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In my October 20, 2021 post, I disclose that I had initiated a 30 share position in Intuitive Surgical (ISRG) @ $336/share in a 'Core' account in the FFJ Portfolio.
In my 3 Great Growth Stocks For Long-Term Investors, I disclose a couple of additional purchases.
These purchases were initiated despite my opinion that shares were richly valued.
A quick look at the recent behaviour of ISRG's share price shows that the timing of these purchases was less than stellar.
With my intended investment holding period being in the decades, however, the recent share price pullback is not worrisome. I remain optimistic about ISRG's long-term prospects and the slight improvement in ISRG's valuation has prompted me to acquire additional shares; I now hold 200 ISRG shares in the FFJ Portfolio and an undisclosed number of shares in an account for which I do not disclose details.
In this post, I explain why I view the recent plunge in ISRG's share price as a buying opportunity.
Financials
On January 12, 2022, ISRG announced preliminary Q4 and FY2021 results in which management indicated FY2021 results would be more than previous estimates. In addition, what management communicated at the January 12 J.P. Morgan Healthcare Conference was encouraging.
On January 21, 2022, ISRG released Q4 and FY2021. The 10-K is not yet available as I compose this post on January 21. The Form 8-K, however, is currently available.
On the earnings call, management indicates COVID has led to many hospitals having to postpone medical procedures that entail the use of ISRG's equipment. Once conditions improve, ISRG will likely experience a marked increase in the demand for its products and services.
Revenue Growth
When I initiated a position, ISRG had recently reported ~$4.159B of revenue for the first 3 quarters of FY2021. It has now reported $5.71B for FY2021. In comparison, ISRG generated $1.757, $2.179, $2.265, $2.132, $2.384, $2.707, $3.138, $3.724, $4.479, and $4.358 (in billions of $) in FY2011 - FY2020.
If we compare FY2021 revenue with that of FY2019 (pre-COVID), revenue has increased by $1.231B.
In 2021, ISRG's da Vinci procedures grew 28% compared to FY2020, reflecting a partial recovery in surgery after the first wave of the pandemic. Over 2020 and 2021, the compound annual growth rate in procedures was 14%.
In 2021, ISRG placed 1,347 da Vinci and 93 Ion systems, driving da Vinci placement growth of 44% over 2020 and at a CAGR of 10% over the past two years. With a 2-year CAGR in procedures of 14% and installed base growth of 10% over the same period, utilization of installed systems continued to climb through the pandemic.
Considering the challenging environment we have experienced over the past couple of years, I consider ISRG's growth remarkable.
Profitability
FY2021 Operating Margin is ~32% versus 39.54%, 40.3%, 37.64%, 25.56%, 31.04%, 35.09%, 33.87%, 32.21%, 30.69%, and 24.09% in FY2011 - FY2020.
In FY2021, ISRG generated $4.66 in GAAP diluted EPS versus $1.37, $1.78, $1.86, $1.23, $1.73, $2.09, $1.92, $3.16, $3.85, and $2.94 in FY2011 - FY2020.
Free Cash Flow
In FY2011 - FY2020, ISRG generated FCF (in millions of $) of 595, 700, 775, 560, 725, 1,033, 953, 982, 1,173, and 1,143. The YTD Condensed Consolidated Statements of Cash Flows are not yet available but in the first 9 months of FY2021, ISRG generated ~$1.319B of FCF. When I initiated my position, ISRG had reported ~$0.886B of FCF for the first half of FY2021.
Capital Expenditures
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 2022, ISRG expects a significant increase in capital expenditures in the range of $0.7 - $1B. 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 also expand ISRG's outside the US footprint in support of opportunities for growth in key international markets, where da Vinci procedures are in earlier stages of adoption.
Product volume growth has allowed the company to in-source some of its high-volume accessories while investing in automation. The benefits from doing so are:
- an improvement in the robustness of the supply chain;
- superior manufacturing quality; and
- lower unit costs.
As ISRG's training, R&D, and manufacturing efforts move to scale, investments are being made in infrastructure, factory builds, training center expansion, and automation. These infrastructure investments are lumpy and the current growth cycle requires building capacity.
These projects have been planned over the past couple of years and will start amortizing moderately in 2022 and more substantially in 2023 and 2024. After 2024, the amortization will normalize over the next few years.
Over the next 4 years, for example, ISRG will be:
- growing and consolidating facilities for operations, R&D, and customer training space in Atlanta;
- doubling the Mexicali manufacturing footprint;
- doubling R&D design space and operations space as its California headquarters; and
- consolidating and growing the commercial training operations and R&D space in Germany.
