2023-10-17 05:39:53 ET
Summary
- Although Intuitive Surgical's valuation is significantly higher than the median for the US healthcare sector, this does not mean that it is a poor investment choice.
- The company is trading at a justified premium in light of the strong historical growth it has recorded and is poised to continue experiencing.
- ISRG is launching new products to complement its flagship da Vinci product line, pointing to continued growth.
- With AI likely to support the future growth of the robotics surgery industry, ISRG is well-positioned to benefit given its dominant industry position.
- The main risk for ISRG is that competition is intensifying, and margins, while still high, have compressed in recent years.
The world's first robotic surgery was done in 1997 to successfully reconnect a woman's fallopian tubes. Since then, adoption of robot assisted surgery has gone mainstream thanks to innovations that have made it possible for a surgeon to remotely control a robot that performs minimally invasive surgical procedures on patients.
During the operation, the surgeon sits at a control unit where their hand movements are translated into controlled movements of the surgical robot. The surgeon and control console may be in the same operating room, an adjacent room, or potentially somewhere else (an option that has been made possible thank to telemedicine).
Intuitive Surgical ( ISRG ) has been at the forefront of the robotics surgery industry for close to three decades and is most notably known for its da Vinci Surgical Systems used by surgeons in the US and in more than 70 countries globally. "Surgeons using a da Vinci surgical system operate while seated comfortably at a console viewing a 3D, high-definition image of the surgical field. This immersive console connects surgeons to the surgical field and their instruments. While seated at the console, the surgeon manipulates instrument controls in a natural manner, similar to open surgical technique," the company notes in its most recent 10-Q filing with the SEC.
Strong business growth
ISRG first commercialized its da Vinci standard surgical system in 1999. This was followed by the da Vinci S surgical system in 2006, the da Vinci Si surgical system in 2009, and the fourth generation da Vinci Xi surgical system in 2014. The company extended its fourth-generation platform by adding the da Vinci X surgical system, commercialized in 2017, and the da Vinci SP surgical system, commercialized in 2018.
Screenshot of visual of Da Vinci flagship product (Intuitive Surgical)
ISRG has enjoyed strong business growth in recent years. This is not only reflected in its financial statements for the past few years, but also in the rapid expansion of the scale of its operations over this period. The company's revenues have doubled from $3.13 billion in 2017 to $6.22 billion in 2022, while the number of installed devices has been growing steadily. The installed base of da Vinci surgical systems reached 7,544 on December 31, 2022, from 6,730 on December 31, 2021, and 5,989 as of December 31, 2020.
High recurring revenues (Intuitive)
The best part about ISRG's business model is that, as of 2022, 79% of revenues were classified as recurring revenue. This consists of instruments and accessories revenue, service revenue, and operating lease revenue. The da Vinci surgical system generally sells for between $0.5 million and $2.5 million, depending on the model, configuration, and geography. The company generally earns between $600 and $3,500 of instruments and accessories revenue per surgical procedure performed, depending on the type and complexity of the specific procedures.
The business model is such that when a customer buys their surgical systems, they also have to sign a service contract for provision of services such as data, training and other support services. "We typically enter into service contracts at the time systems are sold or leased at an annual fee between $80,000 and $190,000, depending on the configuration of the underlying system and the composition of the services offered under the contract," notes the company in its recent 10-Q.
Given the continued growth of robotics surgery and ISRG's dominant market position, impressive historical growth and attractive business model, the stock could be a potentially good investment for long-term investors.
Don't be deterred by the price tag
One of the earliest observations an investor is likely to make when assessing the bullish case and risk factors for ISRG is its conspicuously high valuation. The US based medical devices multinational is currently worth $95.97 billion (market cap) and is exchanging hands at a pricey P/E (Fwd) ratio of 59.04 and EV/EBITDA (Fwd) ratio of 32.31. In comparison, the US healthcare sector has a median P/E of 24.48 and a median EV/EBITDA of 12.36, according to SA valuation data .
As the peer comparison chart illustrates, ISRG is 2-3 times more expensive than select peers across a multiple different valuation metrics that investors use. Its similarly sized peers include Medtronic ( MDT ), with a market cap of $95.75B, Stryker Corporation ( SYK ), with a market cap of $97.94B, and Becton, Dickson and Company ( BDX ), with a market cap of $75.05B.
There is no debate that ISRG is priced at a premium relative to the broader medical devices industry. The real question is whether or not this premium is justified. If the stock's valuation is not well-grounded in the underlying business's fundamentals -- particularly its long-term financial and commercial prospects -- then it's an overvalued stock that will inevitably fall back to earth. Investors who believe this to be the case are certainly not bullish at current levels.
