Intuitive Surgical: A market leader for the future.
Opdateret: 22. jan.
Intuitive Surgical is a market leader in the surgical market with a stunning market share of 80 % in a growing market. Their business strategy is to create value for patients, surgeons and hospitals alike, if they can deliver on this strategy, it will be hard to stop this company from growing. However, t doesn't necessarily mean that you should buy the stock. In this analysis I will investigate if Intuitive Surgical is a buy and at what price.
This is not a financial advice. I am not a financial advisor and I only do these post in order to do my own analysis and elaborate about my decisions, especially for my copiers and followers. If you consider investing in any of the ideas I present, you should do your own research or contact a professional financial advisor, as all investing comes with a risk of losing money. You are also more than welcome to copy me.
Since I have attended the workshop with Phil Town, I have decided to change the layout of my analyses a bit. I will do some more calculations and briefly go through why the company has meaning to me. I have changed the format of the analysis a bit to try to make it shorter and with less numbers. If you want to read more about how I evaluate a company, please go to "MY STRATEGY" on my website.
For full disclosure, I should mention that at the time of writing this analysis, I do not own shares in Intuitive Surgical. If you would like to copy my portfolio or see the stock in my portfolio, you can read about how to do so here. I don't own shares in any of their competitors either but have previously held shares in Johnson & Johnson. Intuitive Surgical has been on my watchlist for years, meaning that I'm interested in the company. Nevertheless, I will keep this analysis unbiased as always.
Intuitive Surgical was founded in 1995 in California, United States. The company develops, manufactures, and markets robotic products designed to improve clinical outcomes of patients through minimally invasive surgery. They are mostly known for their da Vinci system, which allows surgeons to operate while comfortably seated at an ergonomic console viewing a 3DHD image of the surgical field. It means that it isn't a robot that is operating the patients by itself but a robot that is controlled by a surgeon. The advantage is that it gives the surgeons more arms and doesn't expose the surgeons to positions that will result in fatigue. In 2019 Intuitive Surgical launched the Ion Endoluminal System, which enables minimally invasive biopsies in the lung. It means that Intuitive Surgical has extended their commercial offering into diagnostics as well. Hospitals can buy the system one off or they can choose to lease them from Intuitive Surgical. Most hospitals are buying the systems (in the second quarter of 2022, 42 % of the sold da Vinci systems were leased), while 44 % of the total Ion Endoluminal Systems are leased. Intuitive Surgical also generate revenue by selling instruments and accessories, and by service the systems. The average selling price of the da Vinci system in the second quarter in 2022 was $1,5 million. The high price for a system and the time it takes for surgeons to learn to use the system means that it is unlike that a hospital will switch to another system. Hence, Intuitive Surgical has a high switching moat.
Their CEO is Gary S. Guthart. He joined Intuitive Surgical in 1996 and held various positions until he became the CEO in 2010. Before joining Intuitive Surgical, he was part of SRI International (former Stanford Research Center) that developed foundational technology for computer enhanced surgery. He also has experience from a Human Factors Lab at NASA, where he was part of a team that studied human performance assessment of pilots. He has a B.S. in engineering from the University of California, Berkeley and later earned an M.S. and a Ph.D. in engineering science from the California Institute of Technology. Besides being CEO and member of the Board of Directors in Intuitive Surgical, he is also serves at the Board of Directors at Illumina and the Silicon Valley Leadership Group. Interestingly, he has stated in an interview that he didn't and still don't have a burning desire to be CEO but was handpicked for the role by former CEO Lonnie Smith. Instead of inspiring to be the CEO, Gary S. Guthart just loved the direction that Intuitive Surgical was going and it is still what inspires him today. Looking at Comparably, Gary S. Guthart has an employee rating that is placing him in top 5 % of similar sized companies, which indicates that he is liked by his employees. If you had invested in Intuitive Surgical when Gary S. Guthart became CEO, you would sit on more than a 600 % gain. I believe that his results, employee rating, and the fact that he is more interested in the company moving forward than him moving up on the career ladder, all indicates that he is a great CEO.
