Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies Zimmer Biomet Holdings, Inc. (NYSE:ZBH) makes use of debt. But the real question is whether this debt is making the company risky.
When Is Debt Dangerous?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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. The first step when considering a company's debt levels is to consider its cash and debt together.
How Much Debt Does Zimmer Biomet Holdings Carry?
The image below, which you can click on for greater detail, shows that Zimmer Biomet Holdings had debt of US$7.52b at the end of September 2021, a reduction from US$8.31b over a year. However, it also had US$928.6m in cash, and so its net debt is US$6.59b.
How Strong Is Zimmer Biomet Holdings' Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Zimmer Biomet Holdings had liabilities of US$2.94b due within 12 months and liabilities of US$8.36b due beyond that. Offsetting these obligations, it had cash of US$928.6m as well as receivables valued at US$1.39b due within 12 months. So its liabilities total US$8.97b 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$26.8b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.
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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
Zimmer Biomet Holdings has a debt to EBITDA ratio of 2.8 and its EBIT covered its interest expense 6.2 times. Taken together this implies that, while we wouldn't want to see debt levels rise, we think it can handle its current leverage. Importantly, Zimmer Biomet Holdings grew its EBIT by 36% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Zimmer Biomet Holdings can strengthen its balance sheet over time. 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 it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Zimmer Biomet Holdings produced sturdy free cash flow equating to 75% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.
Zimmer Biomet Holdings's EBIT growth rate suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But truth be told we feel its net debt to EBITDA does undermine this impression a bit. It's also worth noting that Zimmer Biomet Holdings is in the Medical Equipment industry, which is often considered to be quite defensive. Zooming out, Zimmer Biomet Holdings seems to use debt quite reasonably; and that gets the nod from us. While debt does bring risk, when used wisely it can also bring a higher return on equity. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 3 warning signs for Zimmer Biomet Holdings that you should be aware of before investing here.
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
What are the risks and opportunities for Zimmer Biomet Holdings?
Earnings are forecast to grow 21.48% per year
Profit margins (4.1%) are lower than last year (11.7%)
Large one-off items impacting financial results
Has a high level of debt
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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.
Zimmer Biomet Holdings
Zimmer Biomet Holdings, Inc., together with its subsidiaries, operates in the musculoskeletal healthcare business in the Americas, Europe, the Middle East, Africa, and the Asia Pacific.
Adequate balance sheet with moderate growth potential.