Ambev (BVMF:ABEV3) Seems To Use Debt Quite Sensibly

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies Ambev S.A. (BVMF:ABEV3) makes use of debt. But the real question is whether this debt is making the company risky.

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. If things get really bad, the lenders can take control of the business. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

See 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 September 2020 Ambev had R$5.28b of debt, an increase on R$2.20b, over one year. However, it does have R$23.1b in cash offsetting this, leading to net cash of R$17.8b.

A Look At Ambev's Liabilities

We can see from the most recent balance sheet that Ambev had liabilities of R$30.3b falling due within a year, and liabilities of R$17.2b due beyond that. Offsetting this, it had R$23.1b in cash and R$7.64b in receivables that were due within 12 months. So it has liabilities totalling R$16.7b more than its cash and near-term receivables, combined.

Of course, Ambev has a titanic market capitalization of R$243.9b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Despite its noteworthy liabilities, Ambev boasts net cash, so it's fair to say it does not have a heavy debt load!

But the bad news is that Ambev has seen its EBIT plunge 16% in the last twelve months. If that rate of decline in earnings continues, the company could find itself in a tight spot. 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 want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Ambev may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. 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 positions it well to pay down debt if desirable to do so.

Summing up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Ambev has R$17.8b in net cash. And it impressed us with free cash flow of R$15b, being 89% of its EBIT. So we don't have any problem with Ambev's use of debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 1 warning sign for Ambev that you should be aware of.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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