Contents
I last reviewed Intuitive Surgical (ISRG) in this April 19, 2023 post at which time it had just released Q1 2023 results. With the release of Q2 and YTD2023 results following the July 20, 2023 market close, I revisit this existing holding.
Overview
Please refer to the company's website and 'Item 1 - Business' in the FY2022 Form 10-K for a good overview of the company.
CEO and NEO Compensation
I touch upon this topic in my April 19 post.
Financials
Q2 and YTD2023 Results
ISRG's Q2 2023 Form 10-Q is currently unavailable. Form 8-K, however, provides a high-level overview of this past quarter's results. Supporting data is accessible here and some data is provided below for ease of reference.
Despite exceeding quarterly sales and profit expectations, ISRG's share price tumbled on July 21. On the earnings call, management indicated that surgeons are reporting that patients are delaying decisions around interventions as they consider new GLP-1 weight-loss drugs. These weight-loss drugs could lead to fewer bariatric surgery procedures with ISRG's da Vinci system; roughly 200,000 bariatric surgeries valued at ~$0.4B in annual instrument revenue are performed annually in the US.
While the tables provided with the Q2 earnings release reflect quarterly results since Q1 2021, ISRG's results were hard hit during the COVID pandemic. Hospitals focused on tackling the COVID pandemic and most elective surgeries performed with ISRG equipment were either cancelled or postponed. It is, therefore, preferable to compare ISRG's current results relative to its pre-COVID results. I, therefore, include ISRG's FY2016 - FY2020 results so we can properly gauge ISRG's performance.
NOTE: ISRG initiated a 3 for 1 stock split on October 5, 2021. We, therefore, need to consider that the $3.65 in FY2022 diluted EPS is equivalent to $10.95 ($3.65 x 3) to draw a proper comparison with FY2019 (pre-COVID) diluted EPS of $11.54.
YTD2023 EPS is $2.18 after half the year. If ISRG experiences a modest improvement in earnings in the second half of FY2023, I envision ~$4.50 and ~$5.45 in diluted EPS and adjusted diluted EPS. Multiply this by 3 to account for the stock split and we get ~$13.50 in diluted EPS and ~$16.35 adjusted diluted EPS.
We see that ISRG's FY2023 Revenue is likely to be just shy of $7B whereas its FY2019 Revenue (pre-COVID) was only ~$4.479B. ISRG now needs to generate ~1.5X FY2019 revenue to generate earnings that will slightly exceed FY2019 earnings.
Source: ISRG - FY2020 Form 10-K
Source: ISRG - Q2 2023 Financial Data Tables
Source: ISRG - Q2 2023 Financial Data Tables
Source: ISRG - Q2 2023 Financial Data Tables
Areas of strength included general surgery and gynecology for benign conditions, particularly in the United States. General surgery procedure growth was led by cholecystectomy and hernia repair. Colon and rectal procedure growth was healthy. Global procedure growth was also strong in Q2 led by a recovery in China and continued strength in Japan, Germany and the UK.
In Q2, ISRG placed 331 systems compared with 279 systems in Q2 2022; the Q2 2022 system placements reflect a delay in the shipment of ~15 systems from June into July as a result of supply chain challenges.
Despite Q2 2023 system placements being ahead of expectations, customers mainly in the US appear to be cautious in their capital spending given ongoing financial pressures.
The clinical installed base now stands at 7,900 multi-port da Vinci systems, 142 single-port da Vinci systems, and 435 Ion systems.
System utilization, defined as procedures per installed clinical system per quarter, grew 9% globally YoY, reaching a new high as customers adopt a broad mix of procedures on ISRG's systems.
Capital and operating expenses are within ISRG's guidance, reflecting continued investments in R&D to support the growth of the company's platforms and digital tools, expansion of the manufacturing and commercial footprints, and capital amortization.
Investments in R&D, manufacturing and commercial operations are likely to be lumpy over the next couple of years as significant operations expansions and other projects come to completion.
