Why Ambev Stock Remains Unattractive Despite Solid Q2 Results

seekingalpha09-28

Ambev's Q2 showed margin recovery and stable volumes, but slow growth and currency risks make the stock less appealing with its reasonable valuation.The beer market in Brazil is mature, limiting Ambev...

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LeoPatrizi Ambev (NYSE:ABEV) had good Q2 earnings and has already shown a good margin recovery and strong volumes, which helps the conviction of the thesis holders. I understand that because it is a very well-established, mature company, with some triggers for recovery (as was shown for margin this quarter), Ambev stocks end up attracting the attention of investors looking for this quality and income. At the same time, I think that a change in perspective is still needed for Ambev to become (or return to being) compelling. Among the reasons for this low appeal are slow growth (probably low-mid single digits in line with Brazilian inflation), currency risks, a valuation that is only reasonable if we factor in this low growth, and, above all, a high opportunity cost Ambev Shows Resilience in Q2 With Margin Growth Ambev's Total Volume in this quarter was +0.4%, which despite being stable, is full of positive trends such as growth of 7.7% in NAB and 2.9% in Beer, while the rest of Latin America and Canada showed retractions of -13.7% and -6.9% which negatively impacted this volume. Despite these and other obstacles such as the greater impact of taxes on the topline in some states of Brazil, with the higher revenue per hectoliter, the result of better mix and prices, Ambev managed to push the top line forward by 4.8%. Although this isn't huge growth, it's more or less what I expect from Ambev on average over the next few years. The beer market in Brazil (which represents something close to 50% of Ambev's volume) is pretty solid, but in the next few years it's unlikely to achieve a volume CAGR above the mid-single digits organically, so revenue would have to come from a better mix, new initiatives and so on. The NAB market in Brazil is also mature and consolidated. Therefore, when I see both volumes growing by 3.8% and 6.1%, I interpret it as positive, with revenue rising at higher levels.   Ambev Q2 Presentation The highlights don't stop there, I believe that the best part of the result was the signaling of margins. On a consolidated basis, the normalized EBITDA margin went from 27.9% to 29%, the result of commodity tailwinds (as in the case of Beer), but also efficient expense management. The problem is that EPS still fell and reached R$0.15, with the increase in income tax in Brazil eroding gains in margin and revenue expense. Cash flow didn't catch my eye either, with operating cash flow remaining at the same level as Q2 2023, but with exchange rate fluctuations having a positive impact and causing cash & equivalents to end at R$14.2bn, which is one of the positive points that increases Ambev shareholder comfort, since the company has a debt (~R$3. 5bn) much smaller than its cash, so it could eventually use it for extraordinary distributions, inorganic growth (M&A) if something interesting comes up, or just keep it in fixed income while maintaining a comfort and greater level of caution. Ambev Stock Still Unappealing Despite the weaker EPS impacted by taxes, Q2 was good, with strong operating results. But I still can't be too optimistic about the company. The beers market in Brazil is already very consolidated, and the company already has a significant share. In my opinion, it's very unlikely that Ambev's volume will grow organically at a reasonable to high rate, in fact, I think it's more likely that it will grow at a slow average rate, something in the low single digits. McKinsey estimates that the CAGR from 2023 to 2028 for the beer market in Brazil will be above 4.83%, but this is for the total market, with other players such as Heineken being able to capture a larger share and cause Ambev to achieve lower growth. I believe that Ambev is far from being a bad company, it's just a very mature one. Some triggers such as improving the mix, macroeconomic trends such as the growing middle class, and some cultural and climatic events can drive revenue growth at Ambev, but I don't think it will be able to drive this revenue so that on average over the next few years/decades it moves closer to the low double-digit. However, what can make the company report faster growth in the bottom line and in generating shareholder value are margins. In Q2 it was able to show good cost and expense management, which together with commodity tailwinds has the power to make margins increase substantially. This is one of the main upside risks. If the company manages to maintain these efficiency gains on a sustainable basis, we may see the company's margin return to levels we've already seen in its history, and this will be a great unlocker of value. Again, there are obstacles to this, such as volatile commodities, a competitive market, and even taxes in Brazil.   