Is Sociedad Quimica y Minera de Chile the Best Lithium Stock to Buy? 1 Analyst Thinks So

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Every day, Wall Street analysts upgrade some stocks, downgrade others, and "initiate coverage" on a few more. But do these analysts even know what they're talking about? Today, we're taking one high-profile Wall Street pick and putting it under the microscope...

With shares that have doubled over the past year, Chilean lithium miner Sociedad Quimica y Minera de Chile S.A. (NYSE: SQM) is one of the hottest stocks on the market today. But with a forward price-to-earnings ratio of 30, it's arguably also one of the most expensive lithium stocks you could own. And yet, according to one brave Wall Street analyst, Sociedad Quimica y Minera -- usually abbreviated SQM for short -- just might be the best lithium stock to own.

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Here are three things you need to know about that.

1. SQM stock does not look cheap

Shares of SQM do not look cheap when valued by traditional metrics. With $341 million in trailing earnings and a market capitalization of $13.7 billion, SQM stock sells for more than 40 times trailing earnings and 30 times forward earnings.

Compare that to other leading stocks in the lithium industry -- Albemarle Corporation (NYSE: ALB) for example, which costs less than 25 times forward earnings, or FMC Corporation (NYSE: FMC), which costs less than 18 times forward estimates -- and SQM stock doesn't look like much of a bargain.

But looks can be deceiving.

2. Comparing and contrasting chemicals

One thing that makes some investors hesitant to buy SQM stock, according to the analysts at Bank of America's Merrill Lynch brokerage unit, may be the worry that SQM's other, non-lithium divisions are holding SQM back. According to data provided by S&P Global Market Intelligence, SQM's "lithium and lithium derivatives" business earns gross profit margins of better than 38%. But SQM's two potassium-focused businesses -- "specialty plant nutrition" and "potassium chloride and potassium sulfate" -- gross barely 13% between them, and are barely a third as profitable as the lithium biz. SQM's "iodine and iodine derivatives" business does even worse, grossing just 7.5% in profits from every revenue dollar it collects.

That may explain why as a whole, SQM generates gross profit margins of only 34.5% from its several businesses, lagging the 35.8% gross margin at Albemarle and the 36.5% gross margin at FMC. And yet, in a note covered on (requires subscription) this morning, Merrill Lynch describes how it believes SQM is working to grow the profit margins at its non-lithium businesses so that they will at least "approac[h]" the profit margins SQM earns from lithium.

3. What to expect out of SQM stock

Such an accomplishment, Merrill believes, could help to grow SQM's profits significantly in coming years. Combined with a program to expand lithium production that the analyst says is "on track," Merrill Lynch believes that Sociedad Quimica stock could earn as much as $1.69 per share this year, $2.02 per share next year, and $2.20 in fiscal 2019.

What it means to investors

It's worth pointing out that these optimistic numbers are far beyond what the rest of Wall Street is predicting for SQM. According to S&P Global data, the average estimate for SQM earnings in the above years are currently just $1.58 per share this year, $1.75 next year, and $1.86 per share in 2019. Yet even so, over the long term, analysts following SQM stock are predicting the company will grow earnings at a compounded annual rate of nearly 32.5% over the next five years.

And now Merrill Lynch is saying the company could do even better than that.

As the lowest-cost producer of lithium in the world, Merrill believes SQM is well-positioned to supply a world that's only getting hungrier for lithium metal to power its electric cars. I now tend to agree.

In addition to ramping lithium production enough to impress Merrill Lynch, you see, and growing the profits that come from that, I notice that over the past 12 months, SQM has also done a great job of ramping up its cash production. S&P Global data show that, over the past year, SQM generated positive free cash flow of nearly $560 million -- 64% more cash profit than its income statement reflects. With so much cash flowing into the business, Sociedad Quimica boasts an admirably modest debt load for its size -- just $357 million net of cash.

And at a valuation of 24.5 times free cash flow, and an estimated growth rate of 32.5%, I think SQM stock just might be cheap enough to buy.

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Rich Smith has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.