These 4 Measures Indicate That Sociedad Química y Minera de Chile (NYSE:SQM) Is Using Debt Reasonably Well

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, Sociedad Química y Minera de Chile S.A. (NYSE:SQM) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Sociedad Química y Minera de Chile

How Much Debt Does Sociedad Química y Minera de Chile Carry?

You can click the graphic below for the historical numbers, but it shows that as of June 2023 Sociedad Química y Minera de Chile had US$3.39b of debt, an increase on US$2.61b, over one year. However, it does have US$2.63b in cash offsetting this, leading to net debt of about US$764.3m.

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

According to the last reported balance sheet, Sociedad Química y Minera de Chile had liabilities of US$2.59b due within 12 months, and liabilities of US$3.02b due beyond 12 months. Offsetting these obligations, it had cash of US$2.63b as well as receivables valued at US$1.10b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$1.88b.

Given Sociedad Química y Minera de Chile has a humongous market capitalization of US$13.4b, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Sociedad Química y Minera de Chile's net debt is only 0.14 times its EBITDA. And its EBIT easily covers its interest expense, being 764 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. On top of that, Sociedad Química y Minera de Chile grew its EBIT by 66% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. 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 weak cash conversion makes it more difficult to handle indebtedness.

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, on a more sombre note, we are a little concerned by its conversion of EBIT to free cash flow. Zooming out, Sociedad Química y Minera de Chile seems to use debt quite reasonably; and that gets the nod from us. While debt does bring risk, when used wisely it can also bring a higher return on equity. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 3 warning signs for Sociedad Química y Minera de Chile you should be aware of, and 2 of them are potentially serious.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.