Should You Buy Intuitive Surgical?

Source: Thinkstock

Source: Thinkstock

Intuitive Surgical (NASDAQ:ISRG) makes the da Vinci robotic surgery system, which is the leading product in the up and coming field of robotic surgery. The success of this product has sent shares soaring over 2,000 percent since 2000. However, more recently, the stock has weakened. After peaking at nearly $600/share in 2012, the stock started to correct, and it breached the $400/share level before recovering somewhat to the $435/share level today.

The correction is due to several concerns. First, the company’s da Vinci system is very expensive, and hospitals and healthcare providers are reluctant to invest in expensive medical devices as they prepare for the Affordable Health Care Act. Second, there are concerns that the company’s da Vinci system doesn’t provide a better service than standard surgery, and given the added expense of performing a procedure using the da Vinci system versus normal methods of performing surgery, hospitals and investors don’t see the benefit of the da Vinci system.

As a result, the company has seen a significant decline in sales of its Da Vinci units over the past year, and this has put pressure on revenues, which rose just 4 percent year-over-year. While this is still growth, this is a significant deceleration from the strong double digit growth posted by the company in prior quarters.

Given all of these concerns, and given the fact that the shares trade at 26 times earnings, it would seem that investors should avoid Intuitive Surgical shares. However, I think it may be time to step in and take a position. Here’s why.

First, the company’s revenue growth has been decelerating due to declining sales of its da Vinci system. However, the company also makes money by servicing these machines and by providing one-time use equipment that is used for each procedure performed by the da Vinci system. In other words, the company utilizes a razor/razor blade business model. Sales of the “razor blades” (i.e. the services and the one-time use equipment) are still growing rapidly, and going forward, this part of the company’s business is going to be the most important.

Second, the company’s international sales are still strong, and the portion of the company’s business that comes from overseas is increasing rapidly. This will mitigate weakness that comes from concerns over the Affordable Healthcare Act. Furthermore, the company has significantly less penetration in foreign markets. One reason that da Vinci unit sales are declining is that there is market saturation; everybody who wants one already has one. This is not a problem for the overseas market.

Third, it may be the case that robotic surgery is a more expensive than conventional surgery and that the results are similar for the two, but we have to realize that robotic surgery is in its infancy, and it is going to be the future of surgery. While there are studies being published that criticize Intuitive Surgical’s da Vinci product and robotic procedures versus traditional surgery, we can intuitively assert that methodologies in robotic surgery are going to greatly improve over time and in a few years these procedures will be far simpler and more effective than traditional surgical procedures. It is also likely that robotic surgery will be more cost effective.

Intuitive Surgical is the leader in this field. While it may not be forever, it is better positioned than its peers to continue to dominate the robotic surgery industry in the future. It has the knowledge to improve its product, and it also has the capital — $1.4 billion in cash and equivalents — to invest in research, or to simply buy out its competition.

There is no doubt that Intuitive Surgical is experiencing some growing pains, and there is little doubt that it will experience more in the future. However, I think the company is extremely well-positioned to substantially grow its revenues and profits over the long run, and investors are being given an opportunity to buy the shares at a discount given the aforementioned setbacks. With this being the case, I think Intuitive Surgical makes for a compelling investment at current prices.

Disclosure: Ben Kramer-Miller has no position in Intuitive Surgical.

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