Intuitive Surgical Stock: Quite Invasive (NASDAQ:ISRG)

Medical team performing gastric bypass surgery

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Intuitive Surgical (NASDAQ:ISRG) is the undisputed leader in minimally invasive surgery, one with a great long-term operating performance as well as great track record for long-term investors down the road.

In the summer of 2019, I have last looked at Intuitive. While I greatly appreciated the strength of the business, the risk-reward was not too compelling in my eyes as valuation have expanded quite a bit at the time.

Former Thesis

Intuitive Surgical is best known from its da Vinci robotic operating system, a system greatly adopted in hospitals across the globe. System sales and lucrative consumable sales drove a great operating performance as revenues came in at $3.7 billion in 2018, with revenues up essentially 20%, as operating margins of 32% resulted in sky-high earnings of $1.1 billion, close to $10 per share.

Shares traded at $460 around the time of the release of the 2018 results, including a $40 per share net cash position. With 119 million shares outstanding, the company commanded a $50 billion enterprise valuation. This was of course a steep valuation at 13-14 times sales and approximately 45 times earnings, yet the longevity of growth and strong value proposition made shares interesting in the true long haul.

By the summer of 2019, shares had risen to $528 per share, pushing up the enterprise value to $55 billion, yet with sales seen up to roughly $4.5 billion, multiples narrowed a bit to 12 times sales and earnings multiples contracted slightly as well, as the valuation was still too rich for me to commit, despite the long-term positioning.

What Happened?

Fast-forwarding three years in time, shares now trade at $206 per share, which is misleading of course as the company has split its shares in a three-for-one stock split in the second half of 2021, translating into a pre-split price of $618 per share. While that marked a $100 per share gain since the summer of 2019, this roughly 20% return in three years’ time has been relatively modest given the performance of wider markets.

Of course, part of these softer returns stems from recent underperformance after shares hit the $370 mark late in 2021, translating into a near $1,100 pre-stock split price! That momentum was induced by cheap money, solid performance, as the Da Vinci system and surgeons have performed a cumulative 10 million surgical procedures.

2021 has proven to be a solid year, but this came amidst easy comparables, of course. Revenues rose to $5.7 billion, some $2 billion ahead of the 2018 results, as operating profits came in at $1.8 billion. Net earnings came in just below that number, at $1.7 billion to be more precise, as higher interest income and low tax rates make the gap with operating earnings very small.

The 366 million shares correspond to a 122 million share count if we adjust for the split, marking a flattish share count versus 2019, or actually slightly dilution as a result of stock-based compensation, which has not been offset. This is partially the result of earnings being retained on the balance sheet, with net cash posted at $8.6 billion by the end of 2021, equal to about $23 per share!

With shares now trading at $206, that implies that operating assets trade around $180 per share with GAAP earnings of $4.66 per share in 2021 translating into a still demanding 38 times earnings multiple, even as shares are down some 40% already from their highs.

Results so far this year do provide few reasons to become upbeat. Even as first quarter sales rose 15% to nearly $1.5 billion, for a run rate of $6 billion, the company has been seeing some margin pressure. Operating expenses keep increasing on the back of higher general and administrative expenses and higher R&D expenses, as earnings of $1.00 per share fell four cents compared to the fourth quarter of 2021, and seventeen cents on the year before, as the question is if earnings can really improve this year.

And Now?

Following a big recent pullback and somewhat underperformance of the share price in recent years, we should in theory see Intuitive trade at more compelling valuations. While this is true, the reality is that the company still trades at near 40 times earnings, as 2022 is set to become a tough year (in terms of progress), certainly on the bottom line.

Part of the reason is, of course, that the pandemic still holds back certain operations in some geographic regions in the world. But there are other factors at hand as well, including strained budgets, more competition, and in the near term certainly issues relating to supply chain disruptions and inflationary concerns pushing down really fat margins.

Competition is a concern as well, as many big medtech names have traditionally been lagging a bit in robotics, yet they have caught up to some extent by pursuing M&A targets in the medical robotics sphere. However, often these are relatively bolt-on deals, not having the integrated solution provided by Da Vinci.

Nonetheless, I think that Intuitive is still top quality and the long-term drivers for the business are intact despite some near-term (margin) issues. Needless to say, valuations are still quite demanding, especially in the light of the current interest rate environment, but some more aggression on the balance sheet might be used (perhaps a big buyback program here) to ignite some imagination on that front as well.

While I am not just yet tempted to buy, I will start to initiate a position at levels significantly below the $200 mark, if the market tests these lows again.

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