Medical stocks have received more than their fair share of attention in the past few weeks as congress passed the health care reform bill. While I see the bill as a major impediment to free commerce – Note AT&T Inc. (T) $1 billion dollar charge related to healthcare – there are still many medical companies which will continue to experience growth and opportunity in the coming years. Best of all, some of these investments are trading at discounts to a “fair market value” due to concern over what healthcare reform will look like.
Intuitive Surgical (ISRG) has put in a very strong performance with the stock up more than 250% since this time last year. The company makes robotic equipment for Minimally Invasive Surgery (MIS) procedures and has expanded the number of procedures and the quality of service that physicians can offer patients. The daVinci Surgical System employs cutting-edge (no pun intended) technology which is assisting surgeons around the world.
According to the company, the technology is changing surgery in three primary ways:
- The technology simplifies existing MIS procedures
- The technology makes difficult MIS operations routine
- The technology allows new MIS procedures to be possible
These changes have led to adoption of the system around the globe, and ISRG recently announced that Japan has approved the da Vinci system for use. During the fourth quarter the number of procedures completed with the system rose by 44%.
Led by outstanding patient outcomes, robotic surgery adoption with patients and the medical community at large continues to grow. ~Gary Guthart, CEO
The primary case against investing in ISRG is the premium multiple. Currently the stock is trading near $345 per share, while the company reported earnings of $5.93 in 2009. This nets out to a historical PE of 58, certainly an expensive proposition. But with the company expected to grow earnings by 31% this year and another 20% next year, the numbers start looking a bit more reasonable.
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I expect that the current estimates for earnings growth may be light as analysts are rightfully concerned that ISRG will face pricing pressures as a result of the healthcare reform act. But with growing international exposure and the expanding necessity of the company’s products, volume should more than make up for the potential pressure on margins.
While Intuitive has been successful in expanding its footprint and selling a large number of systems quarter by quarter, it’s even more impressive to see the stable base of renewable revenue the company is creating. In the fourth quarter, instruments and accessories accounted for $113.3 million in revenue which was up 39% from a year ago. On top of this, service revenue accounted for $47.8 million in revenue – and the two categories combined make up for roughly 50% of total revenue.
So as the installed base of systems grows, ISRG’s long-term revenue stream should continue to be healthy. The additional revenue more than cover additional expense items associated with growth such as overhead issues like medical billing employees.
ISRG finished 2009 with cash of $1.172 billion and no debt. The financial soundness allows for flexibility in pursuing additional growth strategies. Intuitive could easily purchase an ancillary business with attractive products it could cross-sell to its growing client base of surgeons and facilities. The capital can be used for R&D to develop a new line of complementary products. Or the capital could be returned to investors through dividends or stock repurchases (although I would prefer for management not to buy stock at the current high price)
So with the broad equity market still showing strength, it makes sense to buy strong growth companies with the potential to continue to generate improving numbers. The recent pullback offers a good entry point where traders could set a stop point near $330 or so and risk $15 with the potential for much higher gains. If stopped out, investors may want to keep this name on their radar as the fundamental strength of the company should eventually lead to another strong run in the stock.
FD: Author does not have a position in ISRG
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March 30th, 2010 at 9:22 pm
Hi there,
I am a folower of your blog, and very much like your work
ISRG was also in one of my long entry watchlist recently.
But I found out that it’s hitting it’s $350 all time high resistance.
Do you think it’s capable of breaking that resistance?
(http://lionel.textmalaysia.com/a-possible-long-entry-on-isrg.html)
March 31st, 2010 at 2:43 pm
Kudos on a well written article. I have been following this company for 3 years since the day I started trading stocks and it has always been one of my favorites. All you have to do is listen to their conference calls and you will know why it just continues to impress. While the valuations are a bit lofty there aren’t many companies that continually show growth like this company so I wouldn’t be too concerned. I still see a lot of potential growth just by the mere fact that the surgeries will increase as more people get insurance. Robotic assisted surgery is successful because it saves insurance companies money in post operative care and gets people out of the hospital faster and with less complications. The real growth in the stock will come in the next year as we hear more and more about health care during the elections and people realize there is only one leader in the pack. The premium valuation is not always earned by some companies but with Intuitive Surgical like Apple, sometimes it just is worth it.
March 31st, 2010 at 2:44 pm
As a buyer of ISRG since 2001 (and never a seller), I agree on the overall point of the article. However, aside from the (recurring) claim that ISRG is expensively priced, you feel it’s a good buy (for traders only?) since it may once again experience one of its huge runs.
But ISRG shouldn’t invest in itself because it’s too expensive.
Sure, one calculates risk and reward, but either your analysis finds it too expensive or it does not. Saying it’s good for us, but not for thee just doesn’t cut it…
At what price would you consider ISRG fairly priced? (and run your criteria retrospectively, for the past five or so years). It seems to me folks haven’t been able to get a firm price valuation for the fabled “ISRG moat.”
April 2nd, 2010 at 4:37 pm
There is no proven clinical study benefit on this technology vs standard minimally invasive surgery currently and it is very expensive. $1.4 million for the robot and $140,000 a year to maintain. Many hospitals are currently losing money and this device could be one of the items to cut with the new healthcare reform. This is currently only hospital marketing and patient driven. Be careful.
April 2nd, 2010 at 4:37 pm
Do you even listen to the conference calls or read the studies? Patients have less bleeding complications, get out of the hospital in shorter times and that my friend equals a cost savings for the insurers. My guess is that the 700+ buyers of the machines over the past two years have done their due diligence and figured out that the machines do make money. No one spends that much money without knowing the return on the investment. Contrary to your theory, the device will save money for the insurers and make money for the hospitals. One last note..everything is patient driven and Intuitive Surgical’s assisted surgery is well on its way to becoming the standard. I know if I need a surgery I will look for a doctor and hospital that uses the technology and I am sure you will too.