Ambev (BVMF:ABEV3) Has A Pretty Healthy Balance Sheet

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, Ambev S.A. (BVMF:ABEV3) does carry debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Ambev

What Is Ambev's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of December 2020 Ambev had R$2.67b of debt, an increase on R$914.9m, over one year. But it also has R$18.8b in cash to offset that, meaning it has R$16.1b net cash.

How Healthy Is Ambev's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Ambev had liabilities of R$33.5b due within 12 months and liabilities of R$16.6b due beyond that. Offsetting these obligations, it had cash of R$18.8b as well as receivables valued at R$7.59b due within 12 months. So it has liabilities totalling R$23.7b more than its cash and near-term receivables, combined.

Of course, Ambev has a titanic market capitalization of R$241.7b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, Ambev boasts net cash, so it's fair to say it does not have a heavy debt load!

On the other hand, Ambev's EBIT dived 16%, over the last year. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Ambev can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Ambev has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last three years, Ambev recorded free cash flow worth a fulsome 89% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

Summing up

We could understand if investors are concerned about Ambev's liabilities, but we can be reassured by the fact it has has net cash of R$16.1b. The cherry on top was that in converted 89% of that EBIT to free cash flow, bringing in R$14b. So we don't have any problem with Ambev's use of debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 2 warning signs for Ambev you should be aware of.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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