2016 proved to be the most complicated year we have had at Pochteca in a very long time. Several of our main market sectors suffered major contractions, and we experienced a deflationary environment for most of the products we sell.

One of the main adversities we encountered in 2016 was the erosion of industrial activity in Brazil. Specifically, the declines in industrial output of 3.2% in 2014, 8% in 2015, and 6.6% in 2016 have led to a major reduction in demand for our products.

Moreover, the considerable revaluation of the Brazilian real negatively affected Coremal’s margins as inventories acquired at higher dollar exchange rates had to be sold at a lower exchange rates.

A second factor that negatively affected our earnings was a generalized deflation of our product prices. Prices for corn and milk derivatives, mining inputs and petroleum derivatives have been declining in recent years such as the more than 50% drop in petroleum derivative prices in just the past two years. This deflation greatly alters the profitability of many products so that even if logistical, packaging and shipping costs are not greater in absolute terms, they increase significantly as a percentage of the gross margin and the sales price.

A third factor was a drop in demand for inputs in the oil exploration and drilling sector. Between June 2012 and the end of 2016, the number of active rigs in Mexico, Brazil and the United States decreased 82%, 87% and 68%, according to data published by Baker Hughes on line. While our product and industry diversification allowed us to offset part of the reduction in sales to the petroleum industry, it was not possible to completely compensate for those losses as this sector is our most important sales segment.

Lastly, we also experienced a negative effect on the level of mining –previously our second most important market, after oil and gas– as mineral product prices have fallen considerably in recent years and, as a result, so have mining inputs prices and volumes.

In contrast to the strong results we reported for 2015, during 2016 we achieved only a slight 1% increase in sales, which totaled Ps 6.14 billion. The gross margin narrowed 70bp as it fell from 18.2% to 17.5%. Operating income experienced a sharp 48% contraction to Ps 116 million. EBITDA fell 27% to Ps 248 million pesos.

In Mexico, we have yet to see signs of a recovery in sectors that are of key importance to Pochteca such as mining as well as oil exploration and drilling, so we have focused our efforts on other markets offering growth opportunities. In Brazil, industrial production has undergone a severe decline and we do not anticipate a significant recovery in the near term although there appears to be a consensus that the worst has passed.

In an effort to mitigate risks and strengthen our earnings margins, in 2016 we introduced several initiatives directed at bolstering our competitiveness and expanding our cash position. As a result, we have:

• Modified the company’s corporate structure to lower its operating expenses and more efficiently align the commercial area with that of operations.
• Intensified our diversification toward blends and higher value added products, which protects us from price fluctuations.
• Sought to lower our working capital days in order to increase liquidity and achieve growth using fewer resources.
• Invested in systems focused on raising productivity and achieving a more efficient management of our customer and product bases.

We trust that these initiatives will pay off in 2017.

One favorable element within this enduring complex environment is that oil prices appear to have bottomed and in past months have embarked on an uptrend. Recently this has begun to translate into higher prices for some oil derivatives.

We are confident that our customer and product diversification strategy will allow us to shield sales and margins from much of the price deflation of recent years, as well as from the intense competition generated by the sharp downturn in the oil, gas and mining sectors.

Our net debt totaled Ps 728 million at the end of 2016, Ps 174 million or 31% more than in 2015. On the one hand, Coremal’s net debt increased 7% in reais, from 46.8 million to 49.9 million. The peso/real exchange rate depreciated 45% during the same period from 4.36 to 6.33 pesos per real, so Coremal’s net debt increased 55% in pesos, rising from Ps 204 million to Ps 316 million. On the other hand, during 2016 we amortized bank debt in Mexico for Ps 140 million.

Pochteca’s Net Debt / EBITDA closed 2016 at 2.9 times, up from 1.6 times at the end of 2015. This latest level is above our internal policy of restraining debt to no more than 2 times and is the result of weaker EBITDA than had been expected, as well as a rise in debt in Brazil as expressed in pesos resulting from the real’s revaluation. We are confident that with the reduced expense levels achieved with our corporate restructuring, the gradual recovery in Brazil, and the absence of the non-recurring expenses of 2016, our EBITDA will recover to better than 2015 levels, and that this metric will return to our target range levels.