Is Ambev (BVMF:ABEV3) Using Too Much Debt?

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 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. We can see that Ambev S.A. (BVMF:ABEV3) does use debt in its business. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Ambev

What Is Ambev's Debt?

As you can see below, at the end of June 2020, Ambev had R$5.16b of debt, up from R$3.02b a year ago. Click the image for more detail. But it also has R$17.5b in cash to offset that, meaning it has R$12.3b net cash.

A Look At Ambev's Liabilities

We can see from the most recent balance sheet that Ambev had liabilities of R$29.2b falling due within a year, and liabilities of R$16.6b due beyond that. Offsetting this, it had R$17.5b in cash and R$9.59b in receivables that were due within 12 months. So it has liabilities totalling R$18.8b more than its cash and near-term receivables, combined.

Of course, Ambev has a titanic market capitalization of R$197.8b, so these liabilities are probably manageable. 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.

It is just as well that Ambev's load is not too heavy, because its EBIT was down 20% over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. 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 84% 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

While it is always sensible to look at a company's total liabilities, it is very reassuring that Ambev has R$12.3b in net cash. The cherry on top was that in converted 84% of that EBIT to free cash flow, bringing in R$11b. 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. 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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