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Intuitive Surgical Or Varian Medical: Which Makes For A Better Play?

Apr 28 2012, 12:30 by: Tactical Investor  |  includes: FMS, HOLX, ISRG, NVS, VAR

Every man is a damn fool for at least five minutes every day; wisdom consists in not exceeding the limit - Elbert Hubbard

Two marvelous companies in the medical appliances and equipment sector are going to be examined in detail and pitted against each other in the hopes of finding a champion. Additional data has also been provided on three other plays for investors who might be looking for other ideas. At the end of the article, we will offer our opinion as to which one we think is better.

Intuitive Surgical, Inc. (ISRG) produces, designs and markets da Vinci Surgical Systems for various surgical procedures some of which include gynaecologic, urologic, cardiothoracic, etc. The system consists of a surgeons console, a vision system, a patient side cart, Firefly fluorescence imaging product, da Vinci skills simulator and proprietary wrested instruments. The system essentially translates the surgeons hand movements into corresponding movements of instruments positioned inside the patient through small incisions of minimally invasive surgery.

Reasons to be bullish on Intuitive Surgical Inc

  • It issued positive guidance for 2012. Total procedure count is expected to increase between 24%-26% in 2012. Revenues are expected to increase by 17%-19% in 2012.
  • Recurring revenues continue to grow as a proportion of total sales; they increased 30% in fiscal 2011 and accounted for 56% of total revenues during the year.
  • It operates in a niche market and has no direct competition; it acquired its only threat, Computer Motion in June 2003. It also sports operating margins of 39% and profit margins of 29%
  • A good earnings growth rate of 37%
  • A strong revenue growth rate of 27%
  • Gross profit has surged from $751 million in 2009 to $1.27 billion in 2011.
  • Net income has increased from $233 million in 2009 to $495 million in 2011.
  • EBITDA has increased from $431in 2009 million to $756 million in 2011.
  • A long-term debt to equity ratio of 0.00.
  • It has a very strong balance sheet; Cash and Cash Equivalents have increased from $221 million in 2009 to $465 million in 2011.
  • It has a good levered free cash flow of $521 million.
  • Cash flow per share has almost doubled from $7.30 in 2009 to $13.89 in 2011.
  • It has a five year sales growth average of 31%.
  • Annual EPS before NRI has almost increased by 232% from $3.70 in 2007 to $12.32 in 2011.
  • It sports excellent current and quick ratios of 4.60 and 4.10, respectively.
  • Cash flow from operating activities has increased from $392in 2009 to $677 million in 2011.
  • It sports a decent ROE of 21%.
  • Operating income is projected to rise in the range of 39%-40%.
  • $100K invested for 10 years would have grown to $3.05 million dollars.

Click to enlarge

We are bullish on Varian Medical Systems (VAR) for the following reasons:

  • Cash flow per share has increased from $3 per share to $3.94 per share.
  • Annual EPS before NRI has almost doubled from $1.84 in 2007 to $3.44 in 2011.
  • A good five year EPS growth rate of 13.5%.
  • Cash And Cash Equivalents increased from $520 million in 2010 to$564 million in 2011.
  • Cash flow from operating activities has increased over 50% from $304 million in 2009 to $472 million in 2011.
  • A good ROE of 24%.
  • A good levered free cash flow of $301 million.
  • Net income has increased from $319 million to $399 million in 2011.
  • EBITDA increased from $523 million in 2009 to $644 million in 2011.
  • A long-term debt to equity ratio of 0.00.
  • It has an incredibly strong interest coverage ratio of 158.
  • A decent quick and current ratio of 1.28 and 1.75, respectively.
  • A good three year total return of 87%.
  • It has a decent free cash flow yield of 4.22%.
  • A 5 year sales growth rate of 9%.
  • International Agency for Research on Cancer has estimated that annual cancer rates around the world are projected to increase by 50% to 15 million new cases in the year 2020. This will increase demand for cancer treatments in overseas markets, and Varian is well positioned to benefit from this rise in demand; its ex-United States sales in Asia and Europe are now growing at a much faster rate than in then back home in the U.S.
  • It is set to increase its market share in the radiation oncology market. Most international markets are not well equipped to address the growing incidence of cancer. Sales from international markets account for over 50% of its revenues.
  • It recently introduced the Truebeam system for image guided radiotherapy; Truebeam is expected to accelerate the replacement of the company's older systems. Since its launch, Varian has already landed 425 new orders for Truebeam; over 100, installations have been completed already. Its ability to effectively commercialize new products such TrueBeam, without upsetting sales of existing product lines is striking.
  • It has a strong balance sheet; debt levels are minimal, and it has a large cash surplus.
  • It uses part of its strong cash flow on it share repurchase program.
  • One could sell covered calls on Varian and in doing so convert into a dividend paying stock; the premium you receive from selling the calls could be viewed as a dividend; If implemented properly this strategy could produce quite a lucrative stream of revenue in the long run.
  • Varian continues to experience healthy growth in its order book; backlogs are growing 15% a year over year in fiscal 2011. It is also experiencing strong oncology order driven by its service business as well as demand for newer accelerators such as the Unique.
  • $100K invested for 10 years would have grown to 356K.

