Is Zimmer Biomet Holdings (NYSE:ZBH) A Risky Investment?

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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, Zimmer Biomet Holdings, Inc. (NYSE:ZBH) does carry debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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.

Check out the opportunities and risks within the US Medical Equipment industry.

What Is Zimmer Biomet Holdings's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Zimmer Biomet Holdings had US$6.15b of debt in June 2022, down from US$7.87b, one year before. However, it does have US$427.5m in cash offsetting this, leading to net debt of about US$5.73b.

How Healthy 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$2.46b due within 12 months and liabilities of US$6.86b due beyond that. Offsetting this, it had US$427.5m in cash and US$1.28b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$7.62b.

While this might seem like a lot, it is not so bad since Zimmer Biomet Holdings has a huge market capitalization of US$22.7b, 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.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its 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 2.4 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. Importantly Zimmer Biomet Holdings's EBIT was essentially flat over the last twelve months. We would prefer to see some earnings growth, because that always helps diminish debt. There's no doubt that we learn most about debt from the balance sheet. 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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Zimmer Biomet Holdings produced sturdy free cash flow equating to 80% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

Happily, Zimmer Biomet Holdings's impressive conversion of EBIT to free cash flow implies it has the upper hand on its debt. And we also thought its interest cover was a positive. We would also note that Medical Equipment industry companies like Zimmer Biomet Holdings commonly do use debt without problems. All these things considered, it appears that Zimmer Biomet Holdings can comfortably handle its current debt levels. 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. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. We've identified 3 warning signs with Zimmer Biomet Holdings , and understanding them should be part of your investment process.

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.

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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.