Shares of surgical robot maker Intuitive Surgical (ISRG) are currently trading near 52-week and all-time highs. Recently, the company blew out earnings expectations again, something it has done with high frequency. This high growth company, sometimes questioned for its lofty valuation, has continued to be a great investment for those that have held it over time. The medical device leader was one of the best performers of 2011 and is well positioned for another great year in 2012. But there is still plenty of room to grow, and this name could fetch $700 within the next two years. Here's why.
Consistent Growth:
Intuitive Surgical continues to grow at a fast pace and there are still plenty of opportunities ahead. Here are some key income statement numbers over the past few years.
| Income Data | 2008 | 2009 | 2010 | 2011 |
| Net Sales | $874.9 | $1,052.2 | $1,413.0 | $1,757.3 |
| Gross Profit | $620.8 | $751.1 | $1,030.0 | $1,273.8 |
| Operating Income | $310.8 | $377.4 | $555.2 | $694.8 |
| Net Income | $204.3 | $232.6 | $381.8 | $495.1 |
| EPS | $5.12 | $5.93 | $9.47 | $12.32 |
In three years, the company has doubled its revenues and more than doubled its net income. While it is not growing at the 40% or so numbers it was a few years ago, there is still plenty of growth to be had. Analysts are currently expecting 18.2% revenue growth in 2012 and another 15.5% growth in 2013. Given the company's ability to consistently beat analyst expectations, the company could have more than $2.5 billion to $3.0 billion in revenues in 2013, while estimates right now are only for $2.4 billion. Earnings are also increasing, and in the latest quarter, the company posted an EPS number that beat by 40 cents per share (11.9% beat).
Now there was some concern after the Q4 report showed that sequential growth was slowing, but this company is maturing. A Collins Stewart report last week that made it to Seeking Alpha's page on ISRG noted that the Japanese Ministry of Health will support reimbursements of prostatectomies using Intuitive's Da Vinci system. Intuitive and Japanese partner Johnson & Johnson (JNJ) are likely to seek approval for more procedures using the systems. This is pleasant news for the international side of Intuitive, and its always nice to have a large partner like Johnson & Johnson. Intuitive's systems performed approximately 360,000 procedures in 2011, which was up 29% from the previous year.
Both Sides of the Business are growing:
Intuitive is not a one trick pony. There is not just one segment of the business that is growing. Both product sales and service sales are increasing, and here's how the numbers look for product sales.
| Products | 2008 | 2009 | 2010 | 2011 |
| Sales | $748.3 | $879.9 | $1,189.1 | $1,478.9 |
| Costs | $200.1 | $237.6 | $297.3 | $382.3 |
| Gross Margin | $548.2 | $642.3 | $891.8 | $1,096.6 |
| Gross Margin % | 73.26% | 73.00% | 75.00% | 74.15% |
Product sales counted for 84% of total revenues in 2011, which is great because they are the higher margin part of the business. While the company is heavily reliant on sales of its robotic systems, it's not like sales are slowing down, and the company has been able to maintain high margins for this segment. Now let's look at services sales.
| Services | 2008 | 2009 | 2010 | 2011 |
| Sales | $126.6 | $172.3 | $223.9 | $278.4 |
| Cost | $54.0 | $63.5 | $85.7 | $101.2 |
| Gross Margin | $72.6 | $108.8 | $138.2 | $177.2 |
| Gross Margin % | 57.35% | 63.15% | 61.72% | 63.65% |
While services only account for 16% of the business, they are still growing at a faster rate than product sales. The company has also been able to improve its gross margin percentage for the service business. Given the company's leadership position in this industry, it is not crazy to assume that it can get service margins above 65% in the next year or two.
