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. As with many other companies Ambev S.A. (BVMF:ABEV3) makes use of debt. But the more important question is: how much risk is that debt creating?
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
View our latest analysis for Ambev
The image below, which you can click on for greater detail, shows that at June 2022 Ambev had debt of R$957.2m, up from R$681.5m in one year. But on the other hand it also has R$15.7b in cash, leading to a R$14.7b net cash position.
We can see from the most recent balance sheet that Ambev had liabilities of R$33.9b falling due within a year, and liabilities of R$15.1b due beyond that. On the other hand, it had cash of R$15.7b and R$8.01b worth of receivables due within a year. So its liabilities total R$25.4b more than the combination of its cash and short-term receivables.
Given Ambev has a humongous market capitalization of R$239.4b, it's hard to believe these liabilities pose much 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 other side of the story is that Ambev saw its EBIT decline by 9.1% over the last year. That sort of decline, if sustained, will obviously make debt harder to handle. When analysing debt levels, the balance sheet is the obvious place to start. 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, 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. During the last three years, Ambev produced sturdy free cash flow equating to 77% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.
While Ambev does have more liabilities than liquid assets, it also has net cash of R$14.7b. And it impressed us with free cash flow of R$14b, being 77% 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. Be aware that Ambev is showing 1 warning sign in our investment analysis , you should know about…
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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Ambev S.A., through its subsidiaries, produces, distributes, and sells beer, draft beer, carbonated soft drinks, other non-alcoholic beverages, malt, and food products in the Americas.
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