These 4 Measures Indicate That Zimmer Biomet Holdings (NYSE:ZBH) Is Using Debt Reasonably Well

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. We can see that Zimmer Biomet Holdings, Inc. (NYSE:ZBH) does use debt in its business. But the more important question is: how much risk is that debt creating?

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. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Zimmer Biomet Holdings

What Is Zimmer Biomet Holdings's Net Debt?

As you can see below, at the end of September 2024, Zimmer Biomet Holdings had US$6.64b of debt, up from US$5.70b a year ago. Click the image for more detail. On the flip side, it has US$569.0m in cash leading to net debt of about US$6.07b.

A Look At Zimmer Biomet Holdings' Liabilities

According to the last reported balance sheet, Zimmer Biomet Holdings had liabilities of US$3.57b due within 12 months, and liabilities of US$5.77b due beyond 12 months. Offsetting this, it had US$569.0m in cash and US$1.48b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$7.29b.

Zimmer Biomet Holdings has a very large market capitalization of US$20.2b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Zimmer Biomet Holdings's net debt of 2.4 times EBITDA suggests graceful use of debt. And the alluring interest cover (EBIT of 7.7 times interest expense) certainly does not do anything to dispel this impression. One way Zimmer Biomet Holdings could vanquish its debt would be if it stops borrowing more but continues to grow EBIT at around 11%, as it did over the last year. 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're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs 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 59% 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

On this analysis, Zimmer Biomet Holdings's conversion of EBIT to free cash flow was a real positive, just like an unsolicited gift of cupcakes from a work colleague. And its interest cover should also leave shareholders feeling frolicsome. It's also worth noting that Zimmer Biomet Holdings is in the Medical Equipment industry, which is often considered to be quite defensive. All these things considered, it appears that Zimmer Biomet Holdings can comfortably handle its current debt levels. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it's worth monitoring the balance sheet. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Zimmer Biomet Holdings is showing 2 warning signs in our investment analysis , you should know about...

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.