Koyfin If we take the consumer staples sector as the median, Ambev's valuation is A- Grade. Its forward price-to-earnings is 13.4x, while the median for this sector is 18.34x. If we take other beverage companies, Ambev also appears to be discounted, Coca-Cola (KO) is trading at 24.4x earnings forward while Heineken (OTCQX:HEINY) is at 15.5x   Koyfin The thing is, Coca-Cola is American, with revenue mostly in strong currencies, while Heineken is Dutch, and although Ambev also has sources of revenue outside Brazil, most of it is still Brazilian revenue, a country with a higher level of legal insecurity and exchange rate risks, making a certain discount necessary. Compared to the average Brazilian index EWZ (which is somewhat contaminated by its heavy weighting in commodities and banks), the NTM price-to-earnings is ~8.5x, so Ambev is slightly above average. In other words, Ambev's valuation seems only reasonable to me, unless the prospects become clearer and this considerable margin recovery actually occurs. As for exchange rate risk, it's curious to note that Ambev stock's total return (in dollars) was -52.57%, while the Brazilian Real's return against the dollar was -55.36%. It's not something that has an absurd correlation or should be taken as the main source for decision-making since part of this negative return is related to Ambev's operations and financials, but it does serve to note how badly the Brazilian currency has performed for some time now, and that for international investors this is a risk to be monitored. On the other hand, positive commodity cycles and other events can bring some short- and medium-term gains.   Koyfin Why Ambev Struggles Against High-Yield Treasuries and Other Alternatives Again, the main reason I dislike Ambev Stocks is because I see no reason to buy them when there are so many cheaper and/or better prospects in the Brazilian market. The two big Brazilian companies, Petrobras (PBR) and Vale (VALE) are traded at a forward price-to-earnings of 5.7x and 5.2x, respectively, and although they are commodities companies and one is state-owned, they are also two mature companies that generate a lot of cash and remunerate shareholders well, with a dividend yield that is even higher than Ambev's. Moving on to comparisons that are not Ambev's peers, utility companies such as Engie Brasil (OTCPK:EGIEY) and Cemig (CIG), despite having a different dynamic and being capital intensive, also trade with NTM price-to-earnings below Ambev's and in my opinion, their operations are more predictable. Taking a sector that is also a little unfair to compare, banks in Brazil also offer excellent theses that manage to combine value, quality, and dividends. Itaú Unibanco (ITUB) and Banco do Brasil (OTCPK:BDORY) are good examples of banks with ROEs of ~20%, high dividends, and reasonably lower price-to-earnings than Ambev. Not to mention Inter (INTR) which has an NTM price-to-earnings of 13.5x practically the same as Ambev's and its growth prospects are absurdly higher (of course, this comes with additional risk). The ultimate comparison comes now. Fixed income in Brazil pays very well, and although the following figures are gross, the net return is still high, which shows why stocks in Brazil have a high discount on stocks. The Selic Rate is at 10.75% per year, but pre-fixed rate (\"tesouro prefixado\" in the table) treasuries maturing in 2027–2035 are paying more than 12% per year. Inflation-linked treasuries, called IPCA+ (similar to CPI), are paying inflation + 6.5% depending on the maturity.   Tesouro Direto As mentioned, Ambev is a company that is expected to grow topline at a very slow pace, and margins may show some level of recovery with the improvement in cost dynamics, but it still seems a little uncertain and may be insufficient to cover this high opportunity cost. It may be that over a long horizon, until 2035, for example, Ambev will achieve a good total return (to include the dividends distributed), but I don't think it's certain that this total return will be higher than inflation + 6.31% per year gross. The Bottom Line In short, Ambev is a good company, showed decent Q2 earnings, and has some interesting triggers to unlock value in the short/medium term. On the other hand, I still don't find Ambev stocks compelling, given their likely slow and steady growth, along with only a reasonable valuation and strong opportunity costs.  Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.","kind":"highlight","is_publish_news":true,"is_publish_highlight":false,"is_publish_live":false,"is_publish_wemedia":null,"editions":null,"column":"","sentiment":"0","news_tag":"analysis","news_rank":0,"symbols":[],"gpt_button":0},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":0,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.29.3","shortVersion":"4.29.3","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2470001452"}