Ambev Takes a Step in the Right Direction on Margins in Q3

Director

Philip Gorham

Brahma, the Brazilian brewer, was the first foray into the consumer product manufacturing industry by private equity group 3G. In 2000, 3G merged two Brazilian brewers; Brahma and Antarctica, creating Ambev. The company has gone on to roll up brewers throughout Central and South America and holds several monopolylike positions in large markets, including an 81% volume share in Argentina, 68% in Brazil, and 61% in Peru.

In part because of the favorable industry structures, and in part because of its 3G heritage, Ambev is a highly profitable business. The company has a well-entrenched cultural focus on cost management, and implemented zero-based budgeting over a decade ago. Ambev’s largest market is Brazil, which represented 54% of total beverage net revenue and 49% of EBIT in 2022. However, until coronavirus-related social distancing measures prompted the closure of on-trade in some markets, Ambev's beer EBIT margins in Brazil had been in the mid-30% range, among the highest in the global beer industry, though they had faded from above 40% a decade ago. In 2022, those margins troughed at under 21% and have recovered somewhat year to date in 2023.

We believe rebuilding margins is important to the investment case. In our view, the most likely and significant boost to profitability would be a reversion to the historical mean of commodity costs. We estimate the company faced around BRL 3 billion in higher raw material costs in 2022, and a reversal of that by the end of 2024 would increase the gross margin by 3 percentage points, all else equal. In practice, we anticipate that some of the cost relief will be passed to the consumer, but lower costs will be beneficial to margins to a large degree. 

Premiumization should be a long-term growth and margin driver. According to Euromonitor, the premium beer segment represented 15% of Brazil's beer volume in 2021, around half of that of the U.S., and was almost entirely responsible for industry volume growth between 2016 and 2021. Ambev’s portfolio of local premium brands, as well as its access to Anheuser-Busch InBev’s global portfolio, positions it to benefit from a strong mix effect in the medium term.

Business Strategy & Outlook

Ambev has a wide economic moat, in our opinion, benefiting from both a cost advantage and intangible assets in its strongest markets.

Intangible Assets

In its markets in which it holds a commanding volume share, Ambev has relationships with its customers in both the on trade and off trade that allow it to react quickly to negative competitive events. Its leadership positions ensure it has influence over distributors and gives the company unique access to consumer data that it can leverage to adapt to changing consumer tastes and preferences. This has been evident in Latin America, where Ambev has moved quickly into the craft segment. Amid the very early signs of category fragmentation, Ambev has maintained its market shares over recent years.

The ability to launch new products in adjacent categories under the company’s large brand umbrellas can lower customer acquisition costs and is an indication of brand equity, and Ambev has achieved this in spades. In Brazil, for example, the company has developed the Brahma and Skol brands into umbrella brands that now include Brahama Extra Red Lager, Brahma Extra Weiss, Skol Hops and Skol Puro Malt. Product positioning is particularly important in premiumizing markets such as Latin America because beer is often consumed in a social environment, particularly in the on-premise channel, so brand choice is fairly conspicuous.

Cost Advantage

Throughout much of Latin America, Ambev’s cost advantage is powerful and helps to maintain its high market shares. Beer is a scalable business, with scale advantages coming in the procurement of raw materials, packaging, distribution, advertising and fixed cost leverage. Ambev is the third-largest brewer globally behind its parent company AB InBev and Heineken, with 2022 beverage volumes of 186 million hectoliters. Admittedly, it is a distant third, with around two thirds of the volumes of number-two Heineken and roughly half of its parent AB InBev’s volumes, even when Ambev’s contribution is excluded. 

