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Intuitive Surgical, Inc. (ISRG) was founded in 1995 and went public in 2000.
The company came to my attention very shortly thereafter. I have, however, always viewed ISRG's valuation to be excessive and never initiated a position. This is, without a doubt, my most significant investment mistake.
How significant? A $10,000 investment at the time of the IPO is now worth just under $3.3 million. By comparison, a similar investment in the NASDAQ 100 on the same day is worth just under $45,000.
Although ISRG's valuation is rich, I explain in this post why I have initiated a position.
NOTE: All share-related values reflected herein account for the 3 for 1 stock split on October 5, 2021.
Intuitive Surgical - Stock Analysis - Business Overview
ISRG is a global technology leader in minimally invasive care and the pioneer of robotic-assisted surgery.
It brings more than two decades of leadership in robotic-assisted surgical technology and solutions to its offerings, and develops, manufactures, and markets the da Vinci surgical system and the Ion endoluminal system (available only in the U.S.).
There are several models of the da Vinci surgical system. These surgical systems are designed to help surgeons perform minimally invasive surgery in that they offer high-definition 3D vision, a magnified view, and robotic and computer assistance. They use specialized instrumentation, including a miniaturized surgical camera and wristed instruments (i.e., scissors, scalpels and forceps) that are designed to help with precise dissection and reconstruction deep inside the body.
Ion is ISRG's robotic-assisted platform for minimally invasive biopsy in the lung. The system features an ultra-thin, ultra-maneuverable catheter that allows navigation far into the peripheral lung and provides the unprecedented stability necessary for precision in a biopsy.
Management believes numerous additional applications can be addressed with the da Vinci Surgical System and the company works closely with surgeon customers to refine and explore new techniques in which a da Vinci Surgical System may bring value.
At FYE2020 (December 31, 2020), ISRG had an installed base of 5,989 da Vinci Surgical Systems, including 3,720 in the U.S., 1,059 in Europe, 894 in Asia, and 316 in the rest of the world. It is estimated surgeons using ISRG's technology completed ~1,243,000 surgical procedures of various types in hospitals throughout the world during FY2020.
ISRG shipped 336 da Vinci Surgical Systems, an increase of 72% compared with 195 in Q3 2020. The da Vinci Surgical System installed base as of September 30, 2021 is 6,525. This is an 11% increase compared with 5,865 as of the end of Q3 2020.
There are now over 9.7 million lifetime procedures performed with ISRG's da Vinci system and there are over 28,000 peer-reviewed clinical publications. Da Vinci X and XI now have over 70 representative clinical usages allowing broad use across multiple clinical specialties from urology to gynecology, thoracic surgery, general surgery, and trends oral surgery. Tens of thousands of surgeons routinely use ISRG's multi-port systems.
The company continues to invest in its multi-port products, instruments, and services to further expand its capabilities. Many surgeons continue to work with ISRG to pursue new learning and there are several ongoing prospective studies.
The flexible bronchoscopy system, Ion, continues to build momentum clinically and commercially; management believes numerous additional applications can be addressed with the Ion endoluminal system. As of FYE2020, ISRG had an installed base of only 36 Ion endoluminal systems, all of which are located in the U.S.Early clinical trial results point to outstanding capability allowing for definitive diagnosis of harder-to-reach body regions (see October 18, 2021 Press Release).
Part 1 of ISRG's FY2020 10-K has a comprehensive overview of the company's history, business strategy, the competitive landscape, risk factors, and more.
Intuitive Surgical - Stock Analysis - Financials
Q3 and YTD2021 Results
On October 19, 2021, ISRG released Q3 and YTD2021 results. The Q3 10-Q is not yet available but the Form 8-K and management's comments on the Earnings call provide sufficient information for my purposes.
If we compare the Q2 10-Q and Q3 Form 8-K, we see the Q3 diluted weighted average shares outstanding and net income per share attributable to ISRG are adjusted to account for the 3 for 1 stock split.
The Q3 highlights show that ISRG is experiencing rapid growth despite pandemic-related headwinds. The rise of the Delta variant and stresses in some hospitals has pressured the demand for surgery. In addition, global supply chain disruption has yet to abate and this has necessitated the redirection of internal resources to continue to meet customer demand.
The increased COVID burden, particularly in August, tempered the recovery ISRG witnessed in Q2. The impact of the Delta variant drove procedures in the United States below expectations at the start of Q3 but subsequently stabilized in the last couple of weeks of September. Procedures grew 16%, reflecting the impact the COVID resurgence had on hospital resources regionally; the south and southeast regions in the US (where vaccination rates are relatively lower) were most heavily affected.
The adoption of ISRG's da Vinci in the United States continues to be driven by:
- a solid trend in malignant procedures (prostatectomy, hysterectomy, lobectomy, and colon resection);
- the increased use of da Vinci in benign procedures (bariatric surgery, cholecystectomy, and hernia repair); and
- the rising use of the company's advanced instrumentation and targeted procedures.
In the US, new system placements continue to be robust with a balanced mix of hospitals new to da Vinci, as well as strong incremental placements for existing customers, and trade-ins of older technology.
China, Japan, and Europe had solid placements and placements in Brazil also showed strength during Q3.
Management continues to stress that it is difficult to estimate the extent to which the COVID resurgence or future resurgences will impact da Vinci procedures. Furthermore, various regions are more heavily affected than others. In Europe, for example, COVID had a greater impact in Italy and France than in the UK and Germany.
While there continue to be COVID hotspots within some of ISRG's Asia-Pacific markets, overall procedures in the region performed well. Q3 growth in China continued to be far higher than in other regions. This primarily reflects system installation growth over the past year. Many hospitals can better manage increased COVID patient hospitalization relative to the beginning of the pandemic.
