Zimmer Biomet Holdings (NYSE:ZBH) Seems To Use Debt Quite Sensibly

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.' 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. We can see that Zimmer Biomet Holdings, Inc. (NYSE:ZBH) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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. 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.

Check out our latest analysis for Zimmer Biomet Holdings

How Much Debt Does Zimmer Biomet Holdings Carry?

The chart below, which you can click on for greater detail, shows that Zimmer Biomet Holdings had US$6.03b in debt in June 2024; about the same as the year before. However, because it has a cash reserve of US$420.1m, its net debt is less, at about US$5.61b.

How Strong Is Zimmer Biomet Holdings' Balance Sheet?

The latest balance sheet data shows that Zimmer Biomet Holdings had liabilities of US$3.61b due within a year, and liabilities of US$5.16b falling due after that. Offsetting this, it had US$420.1m in cash and US$1.42b in receivables that were due within 12 months. So it has liabilities totalling US$6.93b more than its cash and near-term receivables, combined.

Zimmer Biomet Holdings has a very large market capitalization of US$23.4b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. 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). 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).

With a debt to EBITDA ratio of 2.2, Zimmer Biomet Holdings uses debt artfully but responsibly. And the fact that its trailing twelve months of EBIT was 7.7 times its interest expenses harmonizes with that theme. If Zimmer Biomet Holdings can keep growing EBIT at last year's rate of 10% over the last year, then it will find its debt load easier to manage. 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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of that EBIT is backed by free cash flow. Over the most recent three years, Zimmer Biomet Holdings recorded free cash flow worth 59% 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

We feel that Zimmer Biomet Holdings's solid conversion of EBIT to free cash flow was really heart warming, like a mid-winter fair trade hot chocolate in a tasteful alpine chalet. And its apparent ability to to cover its interest expense with its EBIT is also rather rousing! 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. 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.

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.