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Morningstar | Valuation Upside Remains for Ambev as Beer Brazil Volume Growth Shows Market Will Rebound

Ambev reported first-quarter results that were broadly in line with our forecasts, but offered some cause for optimism with a volume stabilization in Brazil. We have made minor tweaks to our near-term assumptions, but these have no impact on our BRL 20 per share fair value estimate. We continue to believe that Ambev's regional scale gives it a cost advantage that should improve over time with volume growth and premiumisation, although Heineken's move into Brazil may trim its market share over the next few years. In spite of a reasonably strong performance year-to-date, the stock still offers upside to our valuation, and we believe any improvement in Brazilian macroeconomic data could unlock that upside.

First-quarter volume growth of 11.3% in Beer Brazil was a welcome reversal of the low-single-digit declines of the last two quarters, and was materially above our estimates. It was boosted, however, by the favourable timing of the Carnival and by cycling a very weak quarter last year, and it is notable that price/mix in the division has slipped from double digits two years ago to 3% to 4% over the last couple of quarters. Nevertheless, the 3% two-year stacked comp is above our 1% medium-term volume growth estimate, and we believe this could go even higher in the short term if macroeconomic data in Brazil improves.

On the other hand, Latin America South undershot our expectations, with continued macroeconomic pressure in Argentina driving a 10.6% volume decline year over year. Pricing more than kept up with inflation, at 27.1%. In spite of the economic challenges that are depressing consumer confidence in Argentina, Ambev recently doubled down on the market by assuming the perpetual licensing rights to Budweiser, in an exchange with CCU for some smaller Argentinian brands. We expect the Budweiser brand to play well longer term when premiumisation returns to Argentina, although investors will have to be patient to see this playing out in Ambev's numbers.

The gross margin was also a slight disappointment. As we stated in our fourth-quarter results note, we anticipated some gross margin contraction this year, but the 220 basis point reported decline over last year's first quarter was steeper than our estimate. We are retaining our sub-61% gross margin estimate for this year, however, following management's comments that margin pressure should ease by the end of the year. In the long term, we see the gross margin as Ambev's biggest opportunity, driven by premiumisation and to a lesser extent by operating leverage from continued volume growth. Our valuation does not depend on a return to the high 60% gross margin range of five-10 years ago, but we think 64% can be achieved in a normalized economic environment, even if Heineken proves to be a more competent competitor in Brazil than Kirin was.