David Iben said it well when he said: “Volatility is not a risk that interests us. What matters to us is to avoid the permanent loss of capital. It’s natural to consider a company’s balance sheet when looking at its riskiness, as debt is often involved when a company fails. We notice that Sociedad Chemical and Minera de Chile SA (NYSE:SQM) has debt on its balance sheet. But the real question is whether this debt makes the business risky.
What risk does debt carry?
Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, it exists at their mercy. Ultimately, if the company cannot meet its legal debt repayment obligations, shareholders could walk away with nothing. However, a more frequent (but still costly) event is when a company has to issue shares at bargain prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, many companies use debt to finance their growth, without any negative consequences. The first step when considering a company’s debt levels is to consider its cash and debt together.
Check out our latest analysis for Sociedad Química y Minera de Chile
What is the net debt of Sociedad Química y Minera de Chile?
As you can see below, at the end of September 2021, the Sociedad Química y Minera de Chile had a debt of 2.63 billion dollars, compared to 1.92 billion dollars a year ago. Click on the image for more details. However, he also had $2.61 billion in cash, so his net debt is $22.9 million.
A look at the liabilities of Sociedad Química y Minera de Chile
Zooming in on the latest balance sheet data, we can see that Sociedad Química y Minera de Chile had liabilities of US$622.7 million due within 12 months and liabilities of US$2.87 billion due beyond. On the other hand, it had a cash position of 2.61 billion dollars and 649.9 million dollars of receivables at less than one year. Thus, its liabilities outweigh the sum of its cash and receivables (current) by $228.0 million.
This state of affairs indicates that the balance sheet of the Sociedad Química y Minera de Chile seems quite solid, since its total liabilities are approximately equal to its liquid assets. So while it’s hard to imagine the US$15.5 billion company struggling for cash, we still think it’s worth keeping an eye on its balance sheet. Anyway, Sociedad Química y Minera de Chile has almost no net debt, so it’s fair to say that it is not very indebted!
In order to assess a company’s debt relative to its earnings, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its earnings before interest and taxes (EBIT) divided by its expenses. interest (its interest coverage). The advantage of this approach is that we consider both the absolute amount of debt (with net debt to EBITDA) and the actual interest expense associated with that debt (with its interest coverage ratio ).
Sociedad Química y Minera de Chile has a very modest net debt, resulting in a debt/EBITDA ratio of 0.03. And EBIT easily covered interest expense 7.6 times, which reinforces this view. On top of that, we are pleased to report that Sociedad Química y Minera de Chile increased its EBIT by 47%, reducing the specter of future debt repayments. When analyzing debt levels, the balance sheet is the obvious starting point. But it is future earnings, more than anything, that will determine the ability of Sociedad Química y Minera de Chile to maintain a healthy balance sheet in the future. So if you are focused on the future, you can check out this free report showing analyst earnings forecast.
Finally, while the taxman may love accounting profits, lenders only accept cash. We must therefore clearly examine whether this EBIT generates a corresponding free cash flow. Over the past three years, Sociedad Química y Minera de Chile has created free cash flow amounting to 7.4% of its EBIT, a performance without interest. For us, such a low cash conversion creates a bit of paranoia about the ability to extinguish the debt.
Our point of view
The good news is that Sociedad Química y Minera de Chile’s demonstrated ability to increase EBIT delights us like a fluffy puppy does a toddler. But we have to admit that we see that converting it from EBIT to free cash flow has the opposite effect. Given all this data, it seems to us that Sociedad Química y Minera de Chile is taking a pretty sensible approach to debt. This means they take on a bit more risk, hoping to increase shareholder returns. When analyzing debt levels, the balance sheet is the obvious starting point. However, not all investment risks reside on the balance sheet, far from it. These risks can be difficult to spot. Every business has them, and we’ve spotted 1 warning sign for Sociedad Química y Minera de Chile you should know.
In the end, it’s often best to focus on companies that aren’t in debt. You can access our special list of these companies (all with a track record of earnings growth). It’s free.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.