Stock Analysis

Here's Why Ambev (BVMF:ABEV3) Can Manage Its Debt Responsibly

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BOVESPA:ABEV3
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The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Ambev S.A. (BVMF:ABEV3) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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. When we examine debt levels, we first consider both cash and debt levels, together.

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What Is Ambev's Debt?

You can click the graphic below for the historical numbers, but it shows that Ambev had R$768.6m of debt in September 2022, down from R$808.9m, one year before. However, it does have R$19.1b in cash offsetting this, leading to net cash of R$18.3b.

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BOVESPA:ABEV3 Debt to Equity History November 27th 2022

How Healthy Is Ambev's Balance Sheet?

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 it has liabilities totalling R$23.4b more than its cash and near-term receivables, combined.

Given Ambev has a humongous market capitalization of R$248.2b, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. 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.

On the other hand, Ambev's EBIT dived 11%, 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 it is future earnings, more than anything, that will determine Ambev's ability to maintain a healthy balance sheet going forward. 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. During the last three years, Ambev generated free cash flow amounting to a very robust 80% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

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$18.3b. The cherry on top was that in converted 80% of that EBIT to free cash flow, bringing in R$13b. So we are not troubled with Ambev's debt use. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 1 warning sign we've spotted with Ambev .

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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