Many key ratios will be covered in this article and investors would do well to get handle on some of the more important ones which are dealt with below.

Long-term debt-to-equity ratio is the total long-term debt divided by the total equity. The amount of long-term debt a company carries on its balance sheet is very important for it indicates the amount of money a company owes that it doesn't expect to pay off in the next year. A balance sheet that illustrates that long-term debt has been decreasing for a few years is a sign that the company is doing well. When debt levels fall, and cash levels increase, the balance sheet is said to be improving and vice versa. If a company has too much debt on its books, it could end up being overwhelmed with interest payments and risk having too little working capital which could in the worst case scenario lead to bankruptcy.

Operating cash flow is generally a better metric than earnings per share because a company can show positive net earnings and still not be able to properly service its debt. The cash flow is what pays the bills.

The payout ratio tells us what portion of the profit is being returned to investors. A payout ratio over 100% indicates that the company is paying out more money to shareholders than they are making. This situation cannot last forever. In general if the company has a high operating cash flow and access to capital markets, they can keep this going on for a while. As companies usually only pay the portion of the debt that is coming due and not the whole debt, this technique/trick can technically be employed to maintain the dividend for some time. If the payout ratio continues to increase, the situation warrants close monitoring as this cannot last forever. If your tolerance for risk is low, look for similar companies with the same or higher yields, but with lower payout ratios. Individuals searching for other ideas might find "5 Dividend Champs To Mull Over" to be of interest.

Current Ratio is obtained by dividing the current assets by current liabilities. This ratio allows you to see if the company can pay its current debts without potentially jeopardizing future earnings. Ideally, the company should have a ratio of 1 or higher.

Price to free cash flow is obtained by dividing the share price by free cash flow per share. Higher ratios are associated with more expensive companies and vice versa. Lower ratios are generally more attractive. If a company generated $400 million in cash flow and then spent $100 million on capital expenditure, then its free cash flow is $300 million. If the share price is $100 and the free cash flow per share is $5, then the company trades at 20 times-free cash flow. This ratio is also useful because it can be used as a comparison to the average within the industry. This gives you an idea of how the company you are interested in holds up to the other companies within the industry.

Interest coverage is usually calculated by dividing the earnings before interest and taxes for a period of one year by the interest expenses for the same time period. This ratio informs you of a company's ability to make its interest payments on its outstanding debt. Lower interest coverage ratios indicate that there is a larger debt burden on the company and vice versa. For example if a company has an interest ratio of 11.8, this means that it covers interest expenses 11.8 times with operating profits.

Price to tangible book is obtained by dividing share price by tangible book value per share. The ratio gives investors some idea of whether they are paying too much for what would be left over if the company were to declare bankruptcy immediately. In general stocks that trade at higher price to tangible book value could leave investors facing a great percentage per share loss than those that trade at lower ratios. The price to tangible book value is theoretically the lowest possible price the stock would trade to. Additional key metrics are addressed in "Royal Gold Among 5 Attractive Naked Put Plays".

