Back in early February, I proclaimed that Intuitive Surgical (ISRG) could be a $700 stock within the next two years. Today, I stand by my bullish call, and in fact, may be even more positive on the name given recent weakness in global markets. Intuitive is the leader in its industry and still has tremendous growth ahead. The business is very high margin, and the company has an exceptional balance sheet. Let's take another look at this jewel of a name.
Since I last fully analyzed the name, we have seen one earnings report. All the company did was report revenues of $495 million and earnings per share of $3.50, which only beat by $30 million and $0.35 respectively. Another ho-hum huge beat for the company, which has been known for crushing estimates quarter after quarter.
The following table breaks down the Q1 top line results over the past four years, and the associated costs with each product line.
|Cost of Revenues||2009||2010||2011||2012|
|Cost of Revenues||$59.7||$88.1||$109.3||$139.3|
|Gross Margin $||$128.7||$240.5||$278.8||$355.9|
|Gross Margin %||68.31%||73.19%||71.84%||71.87%|
So year over year, product revenues were up 28% and service revenues were up 27%. Not exactly small potatoes. The company was also able to squeak out a small gain in gross margins from the prior year. It was only 3 basis points, but that's better than the year over year decline from 2010 to 2011.
But the company was able to keep operating expenses under control as well. Selling and administrative expenses were up just 25.3% year over year, and R&D expenses were up just 22.3%. That really helped operating margins for the period. The company also saw a lower effective tax rate, dropping from 32.23% in the prior year's period to 27.19% in this period. That helped the bottom line.
The following table shows where the Q1 margins have been over the past four years. While gross margins are not at their highest point, they are still close to 72 percent, a very high number. Operating margins are close to the 2010 high, and net profit margins are near 29%, a more than 2 full percentage point increase over last year's number. This company has nearly doubled profit margins in the past three years. Other than a company like Apple (AAPL), you won't find that kind of improvement anywhere else.
Balance Sheet Strength / Stock Buybacks:
Intuitive Surgical's very strong growth and high profits in recent years has greatly increased the strength of its balance sheet. The following table shows some key financial numbers and ratios at the end of Q1 over the past four years (numbers in millions).
|Cash & Investments||$821.7||$1,395.5||$1,757.0||$2,371.0|
While the current ratio did decline, it is not uncommon for a growth company like this to see this decline. It is pure math. Current Liabilities are starting at a smaller base number, so as they expand slightly faster, the current ratio declines. Yes, the amount of working capital has decreased in the past year. However, that is mostly due to the acquisition of long-term investments, which have nearly doubled in the past 12 months. As shown above, the company has almost $2.4 billion in cash and investments on its balance sheet, nearly triple the amount of three years ago. Intuitive is in great financial strength, and the company should get even stronger going forward.
That financial flexibility has allowed the company to increase the size of its share repurchase plan. At the end of Q1, the company had $568.2 million left on its current plan. The company did not buy back any shares in Q1, as they have been very selective with their program. It is unlikely that they bought any shares back when we were getting close to $600, but on this recent fall, I would expect them to scoop up some shares. As the company continues to increase its profit margins, the buyback will also help earnings per share growth.
If that Q1 report wasn't good enough for you, the company also increased their expectations for the year. Here's what they said:
- Da Vinci procedure growth in 2012 to be 25% to 27% from 2011 levels, compared to prior guidance of 24% to 26%.
- Sales growth of 19% to 21%, compared to prior guidance of 17% to 19%. Wall Street expectations at that time were for 18.5%.
When I covered the name in February, estimates called for 18.2% revenue growth and $14.49 in earnings per share for 2011. Estimates for 2013 called for 15.5% revenue growth and $16.94 in earnings per share.
Today, estimates call for 21.3% revenue growth this year and 16.9% next year. Earnings per share forecasts stand at $14.73 and $17.35 respectively. If the company beats again in Q2 by another nice margin, expect estimates to rise to roughly $15 and $17.75, respectively. I said in February that I expect about $18.50 in 2013 earnings, but with another good quarter, I probably will up my number to $19. I also said in February that when all is said and done (when we look at the numbers in early 2014), $20 could be possible.
