Topic: Growth Stocks

High research spending pays off for surgical robotics maker Intuitive Surgical

A Member of Pat McKeough’s Inner Circle recently asked for his advice on a company that develops, manufactures and markets a computerized surgical system, along with related accessories, training, and services.

The company’s revenues have risen 74.6% since 2014 and an expanding base of installed systems represents a steady source of future revenue from service and accessories. Rising demand globally, including Asia, should also spur revenue and earnings, Still, says Pat, the company faces risk from contracting U.S. hospital budgets and lawsuits arising from use of its systems.

Q: Hi Pat: I would very much appreciate your opinion on Intuitive Surgical, Inc. (Nasdaq: ISRG). Thanks.


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Intuitive Surgical Inc., (Symbol ISRG on Nasdaq; www.intuitive.com), develops, manufactures and markets the da Vinci Surgical System along with related accessories, training, and services. Intuitive Surgical is based in Sunnyvale, California.

Da Vinci is a computerized surgical system that translates a surgeon’s hand movements into corresponding micro-movements of instruments positioned inside a patient through small incisions. The process is safer and less invasive than regular surgery and reduces recovery time, scarring, and risk of infection.

Sales of new systems account for around 29% of revenue. Instruments and accessories account for 53% and service revenue accounts for 17%. U.S. sales account for roughly 73% of revenue while International sales account for 27%.

Over the five years from 2014 to 2018, Intuitive Surgical’s overall revenue rose steadily, up 74.6%, from $2.13 billion to $3.72 billion. Earnings jumped 212.8%, from $418.8 million, or $3.70 a share, to $1.31 billion, or $10.99.

In the three months ended December 31, 2018, overall revenue increased 17.3%, to $1.05 billion from $892.0 million a year earlier. The company shipped 290 da Vinci Surgical Systems in the latest quarter, up 34.3% from 216 a year earlier.

Excluding one-time items, the company earned $353.2 million, up 15.8% from $305.0 million, a year earlier. Earnings per share rose 13.8%, to $2.96 from $2.60. Partly offsetting the higher sales was a $25 million “operating expense” in the quarter. Specifically, that was a donation by the company to start up the Intuitive Foundation, which will support clinical research and community philanthropy. Removing that one-time item, Intuitive Surgical’s earned $3.12 per share, up 20% from a year earlier.

Over the past three years, the company has increased its investment in research and development by 74.5%, from $239.6 million in 2016 to $418.1 million in 2018. Research now represents a high 11% of sales.

Inner Circle: Tightening hospital budgets and lawsuits pose company risk

Intuitive Surgical’s base of installed systems represents a steady source of future service and accessories revenue. Sales of its systems continue to rise and expand that base. In 2018, the company shipped 926 da Vinci Surgical Systems, up 35.4% from 684 in 2017. The annual number of da Vinci procedures performed was in excess of 1 million for the first time in 2018. In the latest quarter, those procedures worldwide grew about 19% compared to the year earlier period. That rise reflects growth in U.S. general surgical procedures as well as more urologic procedures globally.

The company’s research spending should continue to expand the range of surgical procedures served by its systems and lead to the development of more sophisticated systems. For example, Intuitive Surgical shipped the first three da Vinci SP Surgical Systems in the third quarter of 2018. The da Vinci SP system is the company’s latest surgical system platform which delivers the surgical instruments and camera through a single port for narrow-access surgery.

However, the company does face risks. Ever-tightening U.S. hospital budgets could make it hard for Intuitive Surgical to maintain sales growth. Moreover, the company continues to face lawsuits due to complications that may have arisen from da Vinci surgeries. Investor concerns about those cases could hold back the shares.

Meanwhile, though, growth in procedures continues—especially in overseas markets. Much of this can be attributed to strong growth in Japan (procedures up 40% year over year). That market is a key component in Intuitive Surgical’s long-term expansion plans, along with China, Korea and Europe.

The stock trades at a high 42.4 times the forecast 2019 earnings of $12.76 a share.

Recommendation in the Inner Circle: Intuitive Surgical is okay to hold, but only for aggressive investors.

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