However, if you are an investor who, like me, believes that ISRG's pricey valuation is warranted, then the stock is a potentially good pick worth considering as a long-term buy and hold investment. It is my view that ISGR is likely to appreciate in value over the next few years based on the fact that investors are willing to pay high prices today even after the stock's decent performance in the past 3-5 years.
It's instructive to note that, despite its current rich price tag, ISRG is up 43% in the past 1 year and flat YTD after a sharp correction from the July highs of around $350/share. Longer-term, the stock has delivered a total return of 53.74% in the past 5 years, which is roughly on par with the S&P 500's 58.12% return over this period. This may not seem too impressive, but it's always important to remember the dozens of different studies that show that the majority of investors fail to beat the market over the long term. One study by the American Enterprise Institute goes as far as saying that 95% of finance professionals can't beat the market. ISRG's ability to match the broader market's return over the past five years goes to show that it's a stock worth considering if you want to increase your chances of long-term outperformance.
A clear case for continued growth
The main reason why I'm bullish on ISRG despite its high valuation is that the company looks poised to continue growing at a robust pace for the following reasons:
- Its recent launch of new products that will complement the flagship Da Vinci systems and sustain revenue growth
- The potential for AI to accelerate robotic surgery adoption and monetization further
- ISRG's strong balance sheet and sound capital allocation strategy that balances income opportunities with share buybacks
In 2019, the FDA cleared ISRG's Ion endoluminal system. The robotic-assisted system's first cleared indication is minimally invasive biopsies in the lung. Doctors use the Ion robot to find and test lumps in the lungs. Currently available in the US, Ion has experienced strong and steady growth in demand and sales since launch.
Ion procedures showed continued strength with 145% growth in Q2 of '23 , according to Gary Guthart, ISRG CEO. The company is still in the early stages of realizing the growth potential of Ion, considering it only gained European certification for the Ion system in March 2023. In addition to Europe, it is also actively seeking certifications and regulatory approvals to market the product in China and Korea. The company is confident that there is a strong case for continued growth in the US and the targeted global market in light of the 200K+ lung cancer incidences in the US, 1M+ in China and 300K+ in Europe, according to its 2022 Annual Report. Moreover, Ion is a platform that has the potential for additional indications beyond its first one in supporting lung biopsy. This again points to the potential to scale up the platform in coming years and support sustained revenue growth.
Moving on to another catalyst, the robotics surgery industry is undergoing transformative shifts due to AI which ISRG is well positioned to benefit from given its scale and dominance in the industry. According to Sweden-based Surgical Sciences, which is a key supplier to all major companies in the robotics surgery industry, including ISRG: "Systems will become more advanced with an increased element of artificial intelligence providing decision support for the surgeon." The company notes in its 2022 Annual Report that we are transitioning into the age of "digital surgery," meaning AI will be more important. The potential for AI to create new revenue streams for players like ISRG in coming years increases the likelihood of continued growth.
ISRG also has an incredibly strong balance sheet with virtually no debt. Its cash generation surpasses its liabilities by as much as $5.7 billion. The company has also been taking advantage of current high interest rates to earn income on its excess cash, while also repurchasing shares to enhance future shareholder returns by boosting EPS. The company invested in marketable securities worth $2.93 billion in the trailing twelve months and repurchased shares worth $2.80 billion in 2022.
These factors suggest that ISRG's high valuation is well justified, given it is a market leader in an industry likely to continue growing robustly due to advances in AI.
The key risk to watch out for
ISRG's profitability has come under a bit of pressure in recent years. This is something investors should keep an eye on as it may be a sign that competition is heating up. Its EBITDA margin of 30.37% is around 10% lower than its 5-year average of 33.94%, whereas its net income margin of 21.38% is around 20% lower than its 5-year average of 26.73%.
According to Surgical Sciences, a number of major industrial players have just launched surgical robots or are about to. One of the largest challengers to Intuitive is Medtronic, which presented its Hugo RAS in 2019. Other major challengers to ISRG include Johnson & Johnson ( JNJ ), whose subsidiary Auris Health is working on the development of its surgical robot Ottava. "In addition to the major players mentioned above, a further 15-20 robotic surgery companies exist, with different niches in terms of their geographies and applications," notes Surgical Sciences.
The increased competition and pressure on margins come at a time when ISRG's income tax expenses and operating costs have increased. The company's income tax expenses increased from $162.2 million in 2021 to $262.4 million in 2022, while total operating expenses increased from $2.13 billion in 2021 to $2.59 billion in 2022.
Compressing margins may limit the upside for ISRG given how elevated the stock's valuation is at current levels. However, the company's industry leadership is not under any serious threat at the moment. Moreover, the fact that it has no debt makes it attractive in an environment where interest rates are high. It's never easy justifying buying an expensive stock but sometimes they can make great investments if the premium reflects the underlying business's strong competitive position. I believe this to be the case with ISRG.
For further details see:
Intuitive Surgical: When Paying A Premium Makes Sense