2023-07-05 10:46:40 ET
Summary
- Intuitive Surgical is a leading player in the Medical Instruments & Supplies industry, specializing in advanced robotic systems that revolutionize minimally invasive surgeries.
- The company has a strong track record and is expected to maintain double-digit sales growth, capitalizing on the increasing use of surgical robots in various procedures.
- Despite the high stock valuation, recent developments and an upgraded financial outlook make Intuitive Surgical stock an attractive investment, particularly if bought during a market correction.
Introduction
In the past few weeks, we've discussed a wide range of healthcare companies. This included biotech, veterinarian health applications, diversified high-tech equipment, respiratory health, and so much more.
I'm not only doing this because I'm looking to significantly expand my healthcare exposure but also because I believe that healthcare is home to some of the best dividend growth and wealth compounder stocks on the planet.
While competition and innovation risks are always an issue, healthcare demand is often anti-cyclical. On top of that, healthcare is in desperate need of innovation due to an increasing number of issues like the obesity pandemic, an aging population, and a general deterioration in life expectancy.
Scientific American
In addition to that, we're dealing with a shortage of skilled labor in many nations, which further fuels the need to find cost and effort-saving measures.
That's where Intuitive Surgical Inc. ( ISRG ) , the star of this article, comes in.
The company is a fast-growing operator in the Medical Instruments & Supplies industry with a footprint in next-gen surgical equipment.
While it has a very high valuation, I wanted to shed some light on this company, as I believe it could be a fantastic buy on weakness, which is why I put the stock on my watchlist after writing this article.
So, let's get to it!
Buying Fast-Growing Healthcare
Intuitive Surgical is one of the company's who's products I was somewhat familiar with without knowing the company behind the products.
Essentially, with the risk of sounding a bit vague, the company's goal is to improve patient outcomes, enhance the patient experience, increase care team satisfaction, and lower the total cost of treatment per patient episode.
Intuitive Surgical, Inc.
Allow me to explain what this means.
Intuitive Surgical offers advanced robotic systems that enable precise and powerful minimally invasive procedures. Their flagship product, the da Vinci Surgical System, allows surgeons to perform a wide range of surgeries in various specialties.
Intuitive Surgical, Inc.
This system provides three-dimensional, high-definition vision, robotic assistance, and specialized instruments for precise dissection and reconstruction inside the body.
To put it differently, the company specializes in robots that help to perform surgeries with minimal harm to the body. This isn't just a major benefit for both doctors and patients, but it also reduces costs and labor demand. It fills a very important demand gap in modern healthcare.
In 2022, more than 1.8 million procedures were performed on da Vinci systems.
Intuitive Surgical, Inc.
Another system in its portfolio, the Ion endoluminal system, expands the company's offerings into diagnostic procedures, specifically minimally invasive biopsies in the lung, which is a big benefit when dealing with issues like lung cancer.
With this in mind, I came across a Bloomberg article that focused on promising investments for 3Q23. One of the expert picks was ISRG, based on the following reasoning:
The use of robots by surgeons is on the rise, to the point where it’s now the standard of care in prostatectomies and weight-loss procedures. With its Da Vinci surgical system, Intuitive is a prime beneficiary from this shift. BI’s scenario analysis points to an estimated 20% revenue growth in 2023 for the company, versus a consensus of 15%.
Furthermore, the analyst expects a big earnings beat in 2Q23 and a highly successful launch of a next-gen robotic system at some point in the second half of this year.
The overview below shows official revenue and EBITDA estimates, which show that the company is, indeed, expected to grow by 15% this year.
2018 | 2019 | 2020 | 2021 | 2022 | 2023E | 2024E | 2025E | |
Net sales | 3,724 | 4,479 | 4,358 | 5,710 | 6,222 | 7,147 | 8,126 | 9,205 |
EBITDA | 1,660 | 1,921 | 1,732 | 2,625 | 2,487 | 2,735 | 3,179 | 3,646 |
YY Net sales | 20.3% | -2.7% | 31.0% | 9.0% | 14.9% | 13.7% | 13.3% | |
YY EBITDA | 15.7% | -9.8% | 51.6% | -5.3% | 10.0% | 16.2% | 14.7% |
As the data above shows, the company is expected to maintain strong, double-digit sales growth, which is completely backed by strong secular growth for the company's highly innovative products.
During the first quarter earnings call , the company emphasized its success, as it mentioned that customer confidence in ISRG's products as a clinically and economically sustainable option for minimally invasive surgery has contributed to continued share gain from open surgery and laparoscopy in various procedures and countries.
In the first quarter, ISRG placed 312 da Vinci systems and 55 Ion systems worldwide, exceeding the numbers from the same period in the previous year.
Additionally, procedures per system per quarter increased by 13% compared to the previous year, indicating that systems are being utilized for more hours per operating day, and customers are opting for shorter duration procedures—a positive long-term sign for ISRG's business.
This means a strong secular trend continues to do very well. Not only did worldwide procedures grow by 15% per year between 2017 and 2022, that trend even accelerated to 18% growth in 2022. 2023 guidance is between 18% and 21%. Note that this guidance has been updated from 12% to 16%, as seen in the chart below.
Intuitive Surgical, Inc.
Looking at the drivers of last year's growth, we see that general surgery in the US has become a major segment with outperforming growth. The development of that segment in the past ten years is truly mind-blowing.
Intuitive Surgical, Inc.
Going back to 1Q23 (comments), ISRG achieved significant milestones in terms of new products and indications. The company obtained the CE Mark for Ion, enabling its launch in the UK as the first entry into the European region.
