Is Sociedad Química y Minera de Chile (NYSE:SQM) A Risky Investment?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. As with many other companies Sociedad Química y Minera de Chile S.A. (NYSE:SQM) makes use of debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Sociedad Química y Minera de Chile

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

You can click the graphic below for the historical numbers, but it shows that as of March 2022 Sociedad Química y Minera de Chile had US$2.62b of debt, an increase on US$1.94b, over one year. However, its balance sheet shows it holds US$3.29b in cash, so it actually has US$670.5m net cash.

How Strong 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$2.49b due within a year, and liabilities of US$2.77b falling due after that. On the other hand, it had cash of US$3.29b and US$1.19b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$780.4m.

Since publicly traded Sociedad Química y Minera de Chile shares are worth a very impressive total of US$27.4b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. Despite its noteworthy liabilities, Sociedad Química y Minera de Chile boasts net cash, so it's fair to say it does not have a heavy debt load!

Even more impressive was the fact that Sociedad Química y Minera de Chile grew its EBIT by 391% over twelve months. That boost will make it even easier to pay down debt going forward. The balance sheet is clearly the area to focus on when you are analysing debt. 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're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Sociedad Química y Minera de Chile has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Looking at the most recent three years, Sociedad Química y Minera de Chile recorded free cash flow of 43% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Sociedad Química y Minera de Chile has US$670.5m in net cash. And we liked the look of last year's 391% year-on-year EBIT growth. So we don't think Sociedad Química y Minera de Chile's use of debt is risky. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 4 warning signs for Sociedad Química y Minera de Chile (of which 1 can't be ignored!) you should know about.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.