It is in the provincial nature of most beer brands, however, that Ambev’s cost advantage lies. Regional scale is a powerful driver of cost advantages. While there are some global beer brands (in Ambev’s case, it markets AB InBev’s global brands: Budweiser, Stella Artois and Corona) that benefit from global procurement and marketing, the majority of the industry is composed of brands with fairly limited geographic reach. Consequently, brands, marketing, packaging and distribution can vary regionally, and cost advantages are gained by local concentration. This is borne out in our analysis of average cost of production when volumes are adjusted for capacity utilization. A regression of cost of goods sold per hectoliter of beverage manufactured against volume per brewery for the nine brewers under our global coverage generates a statistically significant relationship at the 95% confidence level, and a coefficient of determination of 0.9 when outlier Boston Beer is excluded. Boston Beer’s traditional brewing process and more expensive raw materials contribute to its significantly higher average cost structure, and distort the analysis, in our view.

In most markets in which it operates, Ambev possesses high market share and local scale. For example, according to GlobalData, AB InBev held beer volume shares of 73% in Bolivia, 68% in Uruguay, and 65% in El Salvador and Argentina. The company commands more than half of the market in seven countries in Central and South America. Most of Ambev’s markets are premiumizing, with the consumer moving up the price ladder within the beer category. Nevertheless, the mainstream segment remains dominant, and according to Euromonitor, represented 81% of lager volumes in Brazil in 2022, for example, and lager represented 97% of the beer and cider market, so flexibility to be competitive on price remains important.

In the volatile market of Latin America, the power of the cost advantage is most felt during periods of economic downturn. In Argentina, for example, a country suffering from immense geopolitical volatility and undergoing a multiyear period of recession, hyperinflation and a plummeting currency, Ambev has maintained its margin in the Latin America South segment because its cost advantage has allowed it to raise prices at levels at or above inflation. Consequently, we estimate mainstream brands including Quilmes and Brahma have taken some share both because of downtrading and because Ambev can be price competitive.

Wide

Economic Moat

Ambev

Ambev SA engages in the production, distribution, and sale of beverages. Its products include beer, carbonated soft drinks, and other non-alcoholic and non-carbonated products. It operates through the following geographical segments: Brazil, and Central America and The Caribbean (CAC), and Canada. The Brazil segment focuses on the beer sales division and the NAB sales division. The CAC segment includes its direct operations in the Dominican Republic, Saint Vincent, Antigua, Dominica, Cuba, Guatemala, Barbados, and Panama. The Canada segment covers includes domestic sales in Canada and some exports to the United States market. The Canada segment represents the Labatt’s operations. The company was founded in 1853 and is headquartered in São Paulo, Brazil.

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Ambev S.A. (NYSE:ABEV ) Q3 2023 Earnings Conference Call October 31, 2023 11:30 AM ET Company Participants Jean Jereissati – Chief Executive Officer Lucas Lira – Chief Financial, Investor Relations and Shared Services Officer Conference Call Participants Isabella Simonato – Bank of America Robert Ottenstein – Evercore Thiago Duarte – BTG Pactual Ben Theurer – Barclays Felipe Ucros – Scotiabank Alan Alanis – Santander Operator Good morning, good afternoon, and thank you for waiting. We would like to welcome everyone to Ambev's Third Quarter 2023 Results Conference Call.

Ambev S.A. (ABEV) Q3 2023 Earnings Call Transcript

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Ambev S.A. (NYSE:ABEV ) Q1 2023 Earnings Conference Call May 4, 2023 11:30 AM ET Company Participants Jean Jereissati – Chief Executive Officer Lucas Lira – Chief Financial and Investor Relations Officer Conference Call Participants Lucas Ferreira – JPMorgan Camila Azevedo – UBS Thiago Duarte – BTG Pactual Carlos Laboy – HSBC Isabella Simonato – Bank of America Ben Theurer – Barclays Gustavo Troyano – Itaú BBA Operator Good morning, good afternoon and thank you for waiting. We would like to welcome everyone to Ambev's First Quarter 2023 Results Conference Call.

Ambev S.A. (ABEV) Q1 2023 Earnings Call Transcript

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