Sociedad Química y Minera de Chile (NYSE:SQM) Could Easily Take On More Debt

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. We note that Sociedad Química y Minera de Chile S.A. (NYSE:SQM) does have debt on its balance sheet. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its 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?

As you can see below, Sociedad Química y Minera de Chile had US$2.62b of debt, at September 2022, which is about the same as the year before. You can click the chart for greater detail. But on the other hand it also has US$3.76b in cash, leading to a US$1.14b net cash position.

How Healthy 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$3.27b due within 12 months, and liabilities of US$2.33b due beyond 12 months. On the other hand, it had cash of US$3.76b and US$1.19b worth of receivables due within a year. So it has liabilities totalling US$652.8m more than its cash and near-term receivables, combined.

Of course, Sociedad Química y Minera de Chile has a titanic market capitalization of US$27.0b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. While it does have liabilities worth noting, Sociedad Química y Minera de Chile also has more cash than debt, so we're pretty confident it can manage its debt safely.

Even more impressive was the fact that Sociedad Química y Minera de Chile grew its EBIT by 684% over twelve months. 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 ultimately the future profitability of the business will decide if Sociedad Química y Minera de Chile can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs 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 47% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Summing Up

We could understand if investors are concerned about Sociedad Química y Minera de Chile's liabilities, but we can be reassured by the fact it has has net cash of US$1.14b. And it impressed us with its EBIT growth of 684% over the last year. 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. We've identified 2 warning signs with Sociedad Química y Minera de Chile (at least 1 which is a bit unpleasant) , and understanding them should be part of your investment process.

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.