Ambev: A Quintessential Value Stock With Low Multiples And Strong Financials

seekingalpha2024-10-14

Ambev is a quintessential value stock.It is cheap relative to where it has traded historically, its peers, the consumer staples sector, and the market.The stock has clean financials and operating ...

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(NYSE:ABEV) is a Brazil-based brewer with roots in the 1880s, and is 62% owned by Anheuser-Busch InBev (BUD). It has over 500 alcoholic and non-alcoholic brands. Some of the bigger alcoholic brand names include Skol, Bud Light, and Stella Artois, while the non-alcoholic offerings include Lipton Iced Tea, Canada Dry, and Seven Up. The brewer operates in many countries and reports under five operating segments: Brazilian Beer, Brazilian Non-Alcoholic Beverages, Central America, Latin America, and Canada. The ticker has been listless for five years, and today the valuations are low. This name is my entry in Seeking Alpha’s “Best Value Idea” stock picking contest. For full disclosure, and as a value investor myself, I own Ambev and consider it a Buy. Best Value Idea Thesis The Seeking Alpha's value stock contest does not define what is considered value. It could mean a deep discount to future cash flows, cheap on metrics like price to sales, book, earnings, etc., or inexpensive against peers, the market, or where the symbol has traded historically – or even all of the above. Ambev checks many of these boxes. Take, for example, the valuations today versus where the shares have traded over the past decade. As the chart below highlights, Ambev is cheaper today than at almost any point over the past decade on a variety of metrics, including enterprise value to sales, enterprise value to EBITDA, price to book, price to cash flow, price to sales, and price to earnings. Seeking Alpha - ABEV Valuation Chart Not only is it inexpensive across many metrics, but as the table below demonstrates, the dividend yield is higher today than it has been in the past. There are concerns about the dividend’s sustainability – which will be touched on later – but if the payout is maintained at or near the current level, the yield over 6% will reward owners. It is worth noting that ABEV’s yield is much higher than the sector as well. Seeking Alpha - ABEV Dividend Table When compared to peers, ABEV is cheap too. The Seeking Alpha table below stacks Ambev up against brewers including Anheuser-Busch InBev, Carlsberg, Compañía Cervecerías Unidas, Heineken, Kirin Holdings, The Boston Beer Company, and Molson Coors. Not only do valuations look low, but it ranks well versus peers when it comes to growth and profitability. Seeking Alpha - Brewery Peer Table Finally, Ambev is inexpensive relative to the S&P 500 and the S&P 500 Consumer Staples Sector. The valuation data for the Consumer Staples Sector is presented in the graphic below. S&P - Consumer Staples - Sectoral Data Sometimes it is hard to distinguish between a value stock and a value trap; I unfortunately have plenty of experience with (and scars from) value traps. Over the years, I have come to view cheap securities with skepticism if they have persistently low valuations, declining sales over a multi-year period, lots of debt, a shrinking balance sheet, a history of shareholder dilution, negative cash flows, or a dividend payout ratio regularly near (or over) 100% of earnings. Ambev possesses none of these characteristics, which adds credibility to the company’s genuine value stock credentials. The valuations have not been low for years, and no shareholder dilution has occurred over the past decade. Sales are stable, the dividend payout is below 100% of earnings, and it has produced positive operating cash flows and free cash flows since 2010. As for the balance sheet, debt is low, cash is high, and the organization has a history of carrying a large net cash balance. Total assets have been steady for the past decade, while total equity has risen. Moreover, the share of goodwill on the balance sheet has declined, which reduces the odds of non-cash goodwill impairments. The financial profile is healthy, and the valuations are low in the absence of the characteristics which typify value traps. This means the margin of safety is high. These features make Ambev a strong contender for Seeking Alpha’s stock picking contest as a quintessential value stock. Risks The investment thesis is compelling, but all investments carry risk, and Ambev is no exception. The enterprise has plenty of challenges in many of its geographies. Seeking Alpha - ABEV v BRL:USD Chart A primary consideration for North American investors is the fact the organization reports in the Brazilian Real. This means the US-listed American Depository Receipt (ADR) is a play on the corporation’s prospects as well as a play on the direction of the Real. The Real has done poorly over the past decade, and as the chart above illustrates, there is a positive correlation between the direction of ABEV stock and the BRL:USD. So long as the Real is weak, the performance of the US listed shares will be constrained. In Brazil, Ambev faces tax litigation and tax reform uncertainty. On the tax litigation front, the company is locked in battle with the government over multiple tax items. The latest 20-F (and historic ones for that matter) details a host of disputes over differing interpretations of Brazilian tax law. Though this sounds scary, tax disputes are common. Ambev is not the first corporation to fight its tax bill, and it will not be the last. While the tax litigation is an old news story, the tax reform story is new as Lula da Silva’s government looks to shake things up. One change that came into effect at the start of 2024 eliminated the deduction of interest on net equity paid to shareholders. The old 1995 tax code allowed Brazilian firms to pay interest to shareholders, but unlike dividends paid, these interest payments were considered expenses, which reduce taxable income; this had obvious benefits for companies and owners. In the first quarter release, management noted that taxes had hit results. This is likely to continue, but there are workarounds. Corporations can make better use of tax credits, increase leverage, or divert capital into capex, organic expansion, and M&A instead of returning funds to owners through interest paid on net equity. The Brazilian government has also proposed an overhaul of Brazil’s consumption tax system. The idea would merge five value-added taxes (VATs) into two and simplify the code. This sounds sensible, but the implementation roadmap seems confusing as it would phase in over many years, and during that time there would be multiple tax regimes in place. Tax code complexity breeds uncertainty, hurts consumer confidence, and