I believe that Intuitive Surgical has a switching moat. Furthermore, I feel very confident with the management. Now let us investigate the numbers to see if Intuitive Surgical lives up to our requirements for a strong moat. In case you want an explanation about what the numbers are, you can have a look at "MY STRATEGY" on the website.
The first number I will investigate is the return on investment capital, also known as ROIC. Ideally, you would like to see a ROIC above 10 % in all years. Intuitive Surgical delivers a ROIC above 10 % in all years the last 10 years. Even in the very challenging pandemic years of 2020, Intuitive Surgical managed to deliver a ROIC above the 10 %. Seeing numbers like these makes me very confident as Intuitive Surgical continuously delivers year over year. I would feel very comfortable in investing in a company that delivers a ROIC like this.
The next numbers are the book value + dividend. In my old format this was known as the equity growth rate. It was the most important of the four growth rates I used to use in my analyses, which is why I will continue to use it moving forward. As you are used to see the numbers in percentage, I have decided to share both the numbers and the percentage growth year over year. There have been a few years along the way where the equity of Intuitive Surgical has decreased but it is hardly anything to worry about. Since 2017 Intuitive Surgical has consistently grown their equity and have had a record high equity in 2019, only to top that in 2020 that got topped in 2021. I would feel comfortable investing in a company that delivers these numbers.
Finally, we investigate the free cash flow. In short, free cash flow is the cash a company generates after it has paid for operating expenses and capital expenditures. Intuitive Surgical has delivered a positive free every year in the last 10 years and since 2017 it has grown year over year. Like we saw in equity, Intuitive Surgical has delivered a record free cash flow in each of the last 3 years. However, the free cash flow yield has also been low as it has been below 2 % in all three years. I would like to see a higher free cash flow yield moving forward.
Another important thing to investigate is debt, and we want to see if a business has a reasonable debt that can be paid off within 3 years by calculation long-term debt to earnings. However, it is not possible to do the calculation in Intuitive Surgical, as they have no debt. Obviously, it is something I really like.
Like every other investment there are risks when investing in Intuitive Surgical. One is the supply chain shortages. The supply chain shortages were something that got a lot of attention the conference call in the second quarter of 2022. Supply chain shortages resulted in Intuitive Surgical couldn't deliver all their orders. It meant that in the second quarter of 2022, Intuitive Surgical delivered 279 da Vinci systems compared to 328 in the second quarter of 2021. Supply chain shortages means higher component costs, which in combination with higher logistic costs and a stronger U.S. dollar led to a decrease in pro forma gross profit margin from 71,1 % in the second quarter in 2021 to 69,2 % in the second quarter in 2022. The pro forma operating margin decreased from 40 % to 35 %. While it doesn't sound like much, it does hurt profitability. Management believes that supply chain will be choppy for some time. another risk is Macroeconomics. Management mentioned that higher inflation, higher interest rates, and staffing shortages have led to increased financial pressures on hospitals. It means that hospitals are lowering their capital investment plans and tighten their operational budgets. An investment in a da Vinci system is not a cheap investment, and during the macroeconomics that we are experiencing now, it could lead to lower sales for Intuitive Surgical. Finally, new competition is entering the sector. Intuitive Surgical has a huge market share in a young sector. It gives them an advantage, but large companies are now entering the market. Companies like Johnson & Johnson with Ottava and Medtronic with Hugo are betting on robotic surgery as a future growth catalyst, and they have technological and financial resources unlike any other competitor that Intuitive Surgical has faced. Intuitive Surgical has a strong switching moat, so it is unlike that these companies will take current customers, but they will challenge for future customers.