It's a High Margin Business:
Would you rather have a company that makes 5 cents for every dollar of sales, or 25 cents? While it does depend on the business, there aren't a lot of companies that can boast margins as high as Intuitive Surgical, and they are improving.
| Margins | 2008 | 2009 | 2010 | 2011 |
| Gross | 70.96% | 71.38% | 72.89% | 72.49% |
| Operating | 35.52% | 35.87% | 39.29% | 39.54% |
| Profit | 23.35% | 22.11% | 27.02% | 28.17% |
Gross margins did decline a little in 2011, but they still are at extremely healthy levels. Intuitive Surgical has kept its costs in check, which helped its operating margins to increase by 25 basis points despite the decline in gross margins. Also, as the company has sold on a more global basis, it has benefited from the lower tax rates that foreign countries do provide. This has helped the company lower its effective tax rate, which has really helped the numbers on the bottom line. Barring a setback that I don't see currently, I think that the company will break the 30% profit margin level by 2013. There aren't too many companies in this high margin club, and another one that has done similarly well for investors is Apple (AAPL). Think about the comparisons, which I'll detail later on.
A Very Healthy Balance Sheet:
Intuitive has a very strong balance sheet, with almost no debt. The company has great financial flexibility, which can be seen below.
| Financials | 12/31/08 | 12/31/09 | 12/31/10 | 12/31/11 |
| Cash, Investments* | $901.9 | $1,172.0 | $1,608.9 | $2,171.8 |
| Current Assets | $703.9 | $847.1 | $1,275.8 | $1,466.3 |
| Total Assets | $1,474.6 | $1,809.7 | $2,390.4 | $3,063.1 |
| Current Liabilities | $164.5 | $202.8 | $273.8 | $320.6 |
| Total Liabilities | $207.9 | $272.4 | $353.0 | $417.5 |
| Cash From Operations | $278.2 | $392.2 | $545.8 | $677.6 |
| Current Ratio | 4.28 | 4.18 | 4.66 | 4.57 |
| Working Capital | $539.4 | $644.3 | $1,002.0 | $1,145.7 |
| Debt Ratio | 14.10% | 15.05% | 14.77% | 13.63% |
The company has less than 14 cents of liabilities per dollar of assets. You can't find many companies that can say that. While the current ratio did decline slightly in 2011, it was just due to simple math. Because Intuitive has such low liabilities, an extra million or so in current liabilities can have a huge number on the current ratio. However, the company increased its working capital, so it is still increasing current assets faster than current liabilities. Companies that have high debt loads find it tough to grow or see interest payments kill their potential net income. Intuitive doesn't have that problem, and this balance sheet will allow for plenty of future growth.
Because of the above mentioned financial flexibility, Intuitive has been able to buy back its shares, which helps earnings per share numbers and helps the stock to rise over time. Intuitive started its buyback program in 2009 and the board has authorized multiple increases since then. The company bought back $150 million in 2009 and $198.6 million in 2010. But that number rose sharply to $331.8 million in 2011, and it is likely to increase further in 2012. The company has almost $570 million remaining on its current share repurchase program, which will likely be increased in the next year or two. Given the company's financial flexibility and strong balance sheet, share buybacks will continue for the indefinite future.
A Stock Split - The Next Leg of Growth:
I've maintained my opinion that Intuitive will split its stock this year, and that action will create the next leg of growth higher for the stock.
Consider the following scenario, Google (GOOG) versus Baidu (BIDU). In early 2010, Google and Baidu were both trading above $500 per share. Baidu announced that it would split its stock, 10 for 1, which brought it back down to about $70 after the split. In fact, the first day it traded after the split, Baidu shares rose nearly 10%. More people can buy shares at $75 than they can at $750, it's just the way things are.
Look at the following Baidu/Google chart over the past two years.
Click to enlarge:
Now yes, Baidu is growing faster than Google, but Google still had roughly 50% revenue and net income growth in 2011 over 2009 numbers. What has the stock done? Basically nothing. Baidu made its shares more available to investors, and they decided to buy buy buy.
I bring up this example because at times I have decided against buying companies like Intuitive and Google at such high dollar prices. I have bought and traded all three names in the past, and have made money off all three.
A stock split for Intuitive could spark another rally. Think of the Baidu-type scenario. A 10 for 1 split gets this name to $50. A lot of people could come into the name at that price. While the math is the same, you would think investor psychology would make it a lot easier to go from $50 to $70 than it would from $500 to $700. Baidu has doubled since it split its stock, and I think Intuitive could do the same. I've made a similar argument for Apple splitting its stock, but I think Intuitive will split before Apple does.
