There's little question that Intuitive Surgical (ISRG) has been one of the all-time great med-tech stocks and arguably has claim to a spot on the all-time list irrespective of industry. Not only has the company managed to drive strong adoption in selected indications, but virtually no credible competition has emerged in the robotic surgery space. Along the way, Intuitive has successively blown through price targets and typical standards of what makes for a fair price.
Q1 - More Of The Same
In most respects, the first quarter of 2012 was a pretty typical quarter for Intuitive Surgical. Revenue rose 28% (and beat estimates), as the company coupled 32% instrument/accessory growth to 24% system revenue growth. System sales rose 17% to 140 despite some weakness in Europe, and procedure growth remained strong (up 28%).
Margins were also solid. Gross margin ticked up slightly and operating income rose 30% as the company continues to see solid operating leverage despite ongoing R&D investment.
Gynecology In The Rapid Adoption Phase, Colorectal Just Getting Started
At this point, Intuitive has about one-third of the U.S. market for hysterectomies - a point where adoption really took with the da Vinci system in prostatectomies. Given that robot-assisted hysterectomy offers basically the same benefit profile (shorter recovery stays, less pain, fewer complications), it seems reasonable to expect a similar ramp.
Better yet, though, is the opportunity for add-on usage. As ob/gyns become more comfortable with the robotic approach, robotic procedure counts in myomectomies and sacrocolpopexies could also increase.
Intuitive is also talking more now about new indications in general and colorectal surgery. These haven't been big markets to date, but cholecystectomy (gall bladder removal) procedures seem to be taking off with the earlier introduction of the Single Site instrument. Along similar lines, the approval of a new stapler in the second half of 2012 should be a boost to expanding efforts in colorectal procedures.
Is $1,000 Reachable?
The real question for Intuitive is just how much share they can grab in the surgery market. Skeptics like to point out the flaws of the da Vinci (it's large, it's expensive, it leads to longer procedure times) and claim that it will be a niche application, but it seems like that addressable "niche" keeps getting larger.
At present, da Vinci has about 20% share of the company's designated target market and less than 1% of the share of the surgical market for North America, the EU, and Japan. Moreover, compared to the traditional surgery businesses of companies like Johnson & Johnson (JNJ), Covidien (COV), and Bard (BCR), Intuitive has just scratched the surface.
The bad news for investors is that management's targets may not be ambitious enough at this point. Two million procedures (and the surrounding service and system revenue) is roughly where Intuitive needs to be in just six years to be on target for $1,000 on a cash flow basis. But to stay on track for that goal, the company needs to see over 5.5 million da Vinci-assisted procedures worldwide by 2022. Admittedly that's still a small sliver of the addressable surgical market, but it means nearly 30% annual procedure growth for a decade and an installed base of roughly 28,000 systems.
Now that presupposes that Intuitive fits into a conventional discounted cash flow analysis - something it really hasn't done for years. Let's say Intuitive trades at 10x sales on into the future (a very large premium for most medical device companies) - that still means that the company needs to hit two million procedures in roughly 4 to 5 years and that suggests a surge in procedure volume growth that just doesn't seem possible given hospital capital budgets and Intuitive's own system-building capacity.
The Bottom Line
Clearly $1,000 is just an arbitrary target, but the fact remains that some exceptionally demanding estimates already seemed to be baked into these shares - about $3.5 billion in revenue in 2017 at 10x sales, a target that implies compound procedure growth in excess of 23%. Certainly the developed world hospital market is not yet saturated with da Vinci robots, and doctors have only scratched the surface with what it can do, but a lot is already expected.
Remember, too, that reimbursement and procedural alternatives are also potential issues. Will insurance companies, Medicare, and other national payor systems continue to support relatively expensive procedures in a world where almost everything else is getting squeezed? What's more, drug-coated stents and transcatheter heart valves will likely shrink the open heart surgery market, and companies like Johnson & Johnson and Covidien continue to develop tools that permit much less invasive procedures without the need for a six-figure robot.
I've given up sounding the alarm on Intuitive's valuation, as investors are clearly willing to pay a huge premium for a company with limited competitive threats and enormous addressable markets. I would suggest, though, that these shares are largely a momentum trade on procedure growth and any stumbles in that regard won't go over well.