We Think Sociedad Química y Minera de Chile (NYSE:SQM) Can Stay On Top Of Its Debt

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, Sociedad Química y Minera de Chile S.A. (NYSE:SQM) does carry debt. But is this debt a concern to shareholders?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Sociedad Química y Minera de Chile

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

You can click the graphic below for the historical numbers, but it shows that as of June 2022 Sociedad Química y Minera de Chile had US$2.61b of debt, an increase on US$1.94b, over one year. On the flip side, it has US$2.58b in cash leading to net debt of about US$32.9m.

A Look At Sociedad Química y Minera de Chile's Liabilities

The latest balance sheet data shows that Sociedad Química y Minera de Chile had liabilities of US$3.39b due within a year, and liabilities of US$2.32b falling due after that. On the other hand, it had cash of US$2.58b and US$1.53b worth of receivables due within a year. So its liabilities total US$1.60b more than the combination of its cash and short-term receivables.

Given Sociedad Química y Minera de Chile has a humongous market capitalization of US$26.8b, 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. Carrying virtually no net debt, Sociedad Química y Minera de Chile has a very light debt load indeed.

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.

With debt at a measly 0.01 times EBITDA and EBIT covering interest a whopping 39.0 times, it's clear that Sociedad Química y Minera de Chile is not a desperate borrower. So relative to past earnings, the debt load seems trivial. Better yet, Sociedad Química y Minera de Chile grew its EBIT by 562% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. 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 we always check how much of that EBIT is translated into 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. 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. 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. For example, we've discovered 3 warning signs for Sociedad Química y Minera de Chile (2 are concerning!) that you should be aware of before investing here.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.