ISRG - Intuitive Surgical: Plunged 20% To August Lows - Why I'm Still Not Convinced

2023-09-14 09:00:00 ET

Summary

• Intuitive Surgical investors suffered a steep decline recently, even as Intuitive posted solid quarterly results but provided less robust guidance. As such, it left little room for disappointment.
• Concerns about China's tepid economic recovery and the impact on Intuitive's international growth momentum likely affected investors' sentiment.
• The recent worries about the impact from diabetic drugs on its weight loss procedures could have spooked the market further. Investors need to assess whether the impact could be structural.
• With ISRG priced at a steep growth premium, investors need to brace for more pain. Quant's "F" valuation grade underscores the need to execute exceptionally well.
• I argue why, while ISRG's August lows look robust, sellers rejected further upside recently. As such, a re-test of its August lows cannot be ruled out.

Intuitive Surgical, Inc. ( ISRG ) investors experienced a steep decline in July 2023 as the company reported its second-quarter or FQ2 earnings release . Given its overvaluation, ISRG fell steeply even though the company posted a solid release, corroborating the improvement in procedure volume and leasing momentum undergirding its growth.

I had cautioned investors about the possibility of a steep decline if they continued chasing ISRG's uptrend bias. Accordingly, ISRG collapsed more than 20% from its July highs to late August lows. As such, ISRG briefly entered a bear market before buyers returned aggressively, with ISRG's price action indicating a validated bear trap (false downside breakdown). The extent of the selloff was significant, as buyers gave up nearly three months of gains in five weeks. Therefore, the capitulation leading to seller exhaustion preceding the bear trap didn't surprise me.

Hence, I believe it's apt for me to reassess whether the buying opportunity on ISRG makes sense now, notwithstanding the headwinds in China and on bariatric procedures. China's tepid economic recovery has caused concerns about Intuitive's ability to extend its international growth momentum, as US growth is expected to normalize from the second half of 2023. Accordingly, Intuitive's updated midpoint guidance of 21% procedure growth for the full year suggests an 18% midpoint growth for the second half. As such, it's way below the 26% and 22% growth Intuitive delivered in Q1 and Q2, respectively.

Furthermore, the ongoing anti-corruption drive could hinder Intuitive's China growth recovery momentum, which could delay capital placements. In addition, the significant interest and growth seen in the diabetic drugs used for weight loss treatments could affect procedure volume in the short term. As such, the company anticipates a short-term impact on its weight loss procedures, as Novo Nordisk ( NVO ) and Eli Lilly ( LLY ) saw their stock surge, leading their healthcare peers. Hence, I assessed that investors are evaluating whether there could be a longer-term structural impact on its bariatric procedures, leading to possible downward revisions in its growth estimates.

Makes sense? I think so. Note that analysts' estimates on Intuitive suggest robust growth metrics, which behooves the company to execute well. Accordingly, Intuitive is projected to deliver a revenue CAGR of 14.2% from FY22-25. Analysts also expect Intuitive to post an adjusted EBIT CAGR of 15.7% over the same period. Seeking Alpha Quant's "B" growth grade underscores its growth stock profile, corroborating my observation.

However, its "F" valuation grade (the worst possible) suggests the market likely isn't interested in hearing about "headwinds," as ISRG is priced at a significant premium (relative to peers). I concur that its wide economic moat competitive advantage in robotic-assisted surgery demands a premium valuation. However, as the surge through ISRG's July highs brought its valuation toward the overvaluation zone, buyers who chased it weren't leaving any buffer for disappointment.

Accordingly, ISRG's forward EBITDA multiple has fallen closer to its 10Y average. It last traded at a forward EBITDA multiple of 32.9x, above its 10Y average of 30x. However, it has dropped markedly from the 40x it reached in July 2023 as sellers normalized its growth premium.

As seen above, ISRG buyers returned aggressively and staged an astute bear trap at its August lows ($280 level). However, the recovery attempt was rejected at its August highs ($320 level) and looks likely to be in the near-term resistance zone.

Therefore, I urge buyers to give ISRG buyers time to prove their conviction before returning, as ISRG isn't priced at a discount. I'm keen to assess a possible re-test of its August lows and determine the robustness of its previous bear trap. If that level doesn't hold, more pain could be in store as the market normalizes ISRG's growth premium further before a more robust bottom can be ascertained.

As such, staying on the sidelines and watching how this battle unfolds is the appropriate strategy.

Rating: Maintain Hold. Please note that a Hold rating is equivalent to a Neutral or Market Perform rating.

Important note: Investors are reminded to do their due diligence and not rely on the information provided as financial advice. Please always apply independent thinking and note that the rating is not intended to time a specific entry/exit at the point of writing unless otherwise specified.

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