The frustrating reality with Intuitive Surgical (ISRG) is that there is not going to be any easy way to get into this stock. Investors either have to accept that the high valuation is the admission price for the best growth story in med-tech or they have to hope for a stumble that drives momentum investors away for a bit. That's a shame, as this is definitely a company to own at the right price.
A Nearly Flawless Quarter In Most Respects
Intuitive reported nearly 28% sales growth in the fourth quarter, easily exceeding even the highest guess on the Street despite a steady upward march in estimates. Revenue growth was quite well-balanced, as revenue from system sales rose 27%, instrument revenue rose 30%, and service revenue climbed 24%.
Intuitive Surgical's robots and proprietary tools have long commanded great margins and this quarter was no exception. Gross margin expanded half a point from last year and about 10bp sequentially, while operating income rose more than 30%.
Procedure Growth The One Noticeable Scratch
Such are the expectations and valuation on this stock that there's no room for any perceived problem. This time around it was procedure growth. Although procedure growth had been trending around 30% year-on-year for the last few quarters, this quarter it dipped to 27%.
U.S. procedure growth was down a little, but it was Europe that really pulled down the numbers. Unfortunately, this may persist as European countries are looking to cut costs wherever possible and the state-sponsored healthcare systems are a ripe target.
Still Ample Placement Potential
Intuitive placed 23% more new systems this quarter, with about two-thirds of the placements being net-new additions. Here too Europe may be about to see a slowdown - with tighter budgets all around, the cost of the systems (and the subsequent higher procedure costs) frankly matters more than the incremental benefits in patient outcomes.
As Europe wobbles, Japan may be about to come online in a bigger way. Japan is not especially hospitable to new medical technology (particularly technology developed outside of Japan), but Intuitive Surgical management has been working patiently to get reimbursement in place. Right now there are just 40 systems in place in Japan - a number that flat-out puny when you consider that there are 36 in South Korea - and though this is a wildcard, it's one that can only help the company.
The Question Of How And Where To Expand
Intuitive has the not inconsiderable task of managing expectations and keeping the Street patient with its growth strategy. While the company has been very good at making the daVinci system the veritable go-to approach for prostatectomy and is on the same path in hysterectomy, it has been surprisingly methodical (for a cash-rich growth company) about expanding its potential markets.
Perhaps too methodical. Intuitive's robotic approach would seem to lend itself well to cardiac valve repair and replacement procedures, but there's a real risk that transcatheter approaches from Edwards Lifesciences (EW), Medtronic (MDT), or St. Jude Medical (STJ) will steal the show before Intuitive even really tries this market. Likewise, in coronary bypass where there are already catheter-based approaches on the drawing boards.
Luckily for Intuitive, there are plenty of other fish in the sea. Gastric bypass and other GI/colorectal procedures could be real growth opportunities for Intuitive, and perhaps a risk for Covidien (COV). A new Intuitive stapling device should hit the market late in 2012 or early in 2013 and facilitate that expansion into new surgical areas.
That doesn't necessarily answer the question of whether Intuitive could or should do more with its capital. If Stryker (SYK) sees enough potential in orthopedics-focused robotics that it has publicly mused about developing a product to compete with MAKO Surgical (MAKO), that may well be a market for Intuitive to consider as well. Likewise, image-guided therapy would seem to be another logical growth opportunity for future R&D and product development.
The Bottom Line
The best chance investors have of getting Intuitive Surgical shares at anything like a reasonable price is if procedure volume in Europe continues to weaken. As the European medical community pretty much goes on vacation for the summer (and procedure volumes dip noticeably), that could set up the potential for an even bigger apparent drop in procedures and more weakness in the stock.
As far as strategies go, that's admittedly feeble. Unfortunately, that's about the only way to get in without explicitly buying expensive shares and just hoping that the growth lets it all work out in the end. That has largely worked so far with this stock, but as late 2009 and mid-to-late 2010 show, this is a stock that does periodically get significantly cheaper and it's worth waiting for another sell-off before buying.