Intuitive Surgical Returns To Growth, Sort Of

| About: Intuitive Surgical, (ISRG)
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Summary

Q1 revenue grew 15% y/y, but was down 13% over 2 years.

Q1 EPS was up 127% y/y GAAP, but just 1% non-GAAP.

Growth since 2012 has not been impressive; assigning a P/E ratio target is difficult.

Business Model

Intuitive Surgical (NASDAQ:ISRG) reported first-quarter results on April 21. Net income growth y/y was particularly strong at 119% non-GAAP, which would seem to more than justify Intuitive's trailing EPS of 48.9 and $19.2 billion market capitalization. However, revenue growth has not been as strong over a two-year period, so some caution about projecting out future growth is warranted.

Intuitive makes surgical robots and is the world leader in that market. Except in some specialty area, it has little competition. Yet, Intuitive cannot charge monopoly prices, because it is constrained by the ability of medical systems, both government and private, to allocate capital and pay for surgeries.

The company's revenue has three major components: the robot systems themselves; accessories and instruments (which usually can be used only once before disposal); and services. As the number of robots in the field has accumulated over the years, the accessories and instruments segment has become the largest revenue generator. As a result, the number of surgical procedures and the revenue they generate is a good indicator of growth.

Analysis of revenue trends

Revenue in Q1 2015 was $532.1 million, down 12% sequentially from $604.7 million and up 15% from $464.7 million in the year-earlier quarter. The sequential decrease can be discounted as being within the range of normal seasonality though it had some specific amplifiers this quarter, in particular low sales in Japan, as hospitals awaited the approval of the more advanced da Vinci Xi systems, which came late in the quarter.

The y/y revenue advance was healthy, and when combined with a faster growth rate for profits, would tend to justify long-term optimism and Intuitive's high P/E.

Table 1 paints a slightly different view:

Q1, year of 2012 2013 2014 2015
Revenue, in millions, GAAP $495.2 $611.14 $464.7 $532.1

Intuitive was a rapidly growing company, one of the wonders of the biotechnology world, from its IPO until roughly 2013, except for the rough patch everyone had at the beginning of the Great Recession.

Q1 2015 revenue was down 13% from Q1 2013. Over the three-year period, Q1 2015 was only up 7% from Q1 2012.

In addition, system sales revenue was higher in Q1 2012, at $206.6 million, than in Q1 2015, at $141.0 million. The revenue growth over the years was from instruments, accessories, and services.

EPS and P/E

What P/E should be "assigned" to a stock depends on the future growth of profits, which no one actually knows. Underlying profit growth is revenue growth. Intuitive Surgical has a mixed picture over the last few years on revenue growth.

We can also manipulate results by choosing to use GAAP or non-GAAP numbers (sometimes called "adjusted"). Different camps swear by each. I believe studying the reconciliations provided between GAAP and non-GAAP results is an important part of due diligence for an individual investor like myself.

The company's non-GAAP Q1 net income was $135 million, down 27% sequentially from $184 million and down 3% from $139 million year-earlier. EPS was $3.57, down 27% sequentially from $4.92, but up 1% from $3.54 year earlier.

Normally, non-GAAP numbers make the headlines, because they usually are higher than GAAP numbers. That was the case here. Intuitive's Q1 GAAP net income was $97.0 million, down 34% sequentially from $146.8 million, but up 119% from $44.3 million year earlier. GAAP EPS (earnings per share, diluted) were $2.57, down 35% sequentially from $3.94 and up 127% from $1.13 year earlier.

Focusing on non-GAAP EPS gives you a substantially higher profit per share. But the rate of profit growth looks better if the GAAP EPS, or net income, is chosen.

Cash and Viability

Intuitive Surgical ended the quarter with $2.7 billion in cash, up $170 million sequentially even though $15 million was spent on stock buybacks. There is no debt. I have absolutely no doubt about the company's viability.

2015 Guidance

Surgical procedure growth in 2015 is expected to be 8% to 11% over 2014. There is not a direct way to project EPS growth from procedure growth.

Conclusion

Intuitive Surgical is a well-managed company with an innovative product that helps patients, doctors, and healthcare systems. Nevertheless, healthcare dollars are increasingly rationed out. As a result, Intuitive's growth is more likely to be limited by healthcare systems than by its ability to innovate. I see a capital equipment spending cutback as the main danger to investments in the company.

ISRG has had a couple of major dips over the years I have watched it. Unfortunately, those dips tended to coincide with buying opportunities in biotechnology in general, so I have missed them.

The current price does not look to me to be such an opportunity, though it is down so far, following the Q1 results announcement. At $520.04 (as I write), it is almost 7% off its 52-week high, and is 50% above its 52-week low, which was almost a year ago.

If someone looks at Intuitive and is optimistic about future growth, $520 or so is still a good opportunity. The possibility of substantial sales in Japan and China this year and beyond could justify that. I also like the razor and blade model: Each robot system sold generates additional revenue for disposables and servicing.

But, if something goes wrong, the P/E ratio may dive, as we have seen at least twice so far for ISRG.

I am essentially neutral on Intuitive Surgical at this time, but could become a buyer if either the stock price went down for no good reason (like being caught in a biotechnology sell-off that did not affect ISRG future profit streams), or if growth rates picked up and the stock stayed near flat.

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.