There are also a lot of potential for Intuitive Surgical moving forward. One is sector growth. The global surgical robots market size was valued at $3,6 billion in 2021. However, the sector is expected to grow by a CAGR of 19,3 % until 2030. Intuitive Surgical is by far the market leader in the sector and is expected to take a large chunk of that growth moving forward. Minimally invasive surgery cut costs. While the shock in macroeconomic conditions might keep hospitals from investing in robotic surgical systems to begin with, the trend could change once hospital start to focus on long-term cost cutting. A recent published research report that studied 10.000 adult patients between 2013 and 2018 and differences between open (without robots) and minimally invasive (with robots) surgery found some curious numbers. It found that minimally invasive surgery demonstrated lower health care expenditures between $2.300 and $8.100. The lower health care expenditures were divided between patients and hospitals. Patients use less time at the hospital but were also less likely to have a readmission. While hospitals get more efficient using minimally invasive surgery, which means they cut labor costs. Growing internationally. In the second quarter of 2022, there was a 14 % procedure growth in the United States, while the procedure growth outside of the United States grew by 22 %, despite the lockdown in China, which is their second largest market. It shows that procedures are growing post-Covid, which should increase demand for Intuitive Surgical's products. Furthermore, they delivered more da Vinci systems to Europe and Japan in the second quarter in 2022 compared to second quarter in 2021, they would have in China too, if it wasn't for lockdowns. Furthermore, the Ion Endoluminal System is under regulatory review in Europe, and management also wants to pursue a submission in China. If these gets approved, it will lead to further growth.
All right, we have gone through the numbers, potential and risk regarding Intuitive Surgical, and now it is time for us to calculate a price for Intuitive Surgical. To calculate price, we will need numbers that I have explained in the "MY STRATEGY" section of the website. I do not want to go through the whole calculation here. I chose to use an EPS at 4, which is lower than the record 2021 but higher than previous years. I chose an Estimated future EPS growth rate of 13,5 % (as it is the analysists expected growth rate at Finbox), Estimated future PE 27 (which the double of the growth rate, as the historically PE for Intuitive Surgery has been higher) and we already have the minimum acceptable return rate on 15 %. Doing the calculations by using the formula I described in "MY STRATEGY", we come up with the sticker price (some call it fair value or intrinsic value) of $94,71, and we want to have a margin of safety on 50 % , so we will divide it by 2 meaning that we want to buy Intuitive Surgical at price of $47,36 (or lower obviously), if we use the Margin of Safety price.
Our second way to calculate a buy price is the TEN CAP price, which is also explained at "MY STRATEGY". To do so, we need some numbers from their financial statements, keep in mind that all numbers are in millions. The Operating Cash Flow last year was 2.089,4. The Capital Expenditures was 353,5. I tried to look through their annual report to see, how much of the capital expenditures were used on maintenance. I couldn't find it though, so as a rule of thumb, you expect 70 % of the capital expenditures to be used on maintenance, meaning we will use 247,45 in our further calculations. The Tax Provision was 162,2. We have 356,1 outstanding shares. Hence, the calculation will be like this: (2.089,4- 247,45 + 162,2) / 356,1 x 10 = $56,28 in TEN CAP price.
The last calculation is the PAYBACK TIME. I also described in "MY STRATEGY". With the Free Cash Flow Per Share at 4,16 and a growth rate of 13,5 %, if you want your purchase back in 8 years, the PAYBACK TIME price is $122,70.
I believe that Intuitive Surgical is a very interesting company. They have a huge market share in a market that is going to grow at a high rate over the next many years. I think that almost all hospitals will make minimally invasive surgery an area they will invest in long-term, as it will not only cut costs for hospitals, but it could also be something that insurance companies and patients alike will ask for, as it also cut costs for them. Nonetheless, I think macroeconomics will affect Intuitive Surgical short-term, while I'm less concerned long-term. The same goes with supply chain shortages that will normalize over time. However, I think competition will be different from what we have seen before, as these large companies are entering the market. Thus, competition is a long-term risk that one need to be aware of. Nevertheless, I really like the company and the management. The historical numbers also indicate that Intuitive Surgical is a great company with a management that knows how to execute. I don't expect to be able to buy Intuitive Surgical at a 50 % discount, but I don't want to buy it above the intrinsic value either. Hence, I will buy Intuitive Surgical if it gets near the PAYBACK TIME price at $122,70.
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