2023-11-21 02:27:26 ET
Summary
- Intuitive Surgical's Da Vinci Surgical Systems excel in performing precise and accurate surgeries, contributing to shorter patient recovery times.
- The market for medical robots is projected to expand with a CAGR of 17%, positioning Intuitive Surgical in a robust growth market.
- Intuitive Surgical faces competition from Medtronic's Hugo Surgical System and Johnson & Johnson's Verb Surgical, which may impact its gross profit margin and growth trajectory.
- However, the stock valuation has not yet been adjusted for new competitive threats.
Intuitive Surgical (ISRG) captivates me due to its precise robot-assisted Da Vinci surgical masterpiece. These excel in performing challenging and time-consuming surgical procedures with exceptional accuracy.
The Da Vinci Surgical Systems are robot-assisting systems in which Intuitive Surgical previously held a robust monopoly. What fascinates me is that they facilitate minimally invasive surgery through a console that controls the robot arm, enabling highly accurate operations compared to laparoscopic surgery. The Da Vinci is used in surgical procedures such as prostatectomies and hysterectomies. The advantage is that these precision surgeries contribute to shorter patient recovery times.
The need for precise invasive surgery will increase in the coming years and Intuitive Surgical is well positioned in this market. However, the initial investment of a Da Vinci system is substantial, around $2 million per system, with additional annual service costs. The annual service costs include a technical learning environment, practice setting, peer-to-peer education, program implementation, and more. For Intuitive Surgical, the annual service costs ensure a stable income stream, providing certainty to further innovate its Da Vinci systems.
I see many positives for investing in Intuitive Surgical, the market is expected to grow strongly in the coming years and the annual service fees ensure investors that the company has a stable revenue stream. However, other companies have developed a similar system that could destroy its monopoly position. The stock price is still not adjusted for this risk, and the rich valuation keeps me from making an investment.
The Competitive Landscape of Invasive Surgical Systems
The first surgical robot, developed by Victor Scheinman in 1985 and named PUMA 560, was utilized to inject a needle into a human brain for a biopsy. Such a biopsy posed significant risks when performed manually. Since then, the market for surgical robots has expanded rapidly. Now, advanced surgical robots are used in procedures such as prostate cancer surgery, hysterectomy, laparoscopy, and more.
Intuitive Surgical released its first Da Vinci Surgical Robot 23 years ago and has now facilitated more than 13 million procedures . Over the years, the company has built up a strong monopoly position, but now other competitors have introduced similar systems to the market.
Medtronic ( MDT ) has introduced an invasive surgical system called the Hugo Surgical System. The Hugo Surgical System comprises one or more arms and a console for surgeon interaction. Each arm can be independently moved to the desired position by rolling the console. Because each arm is placed on rolling consoles, which in my opinion makes it more sensitive to vibration and movement. Console stability is important for performing safe invasive surgeries. Therefore, I think the Da Vinci robots provide a more stable and solid solution compared to the Hugo Surgical System.
The Da Vinci Surgical system, in contrast, features multiple arms mounted on only one console. The Da Vinci robots consist of a more stable construction capable of performing precise invasive surgeries.
It took a long time to develop but in October 2022, the Hugo Surgical System received its first approvals from CE in Europe, MHLW in Japan, and Health Canada. It now has become a direct competitor to the Da Vinci Surgical Systems.
And there is another competitor on the horizon. About three years ago, Johnson & Johnson ( JNJ ) acquired Verb Surgical, Verb develops similar invasive surgical robots such as the Da Vinci robots. Verb developed the robot in collaboration with Verily, which is backed by Alphabet. ( GOOGL )( GOOG ). Due to the enormous capital that Alphabet makes accessible, I see Verb Surgical as a major competitor in the coming years. Their surgical robots are currently still in development, but once approved, Intuitive Surgical will face significant headwinds.
