2023-07-03 13:28:27 ET
Summary
- We touch upon some admirable facets of the Intuitive story.
- We then shift attention to some unfavorable aspects of Intuitive.
- We close with some thoughts on the technicals.
ISRG - A Lot To Admire
The stock of Intuitive Surgical ( ISRG ), a trailblazer in the field of robotic-assisted minimally-invasive (RAMIS) surgery systems, has proven to be an excellent source of alpha since its listing back in 2000 (during this period it has delivered over 4.5x the returns of the iShares US Medical Devices ETF). Even this year, on a YTD basis it has managed to generate 29% returns, over 3x what IHI has delivered.
Besides making its public debut, the year 2000 was also monumental for ISRG, as it had received FDA approval to use its flagship da Vinci system for general laparoscopic surgery.
Since then, ISRG has managed to witness a manifold surge in its installed base with over 7700 da Vinci surgical systems deployed across the globe (60% of the installed base is in the US alone). Crucially, the utilization of these systems has stepped up to a different level in recent years, highlighting how the RAMIS tech is becoming even more entrenched; for context, whilst over 12m surgical procedures have been carried out since these da Vinci systems came into the market decades ago, last year alone saw 1.5 million procedures, or 15% of the aggregate procedures in one year alone.
While it's easy to see how minimally-invasive surgical procedures can do a world of good for average patient recovery times, consider how effective robotic-assisted surgical systems could be in ameliorating some of the ever-present staffing challenges faced by this industry (the WHO believes that even by the end of this decade, the globe will have to contend with a shortage of 10m healthcare workers). In light of this backdrop, we think the runway for RAMIS penetration looks huge, particularly as only 3% of the addressable market has been breached as yet.
ISRG, in particular, looks well-positioned to flourish, as it has already built-up ample credibility in this market. This can be validated by exceptional NPS (Net promoter scores) numbers of 79 (2022 figure) which puts it in the top tier.
The growing popularity of ISRG's systems can also be validated by its revenue outlook for the foreseeable future. Typically, when a company has already delivered a healthy cadence of double-digit topline growth for a certain period (3-year CAGR of 12% ), one would expect some slowdown given the high base effect. Well, with ISRG, note that over the next three years, its revenue will grow at an even higher run-rate of 14% (3-year CAGR) crossing the $9bn mark.
The other useful facet of ISRG's business model is that one also gets ample revenue visibility, based on a high share of recurring revenue that is not linked to system sales alone. ISRG also generates topline growth through regular services, operating leases, and crucially, instruments and accessories (I&A), all of which help de-risk the model and make the sales picture look less lumpy. See the image below which highlights how recurring revenue continues to trend up over time.
Besides a vibrant recurring revenue profile, ISRG's defensive quotient is also boosted by a strong balance sheet. The company does not have any debt and crucially, its share of cash and short-term investments (~$4.69bn) has been growing strongly over time and currently accounts for the largest share of the total asset base (36%).
ISRG is also quite well-placed to demonstrate some degree of pricing power. On the Q1 call in April, management noted that they would be implementing a 5% increase in the listing prices of certain I&A offerings which would help bring through $100m of revenue and operating profit benefits this year.
We think they've picked a rather opportune time to implement these price increases, as the financial health of hospitals looks to be in a much better place recently, and thus, they could likely be more amenable to digest these price hikes. For context, note that the Kaufmann Hall Hospital Operating Margin (calendar year to date) continues to convalesce and is now positive for the third straight month.
Yet, There Are Quite A Few Risks That Dampen The Long Trade
Clearly, as covered in the section above, ISRG has a lot of things going for it, but it also isn't without fault. In fact, there are quite a few risks that temper our enthusiasm for the stock at this juncture.
Firstly, whilst ISRG delivered a solid Q1 back in April (which saw the stock gap up the next day), it's important for investors not to extrapolate some of the trends seen in that quarter. Admittedly whilst it was heartening to see ISRG's customers make use of its systems to carry on even more procedures on average (particularly in January and February), it is not sustainable to grow at 13% YoY rates (traditionally, average procedures per system have tended to grow at the single-digit levels).
Also don't get carried away by the impressive 26% procedure growth seen in Q1, as there was also a weak base effect in play (in Q1-22, procedure trends in US, Korea, and China were adversely impacted by COVID). In fact, going forward management expects procedure growth for the whole of FY23 to come in at lower levels of 18-23%. A lower cadence of procedure growth will likely dampen the need for additional capacity, and the overall installed base of ISRG's systems.
Then, it's also worth noting how high component and labor costs have been weighing on the company's gross margins, which have been on a downward trend since the December '21 quarter.
Those factors may abate over time, but also don't forget the growing share of the low-margin Ion endoluminal systems in the overall business mix (this product which is typically used for diagnosis rather than surgery only received FDA approval in 2019, so it is still only a small part of the overall sales mix) which weigh adversely on overall gross margins
We would also urge investors to be mindful of ISRG's growing operating cost base which could keep a lid on operating margin expansion. Previously management was only expecting a 9-13% uplift in opex costs this year, but in Q1, they announced it would likely come in at a higher cadence of 11-15% YoY.
Investors also need to consider that going forward the margin trajectory does not look wholly compelling. As per consensus estimates, even if ISRG will witness some incremental margin progression (over the next few years) from a low base, the FY25 EBITDA margin of 39.6% will still be lower than what was seen last year (39.9%) and before.
Perhaps the most unsavory aspect of the ISRG story is the stock's forward valuations. As per YCharts, ISRG will likely deliver earnings CAGR of 17% over the next three years. There's no doubt that's a very respectable earnings runway to look forward to, and investors shouldn't have any qualms about paying reasonable double-digit P/Es. However, ISRG is currently priced at a whopping multiple of 62 P/E, 20% pricier than the 5-year average, and implying a PEG ratio of close to 5x (based on the long-term earnings forecast)! No matter how attractive the investment case is, it's questionable if you'll get good bang for the buck when you're shedding out such steep multiples.
Closing Thoughts - Technical Considerations
Even the charts suggest that this is an inopportune juncture to consider a long position. On the shorter-time frame daily charts, the stock looks overbought, trading at 52-week highs, and recently forming a reversal shooting star candle , just outside the upper Bollinger band (implying that the stock is trading at over two standard deviations from its 20-day moving average).
If one widens the lens to consider the larger time frame weekly chart, overbought vibes are felt here as well. We can see that since May 2022, the stock had been trending up in the shape of an ascending channel, but recently it has broken past the upper boundary. Normally this would bode well for momentum traders, but also do consider that the stock is now in the midst of an old congestion zone and may struggle to generate further upside gains (between July 2021, and Jan 2022, it spent weeks directionless, chopping around within the $320-$370 range). We wouldn't be surprised to witness a pullback or a flattening out of the price action at these levels.
Finally, we'll close by pointing out a chart highlighting the strength of the ISRG stock versus its peers in the US medical devices space. We can see that over the last two decades, ISRG's strength has been steadily building over time (from sub 1x to over 6x), but the progress has hardly been linear. In fact, we've seen quite a few instances of a pronounced pullback in this ratio. It now appears that we may not be too far away from yet another pullback as the ratio has now hit 6x, a level last seen in 2012, from where we saw a sharp pivot.
For further details see:
Intuitive Surgical - Quality Business, But Unlikely To Reward New Investors At This Time