In Q2, the China National Health Commission published the fourteenth five-year quota of 559 robotic systems. For those systems awarded to ISRG's joint venture under the new quota, it is expected that a significant majority will be placed in 2024 - 2027.
ISRG is also witnessing increased participation of local competitors in tender processes under the national quota.
In addition, during 2023, ISRG experienced pricing pressure in China as a result of provincial government policy changes and competition. The dynamics create greater variability in the outlook for ISRG's procedure, system placement and revenue performance in China.
Leasing represented 50% of Q2 placements compared with 42% for recent prior periods. In the US, 78% of system placements in Q2 were under operating lease arrangements compared to 59% in Q1 2023. The higher rate of operating leases in the US is primarily driven by an increasing customer preference for usage-based leasing models in part due to capital budget constraints and continuing financial pressures faced by many customers.
In addition, some customers are choosing leasing structures to preserve flexibility to upgrade to next-generation technology.
Free Cash Flow (FCF)
In FY2011 - FY2022, ISRG generated FCF (in millions of $) of 595, 700, 775, 560, 725, 1033, 953, 982, 1173, 1143, 1736, and 958.
We can expect ISRG to generate strong FCF in FY2023.
Outlook
Management has amended its forecast FY2023 procedure growth to 20% - 22% from 18% - 21%.
The low end of the range reflects uncertainty around:
- the duration of elevated procedure volumes with patients returning to healthcare;
- continued slowing of bariatric growth rates in the US; and
- macroeconomic challenges that could impact hospitals and patient spending.
At the high end of the range, ISRG assumes macroeconomic challenges do not have a significant impact on hospital procedure volumes and bariatric growth rates in the US continue at the rate witnessed in Q2. Furthermore, the revised range does not reflect significant material supply chain disruptions or hospital capacity constraints.
Management continues to expect an FY2023 68% - 69% gross profit margin. The actual gross profit margin will vary quarter-to-quarter depending largely on product, regional and trading mix and the impact of new product introductions.
Operating expense growth was previously forecast to be 11% - 15%. This estimate is now revised to 12% - 15%.
The FY2023 estimate for non-cash stock compensation expense is now $0.6B - $0.62B versus the previous estimate of $0.6B - $0.63B.
The FY2023 estimate for other income, which is comprised mostly of interest income, is now $0.16B - $0.18B versus the previous estimate of $0.14B - $0.16B. The increase primarily reflects the rise in interest rates.
ISRG continues to forecast ~$0.8B - ~$1B in CAPEX for planned facility construction activities.
The 2023 pro forma tax rate estimate remains at ~22% - ~24% of pre-tax income.
Credit Ratings
No rating agency rates ISRG because it has no debt.
Dividend and Dividend Yield
ISRG does not distribute a dividend.
In FY2011 - FY2022, ISRG's weighted average number of outstanding shares (millions rounded) was 362, 370, 361, 339, 341, 354, 349, 356, 359, 361, 366, and 362. The weighted average number of outstanding shares in Q2 2023 was 357.3 versus 356 in Q1 2023.
ISRG's capital allocation is as follows:
- Invest in the business, both in capital expenditures and in organically investing in operating expenses;
- Acquire technology externally that gives the company differentiated capability or accelerates ISRG in the marketplace. This generally consists of license arrangements, Intellectual Property or tuck-in acquisitions.
- Opportunistically returning cash to shareholders. In the last 18 months, ISRG repurchased 12.6 million shares for $3B at an average price of $234.
Valuation
FY2011 - FY2022 PE ratios are 40.02, 30.69, 22.97, 46.20, 37.72, 34.17, 47.07, 72.02, 53.69, 93.18, 77.44, and 70.38.
Refer to my October 19, 2022 post in which I provide ISRG's valuation at the time I wrote previous posts.
For ease of comparison, I provide ISRG's forward-adjusted diluted PE levels using the ~$211 October 18 closing share price and the forward-adjusted diluted earnings estimates from the brokers which cover ISRG.
- FY2022 - 22 brokers - mean of $4.72 and low/high of $4.59 - $4.83. Using the mean estimate, the forward adjusted diluted PE is ~44.7.