Valuation:
Intuitive has been questioned for its lofty valuation, but I think I've given enough reasons above why it is justified. Let's look at the valuation history, based on high and low share prices for the year and the actual earnings per share for that year.
| P/E | 2006 | 2007 | 2008 | 2009 | 2010 | 2011 |
| High | 74 | 97 | 70 | 52 | 42 | 38 |
| Low | 45 | 23 | 22 | 14 | 26 | 21 |
| Avg. | 59.5 | 60.0 | 46.0 | 33.0 | 34.0 | 29.5 |
Those may seem high, and the physical number is, but you are paying for a low debt, high margin, solid growth company that really doesn't have any competition.
Now Intuitive is trading at roughly 40 times the past twelve months earnings, which appears to be at the high end of the range. However, those numbers above are based on actual year earnings and the highest price of the year.
Analysts are currently calling for $14.49 in earnings for 2012. That implies a P/E of approximately 34. But that's only looking at current expectations. What if the company does $15 this year, or even more? Given its ability to beat, I don't think it is out of the question for Intuitive to do $15.50 at this point, and that could even be low. Remember, the company beat expectations by 40 cents in the previous quarter, and it has beaten by a dollar in the past four reported quarters. At $15.50, the valuation is under 32, and I think that's rather fair for now. Given that the high valuation could trade up to say 36 to 40, that implies a high price this year of $558 to $620, and for this argument, I'm assuming that the company doesn't split the stock. If it does, all bets are off.
Looking into 2013, analysts currently call for $16.94 in earnings. I think that's extremely low, given the growth potential and share buybacks. Take a look at the following value chart, with the top row being earnings per share and the left column being the P/E multiple.
| Value | $16.50 | $17.00 | $17.50 | $18.00 | $18.50 |
| 20 | $330.00 | $340.00 | $350.00 | $360.00 | $370.00 |
| 25 | $412.50 | $425.00 | $437.50 | $450.00 | $462.50 |
| 30 | $495.00 | $510.00 | $525.00 | $540.00 | $555.00 |
| 35 | $577.50 | $595.00 | $612.50 | $630.00 | $647.50 |
| 40 | $660.00 | $680.00 | $700.00 | $720.00 | $740.00 |
Estimates are currently for $17 in 2013, and we still are only in February. Before Intuitive's last report, estimates were for just $16. They've come up $1 already, and that trend is likely to continue. I've only gone up to $18.50 in earnings for 2013, and that number may look extremely conservative in the end. What if Intuitive end up doing $20 a share, or more? The stock wouldn't need a sky high valuation to hit $700, and again, I'm not even counting a stock split here.
Analysts have always been late to the party when it comes to Intuitive, which is why the average price target currently is just $487. One firm raised its number from $520 to $560 after the latest quarter, and that is now the high number on the street. I think it is time for some analysts to check their numbers, and perhaps we'll see some price targets raised in the near future.
Conclusion - This Name Goes Higher:
Would you like to buy a stock that has 70%+ gross margins, almost 30% net margins, is virtually debt free, is buying back stock, the leader in its industry, that is growing at a nice clip with no real competition? Then Intuitive Surgical is for you. I had Intuitive as one of my top growth picks for 2012, and that is an exclusive list. Anytime you can be picked alongside Apple, you know you are doing well. If you think about it, the companies have decent comparisons. Great growth, leader in their industry, high margins, great balance sheets.
I called the price reaction crazy when this name traded below $430 after earnings, and if you bought then, like I did, you've made some nice money. Yes, Intuitive does carry a high valuation and is trading near 52-week highs, so if you think you can get it lower, at say $475 or even $450, you might want to wait. Sure, it has had a nice run and a pullback could come. Or the analyst parade could start and we could be at $525 before you realize what is going on.
Intuitive's growth story is well intact and is one of my favorite names. I don't own any currently because I am a trader, so I usually play this name around earnings. However, for anyone looking to add a solid healthcare name to their portfolio, Intuitive is your stock. I see this name having the potential to hit $700 in the next year or two, or a stock split would send this name higher. The company's growth speaks for itself. You don't need to rely on a split to make money in this name, but if you get one, it will certainly help your chances. We go higher from here.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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