Intuitive Surgical, a long term healthcare play, is acknowledged as a pioneer in robotic surgery technology. A huge and growing installed base means plenty of earnings visibility from its recurring customers.
SINGAPORE (Jan 23): Nasdaq-listed Intuitive Surgical (ISRG) develops, manufactures, and markets robotic-assisted systems that help empower doctors and hospitals to make surgeries less invasive. The flagship innovation of the company is the da Vinci Surgical System launched in 1999, with multiple improved variations of this system launched ever since. Apart from da Vinci, the Ion Endoluminal System, which obtained US FDA approval earlier last year is another key innovation of the company that enables minimally invasive biopsy in the peripheral lung. Both these systems generate recurring revenue for ISRG through the sales and from operating leases. Currently, 72% of ISRG’s revenue is recurring.
Though surgery and acute care interventions have improved significantly over the past few decades, there remains a significant need for better outcomes and decreased variability of these outcomes, which is why ISRG’s systems are being more widely used globally. The number of operating leases of ISRG’s systems, and sales of installed bases with ISRG’s systems is growing at 28% and 13% on average a year respectively. While ISRG’s share price is somewhat fully valued at current prices, the company has growth potential.
ISRG’s systems are more accurate than traditional open surgery because they decrease the variability of surgeries and acute care, hence improving outcomes. Secondly, patient experience can be improved by minimising disruption to lives and creating greater predictability for the treatment experience, which would create stickier demand. Also, ISRG’s systems lower the total cost to treat per patient compared with existing treatment alternatives, providing a return on investment for hospitals and healthcare systems and value for payers.
Worldwide (robotic-assisted) procedure trends have also grown in double digits in the past 5 years, and are expected to grow by 15% this year. Robotic-assisted general surgery procedures are the fastest growing surgery type. To address this, ISRG’s focus in 2020 would be to focus on enhancing general surgery platform and systems, particularly for hernia, bariatrics & colorectal general surgery.
Based on the preliminary results announcement for 4QFY2019 ended Dec 31, 2019, ISRG expects a 22% y-o-y growth in revenue and 19% y-o-y growth in its da Vinci procedures. In the fourth quarter of last year, ISRG also received the US FDA clearance for two of its electrosurgical instruments and generators, which should boost revenue and earnings for 2020 and beyond.
Unfortunately valuations are expensive at current prices. Still, potential returns could be lucrative, if investors are patient, which makes the risk-return trade-off attractive.
Based on our valuation metrics, ISRG’s fundamental growth has been stellar for the past five years, but surpassed by share price growth. The 5-year CAGR for revenue, net profits, OCF and FCF are 14.8%, 21.9%, 15.8% and 13.3% respectively against the share price’s 29.1% CAGR. ISRG has also had 15 consecutive years of profits, positive OCF and FCF which reflects strong business quality, especially for a company in the biotech and medtech industry. ISRG is a pioneer in robotic surgery technology and continues to innovate to maintain its market share, hence its economic moat, reflected by its margins have been consistently high. Gross margins (GM) and operating margins (OM) are currently at 70.0% and 32.2% currently. Gross margins have hovered between 66-72% and operating margins ranged from 26% to 40%.
ISRG trades a 40% and 42% premium for its P/E and EV/Ebitda respectively compared to its global peers, because of its consistent profitability. The company also has a very healthy balance sheet, with very strong liquidity and solvency indicators. ISRG has a current ratio and quick ratio of 4.6 times and 3.8 times respectively with a debt to equity of just 1.0%. With an earnings yield, OCF yield and FCF yield of 1.7%, 1.9% and 1.5% respectively, however, ISRG is not very attractive compared to the benchmark US riskfree-rate of 1.8%.
ISRG has a 75% buy call from analysts, with an average target price of US$625.15 ($842.4), around 3.7% above its current trading price of US$602.69. We think that ISRG’s stock price has the potential to hit four figures over the next three years, based on its projected double-digit growth in fundamentals. A strongly profitable company like ISRG could seem overvalued over the short term, but with repeatedly consistent strong results with a huge global market potential that is yet to be fully tapped makes this a strong growth play company over the medium to long term. Despite being overvalued currently, if earnings continues at their historic pace, share price may not fall. In sum, this stock is suitable for risk-takers.
