ABEV Rockets Upwards. But Is There Reason to Worry?

One of Wall Street's biggest winners of the day is Ambev, an alcoholic beverages company whose shares have climbed 3.6% to a price of $3.02 -- 9.43% below its average analyst target price of $3.34. The average analyst rating for the stock is hold. ABEV outperformed the S&P 500 index by 1.0% during today's afternoon session, and by 18.5% over the last year with a return of 6.2%.

Ambev S.A., through its subsidiaries, produces, distributes, and sells beer, draft beer, carbonated soft drinks, other non-alcoholic beverages, malt, and food products. The company is in the consumer defensive sector. It markets so-called staple goods and services that consumers tend to purchase regardless of their discretionary income. Thus, sales revenue tends to remain relatively unchecked by economic downturns, which in turn can contribute to share price stability. The flipside is that defensive stocks may see comparatively little growth during periods of economic growth.

Ambev's trailing 12 month P/E ratio is 20.2, based on its trailing Eps of $0.15. The company has a forward P/E ratio of 20.2 according to its forward Eps of $0.15 -- which is an estimate of what its earnings will look like in the next quarter.

The P/E ratio is the company's share price divided by its earnings per share. In other words, it represents how much investors are willing to spend for each dollar of the company's earnings (revenues minus the cost of goods sold, taxes, and overhead). As of the third quarter of 2022, the consumer defensive sector has an average P/E ratio of 24.21, and the average for the S&P 500 is 15.97.

ABEV’s price to earnings ratio can be divided by its projected five-year growth rate, to give us the price to earnings, or PEG ratio. This allows us to put its earnings valuation in the context of its growth expectations which is useful because companies with low P/E ratios often have low growth, which means they actually do not present an attractive value.

When we perform the calculation for Ambev, we obtain a PEG ratio of 2.14, which indicates that the company is overvalued compared to its growth prospects. The weakness with PEG ratios is that they rely on expected growth estimates, which of course may not turn out as expected.

To better understand the strength of Ambev's business, we can analyse its gross profits, which are its revenues minus its cost of goods sold only. The extent of gross profit margins implies how much freedom the company has in setting the prices of its products. A wider gross profit margin indicates that a company may have a competitive advantage, as it is free to keep its product prices high relative to their cost.

ABEV's average gross profit margins over the last four years are 56.2%, which indicate it has a potential competitive advantage in its market. These margins are declining based on their four year average gross profit growth rate of -6.1%.

Another key to assessing a company's health is to look at its free cash flow, which is calculated on the basis of its total cash flow from operating activities minus its capital expenditures. Capital expenditures are the costs of maintaining fixed assets such as land, buildings, and equipment. From Ambev's last four annual reports, we are able to obtain the following rundown of its free cash flow:

Date Reported Cash Flow from Operations ($) Capital expenditures ($) Free Cash Flow ($) YoY Growth (%)
2021-12-31 22,900,951,000.0 -7,677,113,000.0 15,223,838,000.0 7.49
2020-12-31 18,855,780,000.0 -4,692,695,000.0 14,163,085,000.0 6.39
2019-12-31 18,381,259,000.0 -5,069,405,000.0 13,311,854,000.0 -9.9
2018-12-31 18,346,075,000.0 -3,570,957,000.0 14,775,118,000.0 n/a
  • Average free cash flow: $14,368,473,750.00
  • Average free cash flown growth rate: 1.3 %
  • Coefficient of variability (the lower the better): 5.8 %

With its positive cash flow, the company can not only re-invest in its business, it can offer regular returns to its equity investors in the form of dividends. Over the last 12 months, investors in ABEV have received an annualized dividend yield of 20.7% on their capital.

Another valuation metric for analyzing a stock is its Price to Book (P/B) Ratio, which consists in its share price divided by its book value per share. The book value refers to the present liquidation value of the company, as if it sold all of its assets and paid off all debts.

Ambev's P/B ratio of 0.5 indicates that the market value of the company is less than the value of its assets -- a potential indicator of an undervalued stock. The average P/B ratio of the Consumer Defensive sector was 4.09 as of the third quarter of 2022.

With a lower P/E ratio than the sector average, an exceptionally low P/B ratio, and a steady stream of strong cash flows with a flat trend, we can conclude that Ambev is probably undervalued at current prices. The stock presents mixed growth indicators because of its consistently strong gross margins with a negative growth rate, and an above average PEG ratio.

The above analysis is intended for educational purposes only and was performed on the basis of publicly available data. It is not to be construed as a recommendation to buy or sell any security. Any buy, sell, or other recommendations mentioned in the article are direct quotations of consensus recommendations from the analysts covering the stock, and do not represent the opinions of Market Inference or its writers. Past performance, accounting data, and inferences about market position and corporate valuation are not reliable indicators of future price movements. Market Inference does not provide financial advice. Investors should conduct their own review and analysis of any company of interest before making an investment decision.