Shareholders of Companhia de Bebidas das Americas (ABV) have had a fair year with the stock price increasing by a modest 7%. This change represents an increase in shareholder value by over $7 billion. Through this analysis, I present the case that fundamentally, ABV is declining from a firm standpoint and in the next few quarters, price may reverse its multi-quarter uptrend.
A History of Declining Returns
In order to analyze any company, investors should isolate and study a few key drivers of firm strength. Two drivers of ABV which have historically driven stock price are return on assets and return on equity. Return on assets is the net income of the firm divided by the assets utilized. Return on equity is net income divided by directly-invested shareholder equity. These two ratios provide a comprehensive number that allows the investor to study the efficiency and effectiveness of the firm's attempt to capture profits.
The chart above shows 5 years of return on assets and return on equity history. Additionally, the market cap of the firm has been included for comparison. Between the years of 2008 and 2011, ABV delivered strong returns, as noted by the return on assets and return on equity. With the organization increasing its ability to translate assets and investments into profits at increasing efficiency, ABV has historically been able to deliver excellent performance. The market recognized the skill of ABV to deliver profit and rewarded the firm with an increase of nearly 300% in market value between 2008 and 2011. In the middle of 2011 however, ABV began a slow decline which has continued to this day. This decline of return on assets and return on equity represents the fact that ABV has reached a more mature stage of organizational growth. As the firm rapidly grew, it reached a "plateau", in which it became progressively more difficult to perform at the same heightened level.
Ever since the middle of 2011, the fundamental picture of ABV has steadily degraded. This degradation of performance has been marked by a gradual decline in return on assets and return on equity. It is very interesting to note that the market has not recognized this decrease in performance. As can be seen in the chart above, historically return on assets and return on equity changes have been accompanied by likewise changes of shareholder value. The past year has experienced a decoupling from the typical relationship however. Over the past 4 quarters, the firm has steadily eroded its excellent performance and yet the share price increased by over 22%. It appears that the market is beginning to awake to the fact that ABV is not performing as well as it did in the past as seen by the recent stalling in stock price, however I believe that further downside is entirely possible. If ABV is unable to reverse its decline in organizational returns, then ABV will eventually find its profits threatened and competition stealing greater swaths of market share. At the current level of returns, ABV is still a strong company, but the trend is what troubles me. The past 4 quarters have been marked by a continuous decrease in ability to generate a return and if this decline is not reversed, share price will inevitably fall.
The technical picture of ABV does not yet reveal the fundamental degradation of ABV. Even though the organization is not performing as well has it has in the past and returns are steadily diminishing, the stock price has not yet ended its solid uptrend. For this reason, I do not believe that it is quite time to short the security. Since my fundamental thesis is that the organization is weakening through time, then it makes sense that we should only short once the market agrees and prices begin to decline. For this reason, I believe the most appropriate method for trading ABV is to wait until prices fall below $36 per share prior to any short position. If prices fall below $36 per share, then the technical uptrend will have ended and future decline in prices is entirely possible. Even though prices have not substantially changed in the past quarter, the market is still in a solid uptrend and shorting prior to any form of price follow-through is more risk than I believe is warranted in ABV. After all, if ABV is able to reverse its current fundamental decline, then prices could once again continue upwards momentum in the future.