Debt-Free Intuitive Surgical's Valuation Continues To Improve

In my October 20, 2021 post, I disclose a new 30 share position in Intuitive Surgical (ISRG) in a 'Core' account in the FFJ Portfolio and conclude that post by stating that 'Despite shares being grossly overvalued, I think ISRG will be a far more valuable company several years into the future.' I followed up this post with further posts (see Archives) in which I disclose additional purchases because debt-free Intuitive Surgical's valuation continues to improve.

Following the April 21, 2022 market close, ISRG released its Q1 2022 results. On April 22, ISRG's share price plunged. My underlying thesis about this investment is unchanged, and therefore, I acquired another 50 shares thus bringing my exposure to 350 shares.


As I compose this post, ISRG's Q1 2022 Form 10-Q is not yet available. Form 8-K, however, provides a high-level overview of Q1 results.

In Q1, da Vinci procedures grew 19%, compared to Q1 2021. The growth in the use of da Vinci in general surgery in the US was led by bariatric procedures, cholecystectomy, hernia repair and rectal surgery. Lobectomy growth was also healthy.

ISRG grew above its quarterly average growth rate in the UK, China, Japan, Germany, and Italy. Some countries (especially China and Korea), however, saw the beginnings of COVID slowdowns later in the quarter.

In ISRG's international markets, the use of da Vinci is diversifying beyond urology in several countries with growth in oncologic procedures in thoracic surgery, gynecology and general surgery.

Japan's Ministry of Health, Labour and Welfare increased reimbursement for robotically assisted gastrectomy and added another 8 procedures to reimbursement coverage in April 2022. This brings the total number of covered da Vinci procedure types to over 25.

In ISRG's flexible robotics program, Ion procedures grew approximately 350% in Q1 compared with Q1 2021.

In Q1, 311 da Vinci systems were installed compared with 298 systems in Q1 2021. ISRG now has a total clinical installed base of 6,920 da Vinci systems. Placements vary by region and are also historically lumpy.

After several quarters of capital strength, ISRG has witnessed some near-term softening in its capital placement pipeline in the US. Contributing factors may include:

  • a pull-forward of Q1 2022 demand into Q4 2021 due to customer budget utilization at year-end;
  • a reduction in the number of third-generation da Vinci systems available for trade-ins; and
  • an overall tightening of hospital finances.

As rates of COVID-related hospitalizations declined in February and March, da Vinci procedures recovered quickly. On a three-year compound annual growth rate basis, first-quarter procedures grew ~15%.

Drivers of procedure performance included general surgery in the US and non-urology procedures outside the US. ISRG, however, was challenged by environmental stresses and is unable to forecast how long these headwinds will persist.

During the quarter, ISRG experienced regional waves of COVID and staffing pressure at hospitals.

In addition, higher logistics costs and manufacturing inefficiencies impacted the gross margin.

The supply chain environment continues to be a challenge. In Q1, ISRG continued to experience constraints in its ability to meet customer demand, and as a result, on-time delivery performance was lower than at any other point since the pandemic began. In Europe, ISRG recently experienced some geographically limited delays in fulfilling orders for some da Vinci instruments and accessories. These delays were due to a combination of the global supply chain and logistics issues, including ISRG's freight forwarder's unanticipated shutdown of its computer system.

While these constraints did not have a material impact on Q1 financial results, risks associated with potential disruption to the manufacturing operations and the ability to supply certain products to customers remain significant.

On the Q1 earnings call, management indicates that since the start of the COVID pandemic in early 2020, hospitals continue to experience financial and operational pressures as a result of staffing shortages, the supply chain environment and resulting inflation. The financial pressures ISRG's customers face have been partially mitigated by government funding, such as ~$178B of the CARES Act and other relief made available to hospitals in the US.

The rising interest rate environment will increase debt servicing costs and may make access to new debt more challenging. To the extent that hospitals continue to face financial pressures, reductions in government funding and higher interest rates, hospital capital spending may be adversely impacted.

In addition, as the competition progresses in various markets, ISRG will likely experience longer selling cycles and price pressure.

Pro forma gross margin in Q1 2022 was 69.8%, compared with 71.8% in Q1 2021 and 70.1% in Q4 2021. This lower gross margin is primarily a result of higher logistics costs and increased fixed costs relative to revenue, as ISRG invests in infrastructure and manufacturing capacity to serve long-term needs.

