Shares of Intuitive Surgical (ISRG) plunged in Tuesday's trading session. The producer of surgical robots, known from the da Vinci robot, reported its preliminary second quarter results on Monday after the close.
I continue to be very cautious to pick up any shares at these levels. The intensified scrutiny about healthcare costs at large, and discussion about the benefits of the robot in "normal" surgical procedures will harm the short-to-medium term prospects.
With roughly a sixth of GDP being devoted to healthcare costs in the US, there will be pressure on all partners involved in the healthcare systems to reduce costs, including Intuitive Surgical. While sales of new systems have come under pressure now, and are the major driver behind the poor results, there are more threats ahead. The high variable costs of the surgeries performed by the da Vinci robot could provide a threat to the lucrative and still stable cash flows from the instruments and accessories business.
Intuitive Surgical generated preliminary second quarter revenues of $575 million, up 7% on the year before.
Net income is expected to come in around $160 million, up slightly from last year's second quarter net income of $155 million.
CEO Gary Guthart commented on the disappointing developments, "While we are disappointed in our performance this quarter, particularly with respect to our capital sales in the US, overall procedure performance was solid in a difficult environment. We remain confident in the value that our products and services bring to patients, hospitals and the healthcare system."
Intuitive Surgical will release its definitive second quarter results on the 18th of July.
A Look Into The Warning
Revenues from instruments and accessories are expected to increase by about 18% to $265 million. Procedure growth was offset by a reduction in stocking orders which are tied to system sales which declined.
The real shocker was a 6% decline in revenues from the da Vinci Surgical Systems, expected to come in at $215 million. The company sold 143 systems, down from 150 systems last year. Economic pressure on hospitals in the US limited sales to 90 machines as growth in benign gynecological procedures is moderating.
Arguments made by some analysts about hospitals delaying large investments ahead of "Obama-care" are not too convincing as the performance in international markets was disappointing as well. Finally, service revenues are expected to increase by 14% to $95 million as the installed base of systems continues to grow.
Intuitive Surgical ended its first quarter with $3.12 billion in cash, equivalents and short-term investments. The company operates without any debt outstanding for a solid net cash position.
For the full year of 2012, Intuitive Surgical generated revenues of $2.18 billion, up 24.0% on the year before. Net income rose by 32.6% to $656.6 million in the meantime.
Trading around $425 per share following the disastrous news, Intuitive is valued around $17.2 billion. This values the firm's operating assets at $14.1 billion, factoring in the solid net cash position. As such, the firm's operating assets are valued at 6.5 times annual revenues and 21-22 times annual earnings.
Despite the solid financial position, Intuitive Surgical does not pay a dividend at the moment.
Some Historical Perspective
The long-term success of the da Vinci systems has resulted in handsome returns for long-term investors. Shares traded as low as $15 back in 2004, to rally to highs around $580 in 2012 and early this year. Shares have given up some 30% of their value from that peak.
Between 2009 and 2012, Intuitive Surgical more than doubled its annual revenues to $2.18 billion. Profit growth was even more spectacular as net earnings nearly tripled to $656.6 million in the meantime.
The slowdown in revenue growth for the second quarter is quite aggressive, warranting Tuesday's sell-off. First quarter revenues rose 23.5% on the year before to $611.4 million, and were up 0.3% on the quarter before. Yet second quarter revenues are expected to grow by merely 7% on the year to $575 million, being down 6% compared to the previous quarter.
Net income is expected to rise by merely 3.2% to $160 million, but will fall an expected 15% on the year before. The revenue guidance is terrible, as it falls short almost $55 million versus consensus estimates of $629.6 million.
Intuitive Surgical blames a decline in admissions, fewer gynecology procedures and more conservative reimbursements by insurers for the slowdown in revenue growth. While the company sees a large market potential for "normal" standard procedures, it appears that insurers are rapidly becoming more cost-aware, not willing to reimburse expensive da Vinci operations for standard procedures.
This threatens the "Razor/Razor Blade Model" as described by JF Global Investing in their article following the news. I tend to disagree to some extent. The poor system sales are not automatically made up for by recurring revenue streams for an existing installed machine base. The variable costs per surgery are significantly higher compared to traditional surgery as well, which threatens the stable cash flow as cost-consciousness could harm demand for its instruments.
Back in March of this year, I took a look at Intuitive's shares after they had fallen towards $460 on the back of critical comments from the American Congress of Obstetricians and Gynecologists. I argued that the valuation did not offer a comfortable margin of safety as the "growth" market, being the normal procedure market, might actually slow growth down. Insurers and society at large are not willing to pay excessive amounts for standard procedures with minimum additional benefits over normal surgery.
I reiterate my stance at the moment. The revenue miss amounts to almost 10% of total revenues, which is really bad. The bad publicity and scrutiny about healthcare costs are impacting the results already at the moment.
While the long-term prospects of the company appear to be rosy, the scrutiny about healthcare costs and benefits could continue to weigh on shares in the short-to-medium term. For current investors, this is a painful lesson as they took a hard hit on the "double-whammy." It was not just earnings growth which slowed down, investors attached a lower price-earnings ratio to these earnings as well.