Sociedad Química y Minera de Chile (NYSE:SQM) Seems To Use Debt Quite Sensibly

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Sociedad Química y Minera de Chile S.A. (NYSE:SQM) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Sociedad Química y Minera de Chile

What Is Sociedad Química y Minera de Chile's Net Debt?

The image below, which you can click on for greater detail, shows that at March 2023 Sociedad Química y Minera de Chile had debt of US$2.95b, up from US$2.62b in one year. On the flip side, it has US$2.83b in cash leading to net debt of about US$120.2m.

How Healthy Is Sociedad Química y Minera de Chile's Balance Sheet?

The latest balance sheet data shows that Sociedad Química y Minera de Chile had liabilities of US$2.83b due within a year, and liabilities of US$2.87b falling due after that. Offsetting this, it had US$2.83b in cash and US$1.72b in receivables that were due within 12 months. So its liabilities total US$1.14b more than the combination of its cash and short-term receivables.

Of course, Sociedad Química y Minera de Chile has a titanic market capitalization of US$19.2b, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. But either way, Sociedad Química y Minera de Chile has virtually no net debt, so it's fair to say it does not have a heavy debt load!

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Sociedad Química y Minera de Chile has very little debt (net of cash), and boasts a debt to EBITDA ratio of 0.021 and EBIT of 292 times the interest expense. So relative to past earnings, the debt load seems trivial. Better yet, Sociedad Química y Minera de Chile grew its EBIT by 182% last year, which is an impressive improvement. That boost will make it even easier to pay down debt going forward. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Sociedad Química y Minera de Chile's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Looking at the most recent three years, Sociedad Química y Minera de Chile recorded free cash flow of 34% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Our View

Sociedad Química y Minera de Chile's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But truth be told we feel its conversion of EBIT to free cash flow does undermine this impression a bit. Looking at the bigger picture, we think Sociedad Química y Minera de Chile's use of debt seems quite reasonable and we're not concerned about it. After all, sensible leverage can boost returns on equity. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 3 warning signs for Sociedad Química y Minera de Chile (2 are significant) you should be aware of.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.