Intuitive Surgical Inc

Levered Free Cash Flow: 521M

Growth

  1. Net income for the past three years
  2. Net Income 2009 = $233 million
  3. Net Income 2010 = $382 million
  4. Net Income 2011 = $495 million
  1. EBITDA 12/2011 = $756 million
  2. EBITDA 12/2010 = $613 million
  3. EBITDA 12/2009 = $431 million
  1. Total cash flow from operating activities
  2. 2009 = $392.2 million
  3. 2010 = $545.8 million
  4. 2011 = $677.6 million
  1. Cash Flow 12/2011 = 13.89 $/share
  2. Cash Flow 12/2010 = 10.75 $/share
  3. Cash Flow 12/2009 = 7.3 $/share
  1. Annual EPS before NRI 12/2011 = 12.32
  2. Annual EPS before NRI 12/2010 = 9.47
  3. Annual EPS before NRI 12/2009 = 6.23
  4. Annual EPS before NRI 12/2008 = 5.12
  5. Annual EPS before NRI 12/2007 = 3.7

Performance

  1. ROE = 20.77%
  2. Return on Assets = 15.6%
  3. Quarterly Earnings Growth = 37%
  4. Quarterly Revenue Growth = 27%
  5. 5 year sales growth = 31%
  1. Price to Sales = 12.28
  2. Price to Book = 7.82
  3. Price to Tangible Book = 8.45
  4. Price to Cash Flow = 38.80
  5. Price to Free Cash Flow = 36.60
  1. Current Ratio = 4.60
  2. Current Ratio 5 Year Average = 4.7
  3. Quick Ratio = 4.10
  4. Cash Ratio = 3.3
  1. Total return last 3 years = 283%
  2. Total return last 5 years = 330%

Varian Medical Systems, Inc.

Levered Free Cash Flow: 301.75M

Growth

  1. Net income for the past three years
  2. Net Income 2009 = $319 million
  3. Net Income 2010 = $360 million
  4. Net Income 2011 = $399 million
  1. EBITDA 12/2011 = $644 million
  2. EBITDA 12/2010 = $585 million
  3. EBITDA 12/2009 = $523 million
  4. Net income Reported Quarterly = $90 million
  1. Total cash flow from operating activities
  2. 2009 = $304.44 million
  3. 2010 = $460.79 million
  4. 2011 = $472.78 million
  1. Cash Flow 12/2011 = 3.94 $/share
  2. Cash Flow 12/2010 = 3.42 $/share
  3. Cash Flow 12/2009 = 3 $/share
  1. Annual EPS before NRI 12/2011 = 3.44
  2. Annual EPS before NRI 12/2010 = 2.96
  3. Annual EPS before NRI 12/2009 = 2.65
  4. Annual EPS before NRI 12/2008 = 2.31
  5. Annual EPS before NRI 12/2007 = 1.85

Performance

  1. ROE = 28.4%
  2. Return on Assets = 14.36%
  3. Quarterly Earnings Growth = -6.5%
  4. Quarterly Revenue Growth = 7.8%
  1. Price to Sales = 2.72
  2. Price to Book = 5.29
  3. Price to Tangible Book = 6.27
  4. Price to Cash Flow = 16.10
  5. Price to Free Cash Flow = 23
  6. 5 year sales growth= 9%
  1. Current Ratio = 1.75
  2. Current Ratio 5 Year Average = 1.83
  3. Quick Ratio = 1.28
  4. Cash Ratio = 0.72
  5. Interest Coverage = 158.61
  1. Total return last 3 years = 87%
  2. Total return last 5 years = 50%

Other interesting companies

Hologic Inc. (HOLX)

Levered Free Cash Flow: $506 million

  1. Net income for the past three years
  2. Net Income 2009 = $ 2.2 billion
  3. Net Income 2010 = $-62.8 million
  4. Net Income 2011 = $157.1 million
  1. Total cash flow from operating activities
  2. 2009 = $550 million
  3. 2010 = $456 million
  4. 2011 = $ 456 million
  1. Gross Profit
  2. 2009 = $857 million
  3. 2010 = $ 736 million
  4. 2011 = $ 923 million
  1. 5 year sales growth= 23.9%
  2. Total return 3 year average= 59%

  1. Current Ratio = 2.2
  2. Quick Ratio = 2.8
  3. Long term debt to equity= 0.51
  4. Interest Coverage = 3.2

Fresenius Medical Care AG & Co (FMS)

Levered Free Cash Flow: 684.74M

  1. Net income for the past three years
  1. Net Income 2009 = $965 million
  2. Net Income 2010 = $1065 million
  3. Net Income 2011 = $1177 million
  1. Total cash flow from operating activities
  2. 2009 = $1.34 billion
  3. 2010 = $1.37 billion
  4. 2011 = $1.45 billion
  1. Cash Flow 12/2011 = 5.42 $/share
  2. Cash Flow 12/2010 = 4.97 $/share
  3. Cash Flow 12/2009 = 4.61 $/share
  1. Annual EPS before NRI 12/2011 = 3.54
  2. Annual EPS before NRI 12/2010 = 3.25
  3. Annual EPS before NRI 12/2009 = 2.99
  4. Annual EPS before NRI 12/2008 = 2.79
  5. Annual EPS before NRI 12/2007 = 2.43