The increase in operating expenses relative to Q1 2021, reflects an increase in headcount, increased variable compensation, and higher customer-facing costs customer training, travel costs and marketing programs.

At the end of Q1, ISRG  had just over 10, 500 employees. This is a 26% increase from Q1 2021 and an increase of 20% on a three-year CAGR basis. Of the ~2,100 employees added over the last year, ~900 are manufacturing employees.

Free Cash Flow (FCF)

Management has indicated the midterm priority for the use of capital is to reinvest in the business, develop new opportunities, and strengthen operating capabilities on a global scale.

In FY2011 - FY2021, ISRG generated FCF (in millions of $) of 595, 700, 775, 560, 725, 1,033, 953, 982, 1,173, 1,143, and 1736.

ISRG continues to invest in global expansion, innovation initiatives and business infrastructure. Q1 capital expenditures were $95 million. This was primarily comprised of infrastructure investments to expand ISRG's facilities' footprint, increase manufacturing capacity, and the automation of certain production lines.

FY2022 Guidance

On the FY2021 earnings call, the FY2022 procedure growth forecast was 11% - 15%. This forecast is now 12% - 16%. The low end of the range assumes ongoing COVID and staffing pressure at hospitals and assumes some continued choppiness with COVID throughout the year. At the high end of the range, the assumption is COVID-19-related hospitalizations around the world decline throughout the remainder of 2022 and there are no additional significant impacts from further resurgence. Furthermore, the procedure growth range does not reflect significant supply chain disruptions.

In Q2 2022, the YoY procedure growth rate will likely be lower than in recent quarters because Q2 2021 results reflected a strong recovery in procedures as COVID began to subside.

On the FY2021 earnings call, the 2022 full-year pro forma gross profit margin forecast was 69.5% - 70.5%. The forecast is now 69% - 70.5%. The lower end of the range reflects the impact on input costs related to supply chain inflation and some impact from a stronger US dollar.

The pro forma operating expense growth was previously forecast to be 21% - 27%. The range is now 23% - 27%.

The non-cash stock compensation expenses forecast remains at $0.51B - $0.55B for FY2022.

Other income, which is comprised mostly of interest income, is expected to be $50 million - $60 million in 2022.

When FY2021 results were released, ISRG expected a significant increase in capital expenditures in the range of $0.7 - $1B. This is now revised to $0.7B - $0.9B based primarily on the current timing of planned facility construction activities.

A sizable portion of this investment involves the construction of facilities to:

  • provide incremental space for growth;
  • consolidate operations to enhance efficiency; and
  • replace lease spaces with company-owned spaces.

These multiyear capital investments will support growth opportunities in key international markets where da Vinci procedures are in earlier stages of adoption.

The 2022 pro forma tax rate remains unchanged at 22% - 24% of pre-tax income.

Credit Ratings

No rating agency rates ISRG because it has no debt.

In my January 21, 2022 post, I note that at the end of FY2021, ~63.6% of ISRG's ~$13.555B Total Assets consisted of ~$8.620B in cash, cash equivalents, and investments; this is an increase from ~61.5% at the end of FY2020.

On the Liabilities side of the Balance Sheet, it had ~$1.604B of Total Liabilities. Included in this total is $0.414B in Deferred Revenue. This Deferred Revenue represents funds ISRG has received from customers in advance of providing services. Once a service is provided, ISRG reflects the appropriate amount as Revenue.

At the end of Q1 2022, cash, cash equivalents, and investments amount to ~$8.4B yet the company's Total Liabilities are ~$1.5B of which ~$0.424B is deferred revenue.

Essentially, ISRG's financial picture has improved from FYE2021 even though it has incurred significant expenses as it ramps up its operations (as noted above) to handle growth.

Dividends and Share Repurchases

Dividend and Dividend Yield

ISRG does not distribute a dividend.

Share Repurchases

Since March 2009, ISRG has had an active stock repurchase program for which there is no expiry date. As of FYE2021, the Board had authorized an aggregate amount of up to $7.5B for stock repurchases, of which the most recent authorization occurred in January 2019, when the Board increased the authorized amount available under the share repurchase program to $2B. At FYE2021, there remained $1.6B available for repurchase under the authorized repurchase program.

In FY2011 - FY2021, ISRG's weighted average number of outstanding shares (millions rounded) was 362, 370, 361, 339, 341, 354, 349, 356, 359, 361, and 366.

