Seeking Alpha
Long only, deep value, growth at reasonable price
Profile| Send Message|
( followers)  

Summary

  • Slow adoption rate of the Da Vinci Systems is causing the revenues as well as earnings to fall.
  • ISRG's decision to focus on high-growth regions should pay-off in the short-term as well as long-term.
  • The current valuation of the stock is a bit stretched, but the strength of the technology and the long-term prospects of the company make it a good pick.

Intuitive surgical (NASDAQ:ISRG) is a U.S. based manufacturer of robotic surgical systems. It is famous for inventing the da vinci Surgical System which allows doctors to perform surgeries remotely with the use of robotic manipulators. The company recently announced its earnings with a surprise for the investors and beat the consensus, which led the stock price to skyrocket with roughly 20% increase. However, recently, the stock price has come under debate and there are doubts about the current valuation. We will try to assess the future growth prospects of the business and also look at the current valuation of the stock - we will also try to determine whether the future growth of the business is enough to justify the current valuation of the stock.

A Glance at the Earnings

In the second quarter of 2014, Intuitive surgical reported $104 million in profits which represents a decrease of about 35% compared to the last year - revenues also fell to $512.2 million recording a decrease of 11%. However, these figures were far better than what the market was expecting. Furthermore, the number of systems shipped stood at 96, up from 87 in the same period last year, which represents an increase of about 10%.

The orders for Intuitive Surgical are slowing down due to the slow acceptance of robotic systems in the market. However, services related to the systems already sold are increasing. The company saw a year-over-year decline of about 16% in the product revenues, but services revenue increased by about 9% in the same period. As opposed to the revenue decline of products, its cost of revenue of products decreased only 5.2%. This represents a decrease in gross profit or, in simple words, its efficiency. On the other hand, cost of services revenues rose 5.86% as opposed to services revenue increase of 8.6%. This means that its efficiency related to services is increasing. A breakup of these figures is shown in the following table.

Source: SEC Filings

Profitability Will Increase

Due to the expensive nature of the company's product, Intuitive Surgical offers sales-type lease for its Da Vinci Surgical Systems. Therefore, the existing leases could also be considered as its order backlog as the customers will pay in installments. In the second quarter, the company's gross lease receivables saw a robust increase of over 217% from $10.1 million to $32 million. Moreover, the maturities of these receivables suggest that the company will be more profitable in the next three years. The following table shows a clear picture of the said increase.

Source: SEC Filings

Expansion

Although the company has been facing slow growth due to its product's acceptance in the current geographical segments; it has been taking measures to increase its global presence. Intuitive surgical is focusing on markets, which are developing with a higher rate. For this reason, it recently announced that it will begin direct sales in Japan through a strategic alliance with Adachi Co. Under this program, Adachi employees will be hired by the company who are already familiar with the da Vinci business. This way, it will increase its local presence in Japan, which will allow the company to have better adaptability with the dynamics of the Japanese market. This agreement is not just limited to Japan, under this agreement, the company will further expand its operations into Asia-Pacific, which will further derive its growth.

Valuation

Due to better than expected earnings, the stock price of Intuitive Surgical shot up and went close to $475 per share; this was the first time after April that the stock price had reached $475 - however, the stock again started trending downwards and currently it stands at around $467. In order to have an idea whether the stock is still undervalued or not, we will look at Enterprise Value to EBITDA ratio of the company in focus and compare it with its peers. For interpretation, a lower ratio suggests that the stock is undervalued. We have chosen Medtronic (NYSE:MDT), UnitedHealth Group Incorporated (NYSE:UNH), and HCA Holdings (NYSE:HCA) as peers in the Healthcare industry.

ISRG

MDT

UNH

HCA

EV/EBITDA

23.69

10.89

8.72

8.42

According to the above figures, Intuitive surgical is way above its peers in the healthcare industry. The valuation on its own represents that the stock is highly overvalued at its current enterprise value. Based on the numbers only, the stock is overvalued at current price levels and the slow adoption rate is also creating doubts in investors' minds. However, there is no doubt about the technology that the company holds and its asset is extremely attractive. ISRG needs to find ways to increase the market penetration of its products. In the long term, we believe ISRG's technology will get better acceptance and the stock will prove to be a good investment.

Conclusion

Intuitive surgical is making the right moves by shifting its focus to strong growth geographical segments. Although, robotic instruments are not a big part of the Healthcare industry yet; it is slowly gaining the attention of this industry. With a wider spectrum of markets to cover, even slower growth rate will pay off for the company in the coming years. Currently, the stock has touched its peak and is heading to stability. Intuitive Surgical investors should hold onto their positions and wait as the adoption rate for da vinci Systems gathers pace.

Additional Disclosure: This article is for educational purposes only and it should not be taken as an investment recommendation. Investing in stock markets involves a number of risks and readers/investors are encouraged to do their own due diligence and familiarize themselves with the risks involved.

You can subscribe for real time alerts by clicking on the button at the bottom of this article, and you can also follow us on twitter here: twitter.com/IAEResearch

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

Source: Is Intuitive Surgical Still A Good Investment?