  1. ROE = 13.07%
  2. Quarterly Earnings Growth = 14.4%
  3. Quarterly Revenue Growth = 4.9%
  1. Current Ratio 09/2011 = 1.34
  2. Current Ratio 5 Year Average = 1.39
  3. Quick Ratio = 1.11
  4. Cash Ratio = 0.45
  5. Interest Coverage 09/2011 = 6.08

Novartis AG Common Stock (NVS)

Levered Free Cash Flow: 11.52B

  1. Net income for the past three years
  2. Net Income 2009 = $8400 million
  3. Net Income 2010 = $9794 million
  4. Net Income 2011 = $9113 million
  1. EBITDA 12/2011 = $11524 million
  2. EBITDA 12/2010 = $12394 million
  3. EBITDA 12/2009 = $10473 million
  4. Net income Reported Quarterly = $1175 million
  1. Total cash flow from operating activities
  2. 2008 = $9.67 billion
  3. 2009 = $12.2 billion
  4. 2010 = $14.07 billion
  1. Cash Flow 12/2011 = 5.52 $/share
  2. Cash Flow 12/2010 = 5.25 $/share
  3. Cash Flow 12/2009 = 3.72 $/share
  1. Annual EPS before NRI 12/2011 = 5.57
  2. Annual EPS before NRI 12/2010 = 5.13
  3. Annual EPS before NRI 12/2009 = 3.7
  4. Annual EPS before NRI 12/2008 = 3.59
  5. Annual EPS before NRI 12/2007 = 2.81

  1. ROE = 13%
  2. Return on Assets = 6%
  3. Quarterly Earnings Growth = -45.8%
  4. Quarterly Revenue Growth = 3.7%
  5. 5 year sales growth= 10.4%
  1. Price to Sales = 2.23
  2. Price to Book = 2.01
  3. Price to Tangible Book = 33.73
  4. Price to Cash Flow = 14.30
  5. Price to Free Cash Flow = 23.00
  1. Current Ratio 09/2011 = 1.04
  2. Current Ratio 5 Year Average = 1.41
  3. Quick Ratio = 0.78
  4. Cash Ratio = 0.34
  5. Interest Coverage = 8.25
  6. Total return last 3 years = 67%
  7. Total return last 5 years = 10%
  1. Payout Ratio 09/2011 = 0.36
  2. Payout Ratio 5 Year average 09/2011 = 0.34
  1. Dividend yield 5 year average = 4%
  2. Dividend growth rate 3 year average = 13.01%
  3. Dividend growth rate 5 year average = 18.15%
  4. Consecutive dividend increases = 5 years
  5. Paying dividends since = 1992

Conclusion

Once again, both companies make for good long-term investments, but we would have to side with Intuitive Surgical Inc - it leads Variance medical in the following areas:

  • 5 year sales growth of 31% Vs 9% for VAR
  • A quarterly earnings growth rate of 37% Vs -6.5% for VAR
  • A quarterly revenue growth rate of 27% VS 7.8% for VAR
  • A ROE of 21% Vs
  • Year over year growth rates for 2012 and 2013 of 19.4% and 16.8% Vs 10.5% and 17% for VAR
  • Total 3 year return of 283% Vs 87% for VAR
  • $100K invested for 10 years would have grown to a whopping $3.05 million Vs $356K for VAR

Investors would do well to wait for a pullback before committing fresh money to this market; granted the process of waiting appears to not have paid off so far, but history clearly indicates that when one follows the masses, one is bound to run into trouble. The markets are extremely overbought and need to let out some steam before they resume their upward trend and attempt to put in a series of new 52-week highs.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Additional disclosure: EPS, Price, EPS surprise charts obtained from zacks.com. A major portion of the historical data used in this article was obtained from zacks.com. Earnings estimate and growth tables sourced from dailyfinance.com.

Disclaimer: This list of stocks is meant to serve as a starting point. Please do not treat this as a buying list. It is imperative that you do your due diligence and then determine if any of the above plays meet with your risk tolerance levels. The Latin maxim caveat emptor applies-let the buyer beware.

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