would impact organizations like Ambev. Regarding the tax issues, a quote from their CFO on the latest conference call provides a helpful overview of the current situation: “In terms of litigation, since our last call, we obtained favorable administrative court decisions totaling about R$2.6 billion as per Note-25 to our financial statements and one partially unfavorable decision regarding IOC deductibility, which we will appeal at the judicial level once we are notified of the decision. And as for the tax reform on consumption in Brazil, in mid-July, the draft legislation was voted in the House of Representatives. And the debate now moves to the Senate, which should vote on the matter before year-end. We will keep everyone posted.” These tax litigation and tax law adjustments should be watched. The VAT tax proposal may see revisions, and while the litigation seems to be going in the right direction, that may change, and there are a lot of other tax disputes to work through. This means legal proceedings are likely to persist. Brazil is also politically volatile and ranks poorly on the Corruption Perception Index. Though political volatility and corruption are not ideal, these factors are well known and likely priced in. Trading Economics - Argentina Inflation Data Argentina is also problematic. The nation’s inflation rate is 209% as of September – while this is better than the 292.2% print in April, it is still far too high. Hyperinflation distorts economics and forces companies to adopt hyperinflation accounting practices. In Ambev’s second quarter, Argentina’s inflationary issues resulted in a negative impact on profits of R$322.6 million. Though inflation is slowing, it remains high enough to hurt Ambev’s results. Not only does the business face risks in Brazil and Argentina, but its operations in Canada are weak. The Canadian division’s sales, volumes, and operating margins have been worse than Ambev’s other geographies for years. From this vantage point, selling the Canadian division looks like a possible way to unlock value and free up capital – assuming the price is right. Such a sale could unshackle the organization and allow it to focus more on Latin America, where it is more successful. Alternatively – and perhaps ideally – parent Anheuser-Busch InBev could acquire the Canadian assets or engage in a geographically rational asset swap with Ambev, given Ambev’s focus in Latin America and InBev’s concentration in North America. My base case, however, is that neither of these outcomes transpire, and Ambev soldiers on and tries to improve Canada’s operating performance on its own. Customer alcohol consumption preferences are changing as people move away from beer and towards other alcoholic options or non-alcoholic beverages. This explains the rise in popularity of pre-mixed ready-to-drink (RTD) cocktails and mocktails. So far, the shift in sentiment has been gradual, which has given brewers time to adapt. Moreover, these trends have not had a material impact on Ambev’s volumes, and it does provide a variety of non-alcoholic options regardless. Nevertheless, shifts in consumer behaviour can be hard to navigate, and it is a risk investors need to keep in mind. Some analysts are bearish on Ambev due to declining margins and questions over the ability to maintain its current dividend. Of the two issues, the margin one appears to be more important. Seeking Alpha’s income statement data for ABEV shows trailing twelve-month gross margins of 50.8% versus 58.3% in 2019 and 66.4% in 2014. Meanwhile, trailing twelve-month net margins were 17.9% compared with 22.7% five years ago and 31.7% a decade ago. One saving grace is that the margin profile has been stable since 2020 and there are signs it could be improving. Still, this is a valid concern and prospective investors need to weigh it carefully. As for the dividend yield’s sustainability, the first observation to make is that the company’s dividend policy is to distribute at least 40% of the corporation’s annual adjusted net income. The dividend per share oscillates as a result, which means income-dependent investors need to be careful. Fears of a dramatic reduction or change in the 40% policy are likely overblown, however, as earnings are consistent and the dividend payout – while high – has been in the 80% to 90% range since 2014. Seeking Alpha - ABEV Income Statement Data No discussion of Ambev would be complete without a mention of the April 2023 Bud Light Boycott. Ambev was not involved in this social media marketing meltdown, but it felt the reverberations given InBev is its parent company. Though this event happened nearly a year and a half ago, InBev continues to face reduced Bud Light volumes. Even when the impacts of this boycott are over, the situation illustrates how difficult it can be to get the marketing message right. Could Ambev face a boycott in the future or get their marketing message wrong? Yes, any brand could, and this will be a risk for any corporation built on brand management and messaging; Ambev is no exception. This list of risks seems daunting, but most businesses face many problems, and such is the nature of investing. In Ambev’s case, some of these challenges look temporary, others appear solvable or manageable, and the remainder do not offset or nullify the company’s investment credentials. Conclusion Ambev is a quintessential value stock with sturdy fundamentals. This makes it a strong contender for Seeking Alpha’s value stock contest. It is cheap versus where it has traded over the past decade, and it provides investors with a good dividend yield as they wait. It is also inexpensive against brewing peers, the consumer staples sector, and the broader indexes. Better yet, the margin of safety is high thanks to a strong balance sheet, stable share count, and consistent cash flows. Despite its solid credentials, it faces a variety of challenges including currency, tax, and litigation issues in Brazil, hyperinflation in Argentina, and lackluster results in Canada. These items appear manageable and/or temporary, however, and are not thorny enough to overwhelm the company’s fundamentals or justify the low price. To make a long story short, Ambev is on sale. Buy it…and wait.  “Editor's Note: This article was submitted as part of Seeking Alpha's Best Value Idea investment competition, which runs through October 14. With cash prizes, this competition -- open to all analysts -- is one you don't want to miss. If you are interested in becoming an analyst and taking part in the competition, click here to find out more and submit your article today!”","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":"4.30.0","shortVersion":"4.30.0","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/2475383731"}