Global Presence, and Financial Strength
Intuitive Surgical's Product Range (3Q23 Investor Presentation)
Intuitive Surgical has had approval for urological operations using Da Vinci Surgical robots since the year 2000. Currently, there are over 8285 Da Vinci Surgical robots installed worldwide, with over half situated in the US, and Europe and Asia are emerging markets. The installed systems grew strongly at a Compound Annual Growth Rate ((CAGR)) of 11%. Intuitive Surgical is still growing steadily as the number of installed systems increased by 12% in 2022. The demand for invasive robotic surgery is significant and a total of more than 13 million procedures are performed on all da Vinci systems. The demand is still intact as the medical robot market is expected to expand at a CAGR of 16.6%.
The current lineup of surgical robots includes Da Vinci SP, Da Vinci Xi, and the Ion system. A Da Vinci surgical system costs between $0.5 million and $2.5 million, and the instrument costs per procedure range from $600 to $3500. The annual recurring costs consist of service fees, approximately $80,000 to $190,000 per Da Vinci Surgical system. This represents a sound and secure revenue model, as more than 79% of the revenue is recurring.
Intuitive Surgical's Recurring Revenue Model (3Q23 Investor Presentation)
The third-quarter results were favorable, with a 12% Y/Y increase in revenue and an improved gross margin of 68.8%. Analysts hold a positive outlook , anticipating annual revenue growth in the low double digits, and earnings per share ((EPS)) growth in the high double digits. What further impresses me is that Intuitive Surgical maintains a debt-free balance sheet, rendering it immune to interest rates and providing over $6.5 billion in capital for potential acquisitions or share buybacks. With a robust free cash flow margin exceeding 18% and a substantial cash reserve, I believe the company should consider returning a portion to shareholders, a practice it has intermittently embraced. In 2022, it repurchased over $2.6 billion in shares, though this year's figure stands at a more modest $350 million.
A Rich Valuation
The next consideration before initiating an investment is stock valuation. Comparing this is challenging due to a limited number of competitors. Medtronic is a major contender, but its broader range of medical instruments complicates the comparison. The same holds true for Johnson & Johnson. Intuitive Surgical, with a forward P/E ratio of 47, is notably more expensive than Medtronic (forward P/E ratio = 13.7). However, this comes with substantial revenue and profit growth. Analysts anticipate an EPS growth of 16% for Intuitive Surgical in 2024, while for Medtronic, it is only 6.7%. Additionally, Intuitive Surgical has a significant cash reserve, whereas Medtronic has a net cash position of -$17 billion. In my perspective, Medtronic offers more value, but at a slower growth rate.
We also observe a substantial valuation if we compare EV to EBIT (EV = market capitalization + debt - cash). Intuitive Surgical's EV/EBIT ratio of 60 is generally a rich valuation. If growth slows down, the stock could face significant downturns. Therefore, I do not find the risk/reward ratio favorable. The new competition from Medtronic and Johnson & Johnson poses a major threat, a risk not yet reflected in the stock price.
Conclusion
Intuitive Surgical is a leader in its invasive surgical systems, and holds a monopoly position with their Da Vinci Surgical Systems. However, its monopoly position is currently at risk due to new competitive threads. Medtronic introduced its Hugo Surgical System, which is recently approved in several countries worldwide. Additionally, Johnson & Johnson is developing a similar system utilizing Verily's technology (Verily is owned by Alphabet). While healthy competition benefits the industry, it will likely exert pressure on Intuitive Surgical's future gross profit margins.
The market for medical robots is expected to grow significantly in the coming years. And Intuitive Surgical is in a good position with its monopoly position. The growth prospects are excellent, and a large part of their revenue is recurring revenue. The stock valuation is rich, and this could be due to strong growth projections. However, the stock valuation has not yet been adjusted for new competitive threats. Partly due to these threats and the rich valuation, the share price could take a big hit if earnings estimates are adjusted downwards. For now, I am keeping a close eye on this exceptional company, considering taking a position when the stock price undergoes correction.
For further details see:
Intuitive Surgical: Monopoly Days May Be Over