2023-05-24 10:30:00 ET
Summary
- Intuitive Surgical dip buyers who followed our call in August last year to add were slightly early, as ISRG didn't bottom out until October 2022.
- However, ISRG bottomed out resoundingly and has outperformed the S&P 500 significantly, as early dip buyers benefited from the market's pessimism last year.
- With ISRG's valuation normalized above its 10Y average, I no longer see the current levels as attractive.
- ISRG's price action also suggests caution, as a pullback is increasingly likely.
Intuitive Surgical, Inc. ( ISRG ) investors have outperformed the S&P 500 ( SPX ) since it bottomed out in October 2022, in line with the growth in the company's capital placements on its da Vinci surgical system.
I highlighted in an article in August 2022 that the steep pullback represented a timely opportunity, as Intuitive reported a 14.9% YoY decline in capital placements in FQ2'22. ISRG bottomed out about two months later, as its capital placements recovered remarkably.
Intuitive posted 312 da Vinci system placements in FQ1'23, slightly ahead of last year's 311. Therefore, dip buyers likely expected the wide-moat robotic surgery leader to recover from its battering, given its market leadership.
Investors should note that the company also has another growing opportunity in the Ion endoluminal systems, which saw 55 placements globally. However, it's still nascent, as " Ion [currently] represents 2% to 3% of procedures and revenue."
As such, the da Vinci system is still expected to be the company's core growth driver, as its installed base increased to 7.78K in Q1. Moreover, keen investors should know that its installed base has been steadily increasing, growing at a CAGR of 11.4% over the past five years.
Furthermore, there's significant potential for increased utilization driving volume growth, as ISRG posted broad-based procedure growth of 26% in the first quarter .
However, I assessed that management commentary suggests that investors must curb their enthusiasm in expecting the above-trend growth rate in Q1 to persist.
Management upgraded its full-year procedure growth guidance to 19% at the midpoint. Therefore, investors should expect a more normalized growth cadence in the second half. Management commentary also suggests that the growth momentum slowed in April as the initial backlog lift and easier comps wore off.
Despite that, Intuitive is still expected to post a robust gross margin in FY23, as management guided to a midpoint forecast of 68.5%. However, OpEx growth is expected to be a headwind against its profitability "due to higher procedure growth performance and associated costs."
As such, I assessed that there isn't an attractive buying opportunity at the current levels, as ISRG's valuation has already reflected the optimism. Accordingly, Seeking Alpha Quant rated ISRG's valuation with a "D-" grade, indicating it isn't attractive.
However, given its wide economic moat and robust profitability, ISRG has consistently been priced at a premium against its healthcare sector ( XLV ) peers.
Therefore, investors expecting ISRG to be priced at cheap valuations need to be realistic. I gleaned that ISRG's forward EBITDA multiple of 35.2x is slightly above its 10Y average of 34.1x. Therefore, while ISRG was no longer undervalued like in October 2022, bullish investors could argue that it might not be overvalued.
I think it makes sense. There's significant earnings growth potential for Intuitive, given its competitive advantage. Management even decided to raise prices for da Vinci instruments and accessories or I&A by about 5% to reflect "increased component labor costs on its gross margin." As such, I believe it demonstrates that the company has significant pricing power as the penetration of robotic surgery expands further.
The company reported strong growth drivers in general surgery, contributing to increased utilization rates in Q1. Management stressed that "hospitals are looking for greater capital productivity by putting more procedures onto the systems they already own."
I assessed that the company's systems have helped its customers improve their productivity amid a challenging macro and high-interest rate environment. As such, Intuitive likely benefits from structural growth drivers that have demonstrated their resilience against harsh cyclical conditions.
However, I don't encourage investors who missed adding to their positions in October to add at the current levels.
ISRG's valuation is no longer as attractive, and its price action suggests a pullback is looking increasingly likely.
With that in mind, I believe it's time to move to the sidelines from here.
Rating: Hold (Revised from Buy).
Important note: Investors are reminded to do their own due diligence and not rely on the information provided as financial advice. The rating is also not intended to time a specific entry/exit at the point of writing unless otherwise specified.
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Intuitive Surgical: Too Late To Join The Party Now