ISRG repurchased ~$0.27B in FY2019 and ~$0.134B in FY2020. It repurchased no shares in FY2021.

In my January 21, 2022 post I indicate:

'Given the recent pullback in the share price and the company's significant liquidity, I would not be surprised if management decides to repurchase shares.'

In Q1, ISRG repurchased 398,000 shares at an average price of $268/share for a total expenditure of $0.107B.


FY2011 - FY2020 PE ratios are: 40.02, 30.69, 22.97, 46.20, 37.72, 34.17, 47.07, 72.02, 53.69, 93.18, and 77.44.

When I initiated my ISRG position, the October 19, 2021 closing share price was ~$336. The two online trading platforms I use reflected the following adjusted diluted EPS estimates from the brokers which cover ISRG:

  • FY2021 - 18 brokers - mean of $4.89 and low/high of $4.50 - $5.06. Using the mean estimate, the forward adjusted diluted PE is ~68.7 and ~66.4 if I use $5.06.
  • FY2022 - 18 brokers - mean of $5.52 and low/high of $5.17 - $5.74. Using the mean estimate, the forward adjusted diluted PE is ~60.9 and ~58.5 if I use $5.74.
  • FY2023 - 18 brokers - mean of $6.40 and low/high of $5.69 - $6.91. Using the mean estimate, the forward adjusted diluted PE is ~52.5 and ~48.6 if I use $6.91.

At the time of my January 21, 2022 post, shares were trading at ~$270 and adjusted diluted FY2021 EPS amounted to $4.96 thus resulting in an adjusted diluted PE of ~55.

Guidance, which I anticipated would be amended over the coming weeks, and the current share price gave us the following forward adjusted diluted PE levels:

  • FY2022 - 16 brokers - mean of $5.12 and low/high of $4.63 - $5.80. Using the mean estimate, the forward adjusted diluted PE is ~53 and ~47 if I use $5.80.
  • FY2023 - 16 brokers - mean of $5.92 and low/high of $4.53 - $7.08. Using the mean estimate, the forward adjusted diluted PE is ~46 and ~38 if I use $7.08.

Despite the drop in ISRG's share price, shares were still a bit rich. However, I stated I was willing to pay a premium given ISRG's growth potential and strong financial position.

The closing share price on April 22, 2022 is ~$252. Adjusted diluted EPS guidance and forward adjusted diluted PE levels are:

  • FY2022 - 19 brokers - mean of $5.00 and low/high of $4.65 - $5.44. Using the mean estimate, the forward adjusted diluted PE is ~50.4 and ~46.3 if I use $5.44.
  • FY2023 - 19 brokers - mean of $5.91 and low/high of $5.48 - $6.30. Using the mean estimate, the forward adjusted diluted PE is ~42.6 and ~40 if I use $6.30.
  • FY2024 - 13 brokers - mean of $6.85 and low/high of $6.29 - $7.19. Using the mean estimate, the forward adjusted diluted PE is ~36.8 and ~35 if I use $7.19.

Debt-free ISRG's valuation continues to improve but is still a bit rich. However, we must remember this is a high-growth company. I also anticipate stronger performance once the COVID and logistics-related headwinds abate.

Final Thoughts

Broad market pullbacks such as that on April 22 have, regrettably, been too few and far between. With any luck, April 22, 2022 will not be a day in isolation.

Many investors may suffer permanent losses. This outcome, however, is likely when we make investment decisions solely on stock price movements! Oftentimes, decision-making using charting strategies leads to investments in questionable companies thereby significantly increasing the probability of a permanent loss. Ask any investor who had no clue what they were doing during the ' bubble'.

Invest in high-quality companies, however, and stock price plunges become less concerning. ISRG, for example, is highly profitable, generates strong FCF, and has more than ample liquidity to wipe out 100% of its liabilities with billions left over to fund the expansion of its operations. This is the type of company where I welcome stock price plunges!

In my April 22, 2022 Invest in Danaher For The Long Term post I conclude (but it is worth repeating).....

Investors would be wise to heed the advice Ben Graham once provided Warren Buffett when Buffett worked for Graham-Newman:

'In the short run, the market is a voting machine. In the long run, it is a weighing machine. People have been successful investors because they've stuck with successful companies. Sooner or later the market mirrors the business.'

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.