To scale up Ion, high-volume production lines were established in the company's Mexicali facility, resulting in a 50% increase in production volume compared to the previous quarter.
In the digital space, ISRG saw strong growth, with a 36% increase in the simulation subscription installed base and an 80% year-over-year growth in the utilization of the Intuitive Hub computing system during da Vinci cases.
In terms of new indications, ISRG received a 510(k) clearance in the United States for urology procedures using the da Vinci SP system, specifically for the treatment of advanced benign prostate hyperplasia through simple prostatectomy.
They also installed the first da Vinci SP system in Japan, with the successful completion of initial cases.
The company is now at a point where roughly 40% of its installed base is outside of the United States.
Furthermore, it needs to be said that almost 80% of the company's revenues are recurring. Not only is the company increasingly selling more high-tech equipment, but it also makes a lot of money from this increasing installed base. We also see an increase in recurring revenue as a share of total revenue, which could make revenue growth much less volatile and more predictable.
Intuitive Surgical, Inc.
With that said, let's see how shareholders benefit from this.
Shareholder Returns
ISRG has been a total beast.
Since 2001, shares have returned 26% per year, which has turned a $10,000 investment into $1.8 million. It may be one of the best performances I've ever seen.
Needless to say, we aren't dealing with a small company anymore. The company has a $116 billion market cap and a much more mature business model. Back in the early 2000s, it was a risky bet to buy a small niche player. Now, the bull case is a continuation of ongoing secular trends.
Over the past five years, the company has returned 16.5% per year. This outperformed the S&P 500 by roughly 430 basis points per year.
It also needs to be mentioned that the company does not pay a dividend. It does engage in buybacks, but these are rather small and mainly to offset stock-based compensation.
However, the company is increasingly generating cash.
Despite a capital expenditure surge of less than $400 million in 2021 to more than $850 million in 2023, the company is boosting free cash flow. In the next two years, free cash flow growth is expected to average 24% per year.
Leo Nelissen
Due to the absence of dividends and aggressive buybacks, the company's balance sheet is benefiting from this.
Last year, the company had $1.3 billion in net cash (more cash than gross debt). That number is expected to reach $6.5 billion in 2025 (assuming no M&A, major buybacks, etc.).
With that said, the stock has come down significantly between mid-2021 and mid-2022. This was caused by traders unwinding extremely bullish post-pandemic bets, triggered by higher rates and massive supply chain issues that hurt ISRG's margins.
The total sell-off was 50%. In general, ISRG is one of the most volatile stocks among fast-growing healthcare suppliers. For example, over the past five years, ISRG's standard deviation was 35%. The S&P 500's standard deviation was 24%. Danaher ( DHR ), which I own and cannot stop talking about, had a 24% standard deviation.
During the past five years, DHR outperformed ISRG by more than 300 basis points per year - mainly because of a less severe post-pandemic sell-off.
Supply chain issues are still somewhat of an issue. According to the company in 1Q23:
Some manufacturing and supply challenges this quarter negatively impacted our product margins. This is an opportunity for sharper execution going forward.
[...] The key area of focus for our Ion and manufacturing teams over the next 18 months is to improve supply stresses, strengthen manufacturing capabilities, lower our product costs.
Nonetheless, ISRG is back. The stock is 87% above its 52-week lows and up 27% year-to-date.
This surge is backed by great developments.
The company upgraded its financial outlook. It now sees at least 18% growth in procedures. That's up from 12%. The new 18% to 21% range considers factors such as the uncertainty surrounding COVID hospitalizations, the timing of the capital quota in China, macroeconomic challenges affecting hospitals and patient spending, and a potential moderation in procedures after the elevated levels observed in early 2023.
Also, as I already briefly mentioned, EBITDA is expected to reach $2.7 billion this year, which implies a 10% growth rate, followed by an expected growth rate of 16% in 2024.
This brings me to the valuation.
Valuation
This is the part I wasn't looking forward to. With high growth and great business models come high valuations. ISRG is trading at 35x 2024E EBITDA, which is by far the highest valuation I've discussed this year.
What's interesting is that this valuation is somewhat fair, considering the company's historical EBITDA multiple range. Prior to 2017, the company used to trade close to 20x EBITDA. Until the pandemic, that number rose to 40x. During the pandemic, the valuation exceeded 60x.
The problem with this valuation is that a lot of positive news has been priced in.
After the most recent rally, the stock is now trading above the consensus price target of $315. On my list, I do not see a single price target above the current price.
While I believe that ISRG will trade much higher ten years from now, I'm not willing to chase the price at these levels.
As much as I love the company's business and secular growth benefits, I own Danaher, which also comes with double-digit EBITDA growth potential, lower volatility, and a better valuation.
Hence, I feel no urge to jump into ISRG. At least not at these prices.
However, as I already explained, ISRG is now on my watchlist. If I get the chance to buy this stock below $300, I'm likely to consider buying it, as I truly believe that it's one of the best healthcare companies in the world.
Takeaway
In my search for healthcare investments with strong dividend growth and wealth compounder potential, I came across Intuitive Surgical, a leading player in the Medical Instruments & Supplies industry.
The company's advanced robotic systems, including the da Vinci Surgical System, revolutionize minimally invasive surgeries, benefiting patients, doctors, and healthcare costs.
With a strong track record and double-digit sales growth, Intuitive Surgical is poised to capitalize on the increasing use of surgical robots, becoming the standard of care in various procedures.
While the stock's valuation is high, recent developments and an upgraded financial outlook make it an attractive investment - although I'm hunting for a correction to potentially buy this stock on weakness.
For further details see:
Intuitive Surgical: Aggressive Wealth Compounding In Healthcare