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Does Zimmer Biomet Holdings (NYSE:ZBH) Have A Healthy Balance Sheet?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that Zimmer Biomet Holdings, Inc. (NYSE:ZBH) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. When we examine debt levels, we first consider both cash and debt levels, together.

What Is Zimmer Biomet Holdings's Debt?

As you can see below, Zimmer Biomet Holdings had US$7.52b of debt at September 2021, down from US$8.31b a year prior. However, it also had US$928.6m in cash, and so its net debt is US$6.59b.

debt-equity-history-analysis
NYSE:ZBH Debt to Equity History November 25th 2021

How Strong Is Zimmer Biomet Holdings' Balance Sheet?

We can see from the most recent balance sheet that Zimmer Biomet Holdings had liabilities of US$2.94b falling due within a year, and liabilities of US$8.36b due beyond that. Offsetting this, it had US$928.6m in cash and US$1.39b in receivables that were due within 12 months. So it has liabilities totalling US$8.97b more than its cash and near-term receivables, combined.

This deficit isn't so bad because Zimmer Biomet Holdings is worth a massive US$27.2b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.

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 debt is 2.8 times its EBITDA, and its EBIT cover its interest expense 6.2 times over. Taken together this implies that, while we wouldn't want to see debt levels rise, we think it can handle its current leverage. It is well worth noting that Zimmer Biomet Holdings's EBIT shot up like bamboo after rain, gaining 36% in the last twelve months. That'll make it easier to manage its 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, 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. 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 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 grow its EBIT delights us like a fluffy puppy does a toddler. 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. Looking at the bigger picture, we think Zimmer Biomet Holdings's use of debt seems quite reasonable and we're not concerned about it. After all, sensible leverage can boost returns on equity. When analysing debt levels, the balance sheet is the obvious place to start. 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.

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.

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

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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