Staffing shortages and hospital supply chain issues, however, are challenging some hospital capacities and could impact deferrable procedures, including da Vinci procedures.
On the newer platforms front, ISRG's single-port system da Vinci SP had a solid Q3. Placements of the flexible bronchoscopy platform Ion grew sequentially in Q2 to Q3.
The average selling price of ISRG's da Vinci system will fluctuate with geographic and product mix. The average selling prices increased to $1.57 million in Q3 2021 from $1.55 million in Q3 2020 and Q2 2021.
Instrument accessory revenue per procedure of $1,900 decreased slightly compared with $1,910 per procedure in Q3 2020 and decreased from $1,940 per procedure in Q2. The year-over-year change reflects increased usage of extended-use instruments, mostly offset by increased usage of advanced instruments. The decreases reflect customers continuing to adjust their instrument buying patterns to reflect the additional uses per instrument included in extended-use instruments.
ISRG has experienced immaterial increases in costs to date. Global shortages, however, could result in future supply disruptions as well as delayed development and regulatory activities. Supply issues will likely also result in higher production costs.
Operating expenses increased 21% compared with Q3 2020 and increased 2% compared with Q2. The increase, compared to the prior year, reflects costs associated with higher headcount, increased variable compensation, and increased spending in areas impacted by COVID.
Despite the increase in operating expenses, Q3 spending was below expectations due to delays in headcount hiring and lower spending on activities restricted by COVID, including clinical development, marketing events, and travel costs. In addition, COVID delayed some R&D work resulting in an underspend on prototypes. Spending on activities restricted by COVID is expected to increase as the impacts of the pandemic decline.
Procedure growth drives capital purchases in many of ISRG's markets. To the extent that COVID impacts procedures, it will also impact capital purchases.
The trading cycle has been a tailwind to system placements. As the installed base of older generation products declines, however, the number of trade-ins will decline over time.
40% of systems placed in Q3 involved trade-ins (97 trade-ins were completed in the US), which is consistent with the 40% last year and higher than the 38% in Q2 2021.
Leasing and alternative financing arrangements enable customer access to ISRG's systems. This will result in the deferral of otherwise current revenue into future periods.
Leasing represents 41% of Q3 placements compared with 35% Q3 2020 and 33% Q2 2021. The percentage of systems placed under operating leases fluctuates quarterly but management believes leasing (or alternative financing arrangements) will increase as a percentage of sales over time.
Macroeconomic conditions created by COVID could regionally impact hospital capital spending. Furthermore, ISRG expects to experience longer selling cycles and price pressure as the competition progresses in various markets.
Looking more specifically at the financial statements, page 10 of 13 in the Form 8-K shows that ISRG has more than $6.7B of cash, cash equivalents, and investments when we deduct ~$1.475B of Total Liabilities from the ~$8.2B of cash, cash equivalents, and investments!
In the first 3 quarters of FY2021, ISRG has generated revenue of ~$4.159B . If it generates similar revenue ($1.4B) in Q4 to that generated in Q3, then FY2021 revenue will be ~$5.56B. By way of 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 millions) in FY2011 - FY2020; FY2020 revenue was negatively impacted by COVID.
Gross profit margin varies quarter-to-quarter. This variance depends largely on product, regional, and trade-in mix, the impact of product cost reductions through manufacturing efficiencies, and competitive pricing pressure.
FY2021 operating expenses are forecast to grow 17% - 21% above 2020 levels.
YTD2021 Operating Margin is ~33% 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 FY2011 - FY2020, ISRG generated GAAP diluted EPS of $1.37, $1.78, $1.86, $1.23, $1.73, $2.09, $1.92, $3.16, $3.85, and $2.94. YTD2021 it has generated $3.63.
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 6 months of FY2021, it generated ~$0.886B of FCF.
Intuitive Surgical - Stock Analysis - Credit Ratings
No rating agency rates ISRG because it has no debt.
Dividend and Dividend Yield
ISRG does not distribute a dividend.
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 - FY2020 and Q3 FY2021, ISRG's weighted average number of outstanding shares was 362, 370, 361, 339, 341, 354, 349, 356, 359, 361, and 365.
Intuitive Surgical - Stock Analysis - Valuation
ISRG's 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.
The company has generated $3.63 in diluted EPS over the first 3 quarters of FY2021. If Q4 is similar to the prior 3 quarters then FY2021 diluted EPS will likely be ~$4.75 - $4.90. Using ISRG's October 19, 2021 closing share price of ~$336, the forward diluted PE is ~68.6 - ~70.74.
The two online trading platforms I use reflect 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.
ISRG's valuation is well beyond what I consider reasonable.
Intuitive Surgical - Stock Analysis - Final Thoughts
ISRG is experiencing significant growth and once medical doctors become proficient in the use of ISRG's equipment I think it is is extremely unlikely these doctors will switch to a competitor's equipment. In essence, ISRG is creating a growing captive market.
ISRG has also generated the vast majority of its revenue from its da Vinci line of products. This line is continually being improved upon which will result in its expanded capabilities and growth in the company's profitability. Add to this the line of Ion products and we have a company that could potentially generate more than $10B in revenue by 2030.
This is a company that should generate over $5.5B in FY2021 revenue and it has NO debt; it would have ~$6.7B of liquidity if it were to repay its liabilities using cash, cash equivalents, and investments on hand. ISRG's balance sheet is essentially a fortress!
Despite shares being grossly overvalued, I think ISRG will be a far more valuable company several years into the future. I have, therefore, initiated a 30 share position @$336/share in a 'Core' account in the FFJ Portfolio. A young investor I am helping to build an investment portfolio has also acquired ISRG shares. We plan to add to our positions should ISRG's valuation become more reasonable.
Stay safe. Stay focused.
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.
