after maintenance downtime in 1Q05 and the start of the new EPS (expandable polystyrene) plant, which came on line at the end of the quarter, increasing capacity by 90,000 tons to 180,000 tons. Sigma (24% of sales). The food division posted a very attractive 27% increase in sales in 1Q05 versus 1Q04 in real peso terms. This was clearly driven by the acquisition of Grupo Chen and Sosua (3Q04) and New Zealand (1Q05); the latter was consolidated for one month during the quarter. Volume increased 23% YoY and prices were up 5% in real peso terms, as the company has been able to pass through higher prices for raw materials. Foreign operations now represent 11.7% of revenues and reported 80% growth YoY. However, at the operating level, the division posted a worrisome 8.4% operating margin and a 10% decline in operating profit versus 1Q04 in real terms. This was partially explained by the change in sales mix, as cheese products have lower margins than cold cuts (Chen and New Zealand are cheese producers) and higher costs IPC 2

3 of raw material, especially milk. However, operating profits were also affected by an undisclosed amount of non-recurring charges related to the acquisition of New Zealand and the company s relaunch of its corporate image. This was the only division that reported EBITDA below our estimate (US$43 million versus our US$45 estimate). Challenging operating outlook. The company stated in its press release that it intends to capitalize on its position on the cheese industry (currently we estimate 31% market share in the domestic market). This will be achieved via synergies, focused on the rationalization of products and distribution, as well as savings in advertising, administrative, and R&D expenses. We will have to closely follow the evolution of this division s performance and the materialization of the expected synergies. Although the weaker-than-expected margins raise some yellow flags that must be monitored, we believe Sigma s management has the capacity and expertise to deliver better numbers in the medium term. Nemak (21% of sales). The division posted strong 19% growth in revenues in real terms in the quarter versus 1Q04, mainly driven by the consolidation for the entire quarter of Rautenbach, the recently acquired European operation. Growth was mainly supported by a 19% increase in volume. Despite the attractive top line growth, EBITDA increased only 3% in real peso terms YoY, as the company had to increase labor expenses on the back of new platforms that the company is developing at its various plants. We believe that during the coming quarter the operating performance of Nemak will improve, as personnel involved with the division s new projects climb up the learning curve. Furthermore, the company will benefit from the consolidation of Rautenbach, which, as we have mentioned before, diversifies the company s client base with higher exposure to European and Asian OEMs. We recognize that these positives are partially offset by the medium-term pressure that the company s high exposure to Ford and GM poses, as the two largest U.S. OEMs continue to suffer strong competition, especially from Asian OEMs. Capex during the quarter was US$152 million, including acquisition. The main projects were the acquisitions of Sigma and Nemak, the ongoing investment in the new polypropylene line, which should be operational by the end of 2006, and the final phase of the EPS plant, which started production in late 1Q05. Net debt increased US$134 million to US$1.2 billion. Nevertheless, we do not believe this is an issue, as interest coverage stands at 8.4 times and net debt to EBITDA is 1.6 times. Bottom Line. We believe 1Q05 results are positive and reinforce our positive view on the stock. We recognize that the outstanding results in Nemak are partially offset by the margin pressure in Sigma. Nevertheless, we believe Sigma s management has the capability to improve profitability. We believe that Alfa will continue reporting solid figures, at least for the next couple of quarters. 3

4 Alfa: 1Q05 Results IMPORTANT DISCLOSURES Alfa Three-Year Stock Performance (U.S. Dollars) M-02 J-02 S-02 D-02 M-03 J-03 S-03 D-03 M-04 J-04 S-04 D-04 M-05 Source: Santander Investment. Dropped Coverage 1/3/03 Alfa (L Axis) B $3.70 1/13/04* B $4.05 1/20/04 B $4.20 3/31/04 IPC (R Axis) SB $6.15 3/10/05 SB $4.30 9/24/04 1,300 1,200 1,100 1, Analyst Recommendations and Price Objectives SB: Strong Buy B: Buy H: Hold UP: Underperform S: Sell UR: Under Review 4

5 IMPORTANT DISCLOSURES (CONTINUED) Key to Investment Codes Rating Definition % of Companies Covered with This Rating % of Companies Provided Investment Banking Services in the Past 12 Months Strong Buy Expected to outperform the local market more than 15%. Buy Expected to outperform the local market 5%-15% % 64.29% Hold Expected to perform within a range of 5% above or below the local market % 21.43% Underperform Expected to underperform the local market 5%-15%. Sell Expected to underperform the local market more than 15% % -- Under Review 10.43% 14.29% The numbers above reflect our Latin American universe. 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 2005 year-end unless otherwise specified. 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