Here's Why Zimmer Biomet Holdings (NYSE:ZBH) Can Manage Its Debt Responsibly

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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. We note that Zimmer Biomet Holdings, Inc. (NYSE:ZBH) does have debt on its balance sheet. 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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Zimmer Biomet Holdings

What Is Zimmer Biomet Holdings's Debt?

As you can see below, Zimmer Biomet Holdings had US$5.70b of debt, at September 2023, which is about the same as the year before. You can click the chart for greater detail. However, it does have US$292.1m in cash offsetting this, leading to net debt of about US$5.41b.

A Look At Zimmer Biomet Holdings' Liabilities

According to the last reported balance sheet, Zimmer Biomet Holdings had liabilities of US$2.07b due within 12 months, and liabilities of US$6.63b due beyond 12 months. Offsetting this, it had US$292.1m in cash and US$1.34b in receivables that were due within 12 months. So its liabilities total US$7.07b more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Zimmer Biomet Holdings has a huge market capitalization of US$24.8b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Zimmer Biomet Holdings's net debt of 2.3 times EBITDA suggests graceful use of debt. And the alluring interest cover (EBIT of 7.5 times interest expense) certainly does not do anything to dispel this impression. If Zimmer Biomet Holdings can keep growing EBIT at last year's rate of 12% over the last year, then it will find its debt load easier to manage. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Zimmer Biomet Holdings's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we always check how much of that EBIT is translated into free cash flow. Over the most recent three years, Zimmer Biomet Holdings recorded free cash flow worth 66% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

The good news is that Zimmer Biomet Holdings's demonstrated ability to convert EBIT to free cash flow delights us like a fluffy puppy does a toddler. And its EBIT growth rate is good too. We would also note that Medical Equipment industry companies like Zimmer Biomet Holdings commonly do use debt without problems. Looking at all the aforementioned factors together, it strikes us that Zimmer Biomet Holdings can handle its debt fairly comfortably. Of course, while this leverage can enhance returns on equity, it does bring more risk, so it's worth keeping an eye on this one. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For example - Zimmer Biomet Holdings has 2 warning signs we think you should be aware of.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.