In a nutshell, ISRG will continue to:
- build on its da Vinci Generation 4 capabilities;
- bring its Ion flexible endoscopy platform to scale; and
- drive capacity, quality, and cost improvements while seeking to broaden access to new markets.
FY2022 Guidance
In FY2021, da Vinci procedures grew ~28% year over year and 14% at a 2-year compound annual growth rate to ~1,594,000 procedures performed worldwide. Management anticipates 11% - 15% FY2022 procedure growth. This range reflects the uncertainty associated with the course of the pandemic.
The low end of this range assumes ongoing COVID pressure and hospital staffing shortages. The high end assumes no significant new surges after the current wave. In addition, this range does not contemplate any material supply chain disruptions throughout the year.
FY2022, the gross profit margin is forecast to be 69.5% - 70.5% of net revenue. The slightly lower gross profit margin anticipated in 2022 reflects higher fixed costs from investments to:
- drive the growth of the business; and
- strengthen operating capabilities.
It also reflects the impact of higher supply chain costs.
ISRG's actual gross profit margin varies from quarter to quarter and is dependent largely on the product, regional, and trade-in mix, and the impact of new product introductions.
FY2021 operating expenses grew 19%. In 2022, 21% - 25% operating expense growth is projected. This operating expense growth reflects increased investment in R&D for new product platforms, expanding outside the US capabilities, and the return of other spending that was previously restricted by COVID.
Noncash stock compensation expense in FY2022 is expected to be $0.51B - $0.55B versus $0.452B in 2021.
Other income, which is comprised mostly of interest income, will likely be $45 - $55 million in 2022 versus $69.3 million in 2021.
Credit Ratings
No rating agency rates ISRG because it has no debt.
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.
In essence, ISRG does not need to rely on debt to fund operations and growth.
Dividend and Dividend Yield
ISRG does not distribute a dividend. In recent posts, I have explained why I do not fixate on dividend income and dividend growth; total potential investment return is of greater importance to me.
In the case of ISRG, its growth potential and attractive returns generated from normal business operations are such that I would much rather funds be retained in the company. If management deems its shares to be undervalued and there are excess funds that are not required to fund growth, then I would much rather see a repurchase of outstanding shares as opposed to the introduction of dividend distributions.
ISRG periodically repurchases shares. In FY2019 and FY2020 it repurchased $269.5 million and $134.3 million. The weighted average number of outstanding shares, however, is relatively stable because ISRG issues shares as part of its employee compensation. 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.
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.
Valuation
FY2011 - FY2020 PE ratios are: 40.02, 30.69, 22.97, 46.20, 37.72, 34.17, 47.07, 72.02, 53.69, and 93.18.
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.
Shares now trade at ~$270 and adjusted diluted FY2021 EPS amounted to $4.96. This gives us an adjusted diluted PE of ~55.
Current guidance, which will likely be amended over the coming weeks, and the current share price now result in 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 are still a bit rich. Having said this, ISRG's growth potential and cash-rich Balance Sheet are such that I am willing to pay a premium.
Final Thoughts
Despite the COVID-related headwinds, ISRG nevertheless generated strong FY2021 results. Management, however, is somewhat cautious about FY2022. This has led to a ~$100 reduction in its share price in under 1 month! Rather than look upon this price drop from a negative perspective, I view it as an opportunity to acquire shares.
While the vast majority of ISRG's revenue is generated from its da Vinci product line, I think investors who have 'bailed' on ISRG underestimate the potential of the Ion endoluminal system. This is a robotic-assisted platform for minimally invasive biopsy in the lung. It features an ultra-thin, ultra-maneuverable catheter that allows navigation far into the peripheral lung, and unprecedented stability enables the precision needed for biopsy.
In Q1 2019, the US Food and Drug Administration (FDA) cleared ISRG's Ion endoluminal system to enable minimally invasive biopsies in the lung.
The rollout of the Ion system in the U.S. is progressing well, and ISRG is continuing to gather additional clinical evidence. In 2021, ISRG placed 93 Ion systems (Ion system placements and procedures are excluded from the overall system and procedure counts) of which 54% of those systems were placed under operating lease arrangements; the list price of the Ion system is $600,000. The entirety of ISRG's Ion installed base is with existing da Vinci customers, the majority of which have large pulmonary and thoracic departments. This, to me, is a clear indication that existing ISRG customers think highly of the company's product offering and service and Ion will one day significantly contribute to ISRG's performance.
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.