- FY2023 - 22 brokers - mean of $5.45 and low/high of $4.99 - $6.10. Using the mean estimate, the forward adjusted diluted PE is ~38.7.
- FY2024 - 19 brokers - mean of $6.43 and low/high of $6.01 - $7.02. Using the mean estimate, the forward adjusted diluted PE is ~32.8.
When I wrote my April 19, 2023 post, shares were trading at ~$298.60. Using this share price and the brokers' earnings estimates, ISRG's valuation was:
- FY2023 - 23 brokers - mean of $5.42 and low/high of $5.03 - $5.60. Using the mean estimate, the forward adjusted diluted PE is ~55.
- FY2024 - 23 brokers - mean of $6.37 and low/high of $5.93 - $6.88. Using the mean estimate, the forward adjusted diluted PE is ~47.
- FY2025 - 16 brokers - mean of $7.43 and low/high of $6.87 - $8.29. Using the mean estimate, the forward adjusted diluted PE is ~40.
ISRG has generated $2.18 and $2.65 in diluted EPS and adjusted diluted EPS in the first half of FY2023. As noted earlier, I envision ~$4.50 and ~$5.45 in diluted EPS and adjusted diluted EPS. On July 21, ISRG's share price closed at $335.83. Using my FY2023 earnings estimates, the forward diluted PE and forward adjusted diluted PE are ~74.6 and ~61.6.
The forward-adjusted diluted PE levels using current broker estimates are:
- FY2023 - 26 brokers - mean of $5.53 and low/high of $4.70 - $5.76. Using the mean estimate, the forward adjusted diluted PE is ~60.7.
- FY2024 - 27 brokers - mean of $6.46 and low/high of $5.56 - $7.08. Using the mean estimate, the forward adjusted diluted PE is ~52.
- FY2025 - 19 brokers - mean of $7.47 and low/high of $6.56 - $8.60. Using the mean estimate, the forward adjusted diluted PE is ~45.
Final Thoughts
With industry conditions now returning to normal following the COVID pandemic, ISRG should benefit from the global adoption of robotic surgery despite the entry of new rivals in the area of robot-assisted surgery that ISRG has dominated.
ISRG's procedure volume is likely to exceed 2 million in 2023. However, the total addressable global is several times this level. There are ample growth opportunities, particularly in overseas developed countries, where robotic surgery's acceptance is generally significantly lower than in the US.
In a world where companies have feasted on debt during years of low-interest rates, it is refreshing to see ISRG has NO debt. At the end of Q2 2023, it had ~$7.13B in cash, cash equivalents, and investments versus ~$1.944B in TOTAL liabilities (of which ~$0.451B is deferred revenue - money ISRG has received BEFORE providing products/services).
In hindsight, I overpaid (just above $300) when I made my first few ISRG share purchases. Fortunately, I have been able to 'average down'. With the following purchases, my average cost is now ~$279:
- January 21, 2022 @ $279.86
- February 17, 2022 @ $287.43
- June 1, 2022 @ $214.32
- July 22, 2022 @ $210.24
I currently hold 450 shares in a 'Core' account in the FFJ Portfolio. ISRG was my 14th largest holding when I completed my Mid-2023 Investment Holdings Review. At the time of this review, ISRG shares were trading at ~$342. While ISRG's share price has subsequently fallen slightly, I am confident ISRG is still a top-20 holding.
Although multiple positive secular tailwinds continue to drive accelerated robotic adoption, I think ISRG's current valuation is 'off the charts'. I am not, therefore, adding to my exposure at this time.
I wish you much success on your journey to financial freedom!
Note: Please send any feedback, corrections, or questions to [email protected].
Disclosure: I am long ISRG.
Disclaimer: I do not know your circumstances and do not provide individualized advice or recommendations. I encourage you to make investment decisions by conducting your own research and due diligence. Consult your financial advisor about your specific situation.
I wrote this article myself and it expresses my own opinions. I do not receive compensation for it and have no business relationship with any company mentioned in this article.
