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

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Ambev S.A. (BVMF:ABEV3) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Ambev

How Much Debt Does Ambev Carry?

The image below, which you can click on for greater detail, shows that Ambev had debt of R$768.6m at the end of September 2022, a reduction from R$808.9m over a year. However, it does have R$19.1b in cash offsetting this, leading to net cash of R$18.3b.

A Look At Ambev's Liabilities

According to the last reported balance sheet, Ambev had liabilities of R$35.0b due within 12 months, and liabilities of R$15.5b due beyond 12 months. Offsetting this, it had R$19.1b in cash and R$8.09b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by R$23.4b.

Since publicly traded Ambev shares are worth a very impressive total of R$210.9b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. While it does have liabilities worth noting, Ambev also has more cash than debt, so we're pretty confident it can manage its debt safely.

But the bad news is that Ambev has seen its EBIT plunge 11% in the last twelve months. If that rate of decline in earnings continues, the company could find itself in a tight spot. When analysing debt levels, the balance sheet is the obvious place to start. 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. 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 80% 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

Although Ambev's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of R$18.3b. And it impressed us with free cash flow of R$13b, being 80% of its EBIT. So we are not troubled with Ambev's debt use. 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 example, we've discovered 1 warning sign for Ambev that you should be aware of before investing here.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.