Buying Intuitive Surgical Makes Intuitive Sense

In the health care sector, there are leaders and then there are followers. Intuitive Surgical (NASDAQ:ISRG) is a clear leader in the emerging field of robotic-assisted surgery. The company's state-of-the-art technological platform for performing less traumatic, minimally invasive surgeries has been around since the mid 1990's—but the growth runway remains long.

As more and more hospitals learn of the benefits of Intuitive Surgical's technology for general, urology, gynecology, thoracic, and other surgical procedures, the opportunity for global expansion is substantial. Let's dissect Intuitive Surgical's business model and financial strength to learn why investors should hold the stock in a long-term growth portfolio.

What Does Intuitive Surgical Do?

Intuitive Surgical makes the da Vinci robotic surgery system along with a variety of instruments and accessories that go with it. The system, which features 3-D high-definition vision, allows surgeons to conduct a range of minimally invasive surgical procedures faster and more accurately. Intuitive offers several da Vinci models ranging from a price of $0.5 million to $2.5 million.

While the da Vinci system is surely a big-ticket purchase for a hospital, Intuitive Surgical generates over half of its revenue from the related surgical instruments and accessories through its EndoWrist lineup of forceps, scissors, scalpels, and other surgical tools. The surgical systems themselves account for roughly one-third of sales and the remainder comes from services revenue. The business model, therefore, provides a steady recurring revenue base after the sale of the system.

As you'd imagine, Intuitive Surgical is active on the innovation front. It is developing additional robotic platforms including the Ion Lung Biopsy tool which is designed for minimally invasive lung biopsies. The growing use of artificial intelligence (AI) in the medical technology industry is also a source of future growth.  AI stands to enhance Intuitive Surgical' s portfolio by introducing new clinical applications and diagnostic support tools.

How is Intuitive Surgical's Financial Performance?

Before the pandemic, the company was seeing strong sales of its surgery equipment. Sales and earnings were up 20% and 16%, respectively in 2019. More than 1.2 million procedures were performed using the da Vinci system last year across the over 5,500 da Vinci systems that are in place around the world.  

More recently sales have slumped as hospitals and patients have cancelled or postponed surgeries due to COVID-19. Procedure volume is an important performance metric for Intuitive Surgical because instruments and accessories generate revenues of around $700 to $3,500 per procedure. The pandemic-related disruptions caused a 79% earnings decline in the second quarter of 2020 as demand for da Vinci instruments and accessories was muted.

Although procedure volumes have turned higher since June, as with many medical tech companies, it will probably be a while before sales return to pre-pandemic levels. Yet over time, investors should expect the company's historically strong financial performance to resume as hospitals increase their purchases of the da Vinci systems and related products.

Intuitive Surgical is the pioneer in the fast-growing robotic-assisted surgery field. It has always had a strong presence in the U.S. but has been strengthening its position in international markets by placing da Vinci systems in Europe, Japan, and China. Overseas expansion is a key growth driver.

For a while, Intuitive Surgical was the only show in town operating in a niche market. Today it faces competition from the likes of Johnson & Johnson, Stryker, Zimmer Biomet, and Medtronic. Medtronic recently launched a robotic-assisted surgical system called Hugo to go head-to-head with Intuitive Surgical. Fortunately, however, the threat of more entrants is low given the enormous amount of time and financial resources required to build a surgical robot ecosystem.

How is Intuitive Surgical' s Financial Strength?

Aside from the enormous market opportunity, Intuitive Surgical's financial strength makes it a standout growth investment. It has a pristine balance sheet that is free of long-term debt. The company's cash position is solid at $2 billion and is supported by a strong cash generation ability.

Profitability is also a noticeably good. In a normal business environment, the operating margin hovers around 40%. Intuitive' s five-year earnings growth rate is 18%.

The company will report third quarter results after the close on October 15^th. Sell-side analysts are expecting earnings per share (EPS) of $1.62 which is less than half the EPS generated in the third quarter of last year. But more importantly, it marks a significant sequential improvement from the second quarter's $0.59 EPS figure —and suggests the company is already on the fast track to recovery.

How about the valuation? Well, it is undoubtedly high at 80x earnings. But given Intuitive Surgical's growth record and outlook, along with its underappreciated financial strength, the price tag makes intuitive sense.

Although Intuitive Surgical shares trade not far from the all-time intraday high of $778.73 set last month, there appears to be more upside. Earlier this week, Raymond James reiterated its buy rating and Street-high $800 target. Once Intuitive Surgical can resume normal marketing activities, a share price of $1,000 is likely not far away.

In the coming years, demand for minimally invasive robotic surgery will be strong and Intuitive Surgical will continue to operate from a position of strength. Hospitals worldwide are expected to continue to embrace robotic surgery technology to improve surgical accuracy and market their capabilities. This means the future is bright for the medical community and its patients—as well as for Intuitive Surgical shareholders.