Shares of Intuitive Surgical (ISRG) have been stock market laggards for more than a year now, as the company, a leader in the growing robotic surgery sector, has faced gross margin pressures and numerous questions about its advertising efforts, training methods, and safety record. The medical device maker also disappointed Wall Street back in April, when it slashed its 2014 procedure volume guidance, to a range of 2%-8% (down from 9%-13%). Utilization of its da Vinci machines is being hampered, it seems, by slowing gynecology volumes (this is a core market for Intuitive), a heightened cost-consciousness on the part of insurers, and a slowdown in capital spending by the nation’s largest hospitals. Still, procedure growth ought to accelerate again before too long, with more types of surgeries around the world incorporating robots. And the long-term earnings picture here appears bright. Should patient investors take advantage of the current entry point to build positions in this unique device maker? Or is the large-cap stock too expensive to justify the risks at this point? In this article, we will attempt to address these questions by taking a look at Intuitive’s business and performing an easy-to-follow SWOT analysis of the company, evaluating its Strengths, Weaknesses, Opportunities, and Threats.
Intuitive Surgical, founded in 1995 and based in Sunnyvale, California, is the global leader in minimally invasive robotic-assisted surgery. Its mainstay da Vinci systems, providing doctors with 3D magnification of the surgical field, are used in a range of procedures, including prostatectomies, hysterectomies, nephrotomies, and mitral valve repair. The company also sells proprietary EndoWrist instruments, allowing for more precise movements during operations, which are used in conjunction with the da Vinci machines. Lastly, it generates service revenue by familiarizing surgeons and hospital administrators with its equipment.
Market Leader: Intuitive’s da Vinci machines dominate the robotic surgery market, with the company so far making its bread and butter in the areas of gynecology and urology. Rapid product cycles, and the device maker’s close relationships with doctors and hospitals worldwide, suggest that the company will maintain its dominance for some time to come, too. Notably, a next-generation device, the da Vinci Xi System, was recently approved by the U.S. Food and Drug Administration. The new machine, containing improvements that enable overhead robotic arms to easily reach all parts of a patient’s body, should contribute to a rebound in procedure growth going forward. Furthermore, it should be more cost-effective, notwithstanding the device’s hefty upfront price tag (of between $1.85 million and $2.3 million).
Entrenched User Base: Apart from just selling its systems, the company has taught countless doctors how to use the robots over the past couple of decades. Indeed, much of the medical community has now become accustomed to using Intuitive’s products. This mind share, along with the company’s large installed base (of around 3,000 da Vinci machines), represents a big competitive edge, since it means that rivals will probably have a harder time bringing products to market and winning business. Not only do new devices need to clear regulatory hurdles, but they need to gain favor with the country’s doctors, an endeavor that would likely take years. Thus, we think that it will be quite a while before any serious competitive threats materialize.
Safety Questions: Safety concerns have plagued the company in the past, and have sometimes wreaked havoc with its shares. (The small float adds to the issue’s volatility at times.) Early last year, for instance, the stock took a double-digit percentage hit when the FDA announced a probe into possible medical complications produced by the da Vinci machines. This investigation turned up a number of unfortunate tales, including serious complications with a handful of gynecological procedures. But user error may well have been to blame in many of those cases. And aside from the bad press, the regulatory probe did not yield any punitive consequences (e.g., major product recalls) for Intuitive, which insists that its devices are comparatively safe and very cost-effective. That said, we would expect safety questions to arise from time to time, especially as the applications of robotic surgery skyrocket over the next several years and the company stays aggressive on the promotional front. Investors should be prepared for these developments, and prepared to exercise a fair amount of patience here.
High Investment Spending: The robotic surgical systems are quite expensive to develop, and lofty R&D expenditures curtail profit growth a bit. We do not see this situation changing anytime, either, with spending demands apt to increase as new competitors attempt to capitalize on the huge robotic market opportunity. Over the past few years, R&D costs have amounted to between 7% and 8% of sales.
New Applications: With a top line of just over $2 billion annually, we think that Intuitive is just scratching the surface in terms of market penetration. What’s more, we believe that the number of robot-assisted procedures will jump during the balance of the decade, in areas from cardiothoracic surgery to head and neck surgery, as the da Vinci machines are increasingly seen as a way for hospitals and insurance companies to save money. More patients will likely come to embrace robotic surgery, as well, once they appreciate that it’s safe and often less invasive than many alternate treatment options.
International Expansion: While far from the saturation point at home, robotic surgery has ample room to make inroads in Europe and Japan. These overseas territories are underpenetrated relative to the U.S., and should support strong growth through 2017-2019.
Insurance Cutbacks: Since we are still in the early innings of what will likely be a robotic surgery boom, insurers may not fully appreciated the value proposition of the da Vinci systems. As such, in the current belt-tightening environment, patients may have a hard time getting reimbursed for the automated procedures. This situation, coupled with a general tightening of hospital capital budgets, would probably keep adoption rates and Intuitive’s overall growth rate in check.
New Rivals: Though serious competitive threats appear to be a ways off, new, more-specialized rivals are almost sure to enter the fray, given the size of the robotic surgery opportunity. Intuitive’s da Vinci systems are somewhat general-purpose in nature, which means that they can potentially be used for many different types of applications. This increases the company’s addressable market, to be sure, but it does make the device maker vulnerable to smaller rivals that choose to target a specific surgical field.
In sum, although the bottom line is apt to retreat this year amid a procedure slowdown, we think that Intuitive’s strengths and opportunities easily outweigh its weaknesses and threats at present. What’s more, while the stock continues to trade at a big premium to the broader market, the high multiple seems to be justified, considering Intuitive’s long-term growth prospects and earnings power. In fact, we believe that our 3- to 5-year share-net call of $22.00 may well prove to be conservative if the robotic surgery space expands as we anticipate, and if the company continues to grab a lion’s share of the market.