Sociedad Química y Minera de Chile

Moat: 3/5

Understandability: 3/5

Balance Sheet Health: 4/5

A global producer of lithium, potassium, and specialty plant nutrients, SQM’s operations are primarily located in Chile, with additional operations in China and Australia. They are a vertically integrated producer of lithium and other lithium derivative products.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview:

  • Revenues Distribution: SQM operates through several business segments. This includes lithium and its derivatives, specialty plant nutrition, iodine and its derivatives, potassium, and industrial chemicals.
  • Lithium Lithium and lithium derivatives account for a significant portion of SQM’s revenues due to growing demand from electric vehicles.
  • Potassium: SQM produces potassium chloride and potassium nitrate, primarily used in agriculture as fertilizers.
  • Specialty Plant Nutrition (SPN): This segment includes water-soluble fertilizers and nitrates used in specialized agricultural applications.
  • Iodine and Derivatives: SQM is the world’s largest producer of iodine, which is used in pharmaceutical, industrial, and electronic applications.
  • Industrial Chemicals: The industrial chemicals segment focuses on production and sales of sodium nitrate, sodium chloride, and sodium sulfate.
  • Global Operations: While operations are primarily in Chile, SQM also has operations and sales in Asia, Europe, North America, and other parts of the world. They also have lithium resources in Australia.

The geographic split of revenues as of 2023 was 33% in Asia and other, 29% in North America, 23% in South America and 15% in Europe. The demand growth for the EV market is primarily responsible for this geographic revenue split.

Industry Trends:

  • Lithium Market: The lithium market is experiencing explosive growth due to the increasing adoption of electric vehicles. This growth has made the lithium market increasingly critical for supply chains. The lithium market is a very concentrated market where supply may not keep up with the demand.
  • Potassium Market: The potassium market benefits from long-term demand growth stemming from food consumption and is a stable market for fertilizers.
  • Iodine Market: The iodine market, while not as high growth as lithium, is still relatively reliable because of its use cases in pharmaceuticals and industrial applications.

Competitive Landscape:

  • Lithium: The lithium market is oligopolistic, with a few large players dominating the market. This creates considerable pricing power for producers.
  • Potassium: The potassium market is also dominated by a limited number of players. SQM has good market share but faces strong competition from other large producers.
  • Iodine: In the iodine market, SQM dominates globally and has the most efficient production facilities.
  • Competitive Advantage: SQM is one of the lowest-cost producers of lithium and potassium, they also benefit from their large resources, having low-cost brine deposits in Atacama desert. They also have high-quality specialty plant nutrient products that are differentiated by their high quality and purity, that makes it hard to copy their products. However, the competition is quite strong and price wars may cut into their profitability.

Financial Analysis:

  • Revenue Growth: Revenue growth has been impressive over the past few years due to significant price increases in the lithium market. Revenue from speciality plant nutrition has grown also.
  • Gross Margins: Gross margins have fluctuated. The margins have improved due to higher prices, particularly in the lithium and specialty plant nutrition segments.

Financials - Latest Data: SQM’s latest Q3 2023 report reveals: * Net income of US$580.2 million, an 8% increase versus Q3 2022. * Revenues for the 9 months ending 30th September was up 4% at US$6.9 billion. * Lithium and derivatives volume was up by 17% year-on-year. * Prices are still high, but there are some signs they may have peaked.

  • Gross profit was US$3546.5 million, or an increase of 11%, mainly due to increased prices for lithium, and potassium.

  • Net financial income was $131.2 million, compared with US$456.3 million in the first nine months of 2021, mainly attributable to lower debt and the absence of major currency gains.

  • Profitability: Profitability of SQM is affected by price fluctuations in commodity markets, particularly for lithium, iodine, and potassium.
  • Debt: Debt levels are relatively reasonable, allowing the company to pursue expansion without undue financial strain. At the end of 2022 SQM’s debt was 10.1 billion, and at the end of Q3 2023 debt was 11.3 billion.
  • Cash: The company generates a significant amount of cash from operations, although capital expenditures related to expansion will cut into it. In Q3 2023 it generated 4.15 billion in operating cash flow, in total the company has 3.13 billion in cash or cash equivalents in the balance sheet.

Latest Concerns: * A new Lithium strategy announced by Chilean government in April 2023 may have an effect on SQM’s business. * There are ongoing litigation claims against the company that may impact its finances. * Some analysts suggest that lithium prices have peaked and might fall significantly, which will affect their profitability.

Moat Rating: 3/5

  • Sources of Moat:
    • Cost Advantages: SQM enjoys a strong cost advantage due to its access to low-cost brine deposits in Chile.
    • Regulatory Moats: The regulatory barriers to enter the lithium space provide strong barriers to entry.
    • Brand: There is a high level of customer loyalty and strong brand recognition in specialty plant nutrition and iodine.
  • Limitations of Moat:
    • The competitive landscape in both lithium and potassium is fierce, with multiple large players with access to large resources.
    • Prices for Lithium and Iodine are volatile, so demand and profitability is dependent on external market conditions.
    • Governments and regulatory bodies in various countries can easily hinder the companies future progress.

Risks to the Moat and Business Resilience:

  • Commodity Price Volatility: The company’s profits are heavily influenced by commodity price fluctuations, especially in lithium. A sharp decline in prices would cause a reduction in profitability and decrease value creation for shareholders.
  • Regulatory Risks: Operating in multiple countries exposes SQM to various regulatory risks that could harm operations.
  • Political Risks: Instability in the home country Chile could drastically effect the financial performance and operations.
    • The Chilean government and SQM have agreed to continue talks until the 2024 Chilean Presidential elections. What new deal is struck depends on the direction the country takes politically.
    • The new lithium policy by the Chilean government might severely impact their operations.
  • Environmental Concerns: Lithium extraction has come under increased scrutiny regarding its ecological impact. New regulations, rising costs to comply with environmental law, or damage to the company reputation might all have negative financial implications.
    • In particular, the Atacama desert has been under scrutiny for its ecological impact and concerns by indigenous peoples.
    • The company faces scrutiny regarding its water usage, particularly from a water-scarce region.
  • Operational Risk: While the company has operations in Chile, Australia, and other parts of the world, some of their operations have been under scrutiny from investors due to their low operational efficiency and sustainability.

Understandability: 3/5

  • While SQM is primarily a commodity-based company, its revenue streams and operations are slightly complicated. The company needs considerable understanding of the specific chemical process, the commodity market dynamics and financial statements. However, as long as the company’s businesses are understood within their own context, it is not too complicated to understand.

Balance Sheet Health: 4/5

  • Debt Levels: Relatively stable debt levels are offset by the companies’ operating revenues. They still have plenty of cash to meet short and long-term liabilities.
  • Cash Flows: The company has consistently generated a high free cash flow from operations which allows it to meet liabilities and make significant investments.
  • Assets: Although the company owns large quantities of minerals, which can be considered an asset, they are dependent on the market conditions and do carry some risks, due to geopolitical factors. The total value of the assets are highly correlated with commodity prices. Overall the balance sheet is healthy but there is considerable risk that it might get impaired by unforeseen events like regulation or commodity price drop.

Overall Summary:

SQM is a large commodity company that is seeing massive interest due to lithium demand for EV. The company has a good moat due to their access to low-cost resources, technology and regulatory advantages. However, there are also significant headwinds due to risks related to industry volatility, political instability and other external factors. The financial performance of the company is very dependent on external commodity prices and may cause their stock price to have volatile behavior. If investors understand and take into account this risks, SQM might be an investment to consider.