Valuation / Price Movement:
I used the following table in my February article, and I'll bring it back here. Critics of Intuitive have claimed that the price to earnings multiple is just way too high, but sometimes, you have to pay a premium for a company as strong as this. Investors in recent years have been willing to pay this premium, and I expect they will pay a fair valuation for the next couple of years at least. The table shows the high and low price to earnings multiple, along with the average, since 2006. The numbers are based on that year's highest and lowest stock price, and the actual earnings per share achieved that year.
Based on Intuitive's 2012 range of $429.26 to $594.89, the stock has traded at a P/E multiple so far this year of 29.1 to 40.4. That is comparable to 2010 numbers at the moment. However, that is based on the current expectations for $14.73 in earnings per share. Since I'm guessing the company will do between $15 and $16 in earnings this year, the valuation number will come down a bit more.
Thanks to the Q1 beat and the continued greatness of the company, analysts have raised their price targets over the past few months. The current average price target is $585, with a range of $475 to $670. I figure those targets will continue to increase if the company continues to do well, and I stand by my $700 prediction for 2013.
Competitors / Other Names in the space:
Intuitive is considered a medical equipment name, so there are a few other names that could be called competitors. However, they aren't 100% truly competing, as Intuitive doesn't have a main competitor, not in the Coca-Cola (KO) versus Pepsi (PEP) sense anyway.
When I hear about Intuitive, the next logical name brought up is Mako Surgical (MAKO), which develops robotic arms and orthopedic implants for orthopedic procedures. Mako is a small company, with a market cap that's less than a billion. Intuitive's market cap is $20 billion. Mako is growing revenues faster (expected growth of more than 40% this year and next), but the company is not profitable yet. Current forecasts don't have Mako turning a profit until at least 2014. Mako's balance sheet has also worsened in the past year, while Intuitive has improved theirs by the quarter.
Accuray (ARAY) is another smaller name that is involved in the development of medical radiation systems. Their CyberKnife system is an image guided robotic radiosurgery system used for the treatment of tumors. Like Mako above, Accuray is showing explosive revenue growth right now, but is not a profitable company, and may also be two years or more away from profitability. The market cap of this name is less than $440 million.
The biggest name in the medical device industry is Medtronic (MDT). Medtronic is nearly twice the size of Intuitive Surgical, but is more involved in the development of defibrillators and pacemakers. Medtronic is more of a value play. The company boasts a 2.7% dividend, but is only projected for revenue and earnings growth in the low to mid single digits for both this year and next. Intuitive also trades at 1.7 times the five year expected earnings growth figure, while Medtronic trades at 1.96 times. Medtronic is the biggest name in the space, but is unlikely to heavily compete with Intuitive right now.
Johnson and Johnson (JNJ), one of the world's largest healthcare names, also has a medical devices business. However, as I mentioned in my previous Intuitive article, J&J is actually a partner to Intuitive in some countries, including Japan. J&J and Intuitive work on procedures together, and are looking for government approval to do even more procedures going forward. Johnson and Johnson has always been rumored as a potential acquirer of Intuitive, and the fit seems logical. However, I see that unlikely at this point given the size of Intuitive. Maybe a few years ago when the market cap was in the $5 to $10 billion range, but not at $20 billion plus. Intuitive and J&J are good partners, and it is likely that the relationship will expand going forward.
Intuitive closed Friday at $503, down about $20 on the day. That means the stock is trading at 34 times the currently expected earnings for this year. To me, that valuation is not unreasonable for a company with very high margins and a crystal clear balance sheet. The company is still growing revenues and profits at a nice clip, and will have the continued ability to buy back its stock. Intuitive is now down more than $90 from its 52-week high. To me, this is a great buying opportunity for long term investors. However, I would caution that if you expect the markets to continue lower, you might want to wait. As a high growth name, Intuitive could continue to be hit. For those looking to enter, it might be wise to start a position at this level, but be ready to accumulate more if it goes lower.