Dip or No, Ambev Stock Is on Shaky Ground so Steer Clear

Ambev stock - Dip or No, Ambev Stock Is on Shaky Ground so Steer Clear

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At the beginning of 2018, it looked like the worst was over for Brazilian brewing company Ambev (NYSE:ABEV).

Ambev is the largest brewery in Latin America and the fifth largest in the world with a portfolio of brands that includes Skol, Brahma, Stella Artois, Bud Light, Modelo Especial, Corona and Budweiser. Despite the ostensible strength of its brand portfolio, Ambev struggled from 2013 to 2017 as its biggest market, Brazil, fell into a recession.

ABEV stock consequently fell from a $9 high at the beginning of 2013 to $5 by the start of 2017.

But Ambev stock started showing signs of life in 2017 as expectations for a turnaround in the Brazilian economy grew. Indeed, by the end of 2017, Brazil’s economy was slowly climbing out of its recession. And things looked good for ABEV stock.

But that golden era has been short circuited by still weak discretionary spending in Brazil. Ambev’s results so far in 2018 have failed to live up to expectations. And Ambev stock has dropped.

It now sits right back at $5.

Is this an opportunity to buy the dip? Or should investors steer clear of this name?

I think the latter. Growth in Brazil will remain challenged by still weak economic conditions. Meanwhile, growth globally will be challenged by a marijuana legalization trend which threatens alcohol sales everywhere.

All together, I can’t justify a price tag much higher than $5-6 for Ambev today.

Here’s a deeper look.

Marijuana Moves Up

There are two big things which presently threaten the growth narrative supporting ABEV stock:

  1. Brazil’s economy is improving, but discretionary spending remains weak
  2. Marijuana legalization is a global trend that will inevitably hurt alcohol sales

For all intents and purposes, the Ambev growth story parallels the Brazil drinking growth story. Ambev does operate in Central America, other parts of South America and Canada. But Brazil accounts for nearly 60% of EBITDA, so as goes Brazil’s drinking market, so goes Ambev stock.

Unfortunately, despite a bounce back in the Brazilian economy, discretionary spending on items such as alcohol remains weak. That is why despite Brazil’s economy expanding for five consecutive quarters in a row now, Ambev’s Brazil beverage volumes dropped by more than 10% last quarter.

That is no good. While this trend should improve with an improving economy, still weak discretionary spending habits amid a still weak economy in Brazil will pressure operating results going forward.

Longer-term, Ambev is staring at a huge risk in the form of marijuana legalization.

Canada, which is one of Ambev’s larger markets, recently legalized marijuana. In U.S. states where medical marijuana is legal, alcohol sales have dropped 15%. Moreover, in Aspen, Colorado, marijuana sales are now greater than alcohol sales.

Thus, wherever marijuana is legal, alcohol sales will drop. Ambev has 10% exposure to Canada, so that is 10% of Ambev’s business that is presently at risk to marijuana legalization. But more than that, marijuana legalization appears to be a global trend.

Thus, it is likely coming to Brazil and Ambev’s other operating markets. That means that the other 90% of Ambev’s business is also at risk to marijuana legalization in the foreseeable future.

Put the weak Brazil economy and marijuana legalization headwinds together, and it is easy to see why ABEV stock may not bounce back any time soon.

Fundamentals Support a $5-6 Price Tag

At the end of the day, I’m a numbers a guy. Thus, regardless of the story, if the numbers add up, I’m a buyer.

Unfortunately, the numbers don’t add up for Ambev.

Revenue growth over the past five years has run around 8% per year. That will inevitably slow over the next five years considering the two big aforementioned headwinds. Consequently, revenue growth will likely run around 5% per year into the foreseeable future.

As Brazil’s economy limps back from the dead, pricing should become more favorable for Ambev, and margins should head materially higher. As such, I think margins can head several hundred basis points higher over the next several years.

But even assuming 5% revenue growth and huge margin expansion, I still think Ambev can do only about $0.40 in earnings per share in 5 years. A historically average 20-times forward multiple on that implies a four-year forward price target of $8. Discounted back by 10% per year, that equates to a present-day value of $5.50.

Bottom Line on Ambev Stock

This was supposed to be a play on the rebound in Brazil’s economy. But that rebound is limping along, and discretionary spending hasn’t come back yet. Meanwhile, the global trend of marijuana legalization presents a long-running sizable risk.

All together, the recent drop in ABEV stock makes a ton of sense. A rebound isn’t likely until Brazil’s discretionary spending rebounds, and/or marijuana legalization momentum slows.

As of this writing, Luke Lango did not hold a position in any of the aforementioned securities. 

Article printed from InvestorPlace Media, https://investorplace.com/2018/06/ambev-stock-shaky-ground/.

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