In my first 10 (actually to be 11 since I’ve got another pick up my sleeve today) picks for my new Millennial Portfolio (for investors who have more time than money) on my subscription site JubakAm.com I’ve been on the hunt for shares of companies with long, long revenue and earnings growth runways ahead of them, with short-term catalysts that might produce enough of a gain in the near term to keep investors on board for the long run, and some bad news in the present that been negative enough to take a bite of the stock price.
Today, February 15, I’m adding Intuitive Surgical (ISRG) to my Millennial Portfolio and to my Jubak Picks Portfolio with a target price of $860 a share (well, actually for purchase tomorrow since I’m writing this after the market has closed in New York). The stock dropped 1.9% today (or $15.86 a share) to close at $791.95. The retreat is on renewed fears that the coronavirus pandemic will, as the company announced in late January, put a crimp in purchases of the company’s robotic surgery equipment and supplies, since many hospitals have banned or at least severely restricted electric surgery for the duration of the pandemic. But that worry also means that Intuitive Surgical is one of the companies most likely to see a big pickup in revenue growth once the pandemic is over (or under control to a significant degree.) And, from a long-term perspective, Intuitive Surgical is the leader in this segment of the med tech sector. The company is the beneficiary of a virtuous loop–the more procedures that the company’s da Vinci systems perform, the more knowledge it can add to the software that guides its surgical robots. Which makes Intuitive Surgical very difficult to dislodge from its dominant market position.
Back on January 22 when Intuitive Surgical announced its fourth quarter earnings, it warned that the pandemic was taking a big bite out of sales of its da Vinci robot surgical equipment and out of revenue from consumables too as hospitals were performing fewer elective procedures. Procedures using da Vinci rose just 6% and the company shipped 3% fewer da Vinci systems in the quarter than it did in the fourth quarter of 2019. The first quarter of 2021 is likely to be hit even harder, the company said, and lowered its 2021 sales estimate to $4.96 billion from $4.99 billion. For the year Intuitive Surgical said it expected revenue growth of better than 23%.
Intuitive is one of those stocks that doesn’t drop much on run-of-the-mill bad news. At today’s close of $791.95 the shares are only modestly below their $818.10 high on December 31, 2020. That’s not much of a retreat on the January negative guidance.
The stock is so rock solid–under most circumstances (of which more later)–because the growth story is so impressive.
The first thing that pops out at you when you look at the operating parameters for Intuitive Surgical (ISRG) is the company’s gross profit margin of 69.08% on average for the last five years.
That’s the kind of gross margin a software company pulls in because the production costs for software companies are so low. The gross margin at Microsoft (MSFT) for example, is 64.54% for the last 5 years. Amazon is barely in the conversation with a gross margin of 24.41% in that period. (Gross margin is total revenue minus cost of goods sold divided by total revenue.)
Take it down another rung in the road from sales to profit and you’ll see that Intuitive Surgical shows a net profit margin of 27.02% for the last five years. Microsoft’s net margin in that period is 23.72%.
What’s the story behind these extraordinary margins?
Intuitive Surgical is a hardware based company–it’s leading edge product right now is its da Vinci system for robotic surgery that sells for around $1.5 million a pop. The replacement or upgrade cycle on that system is about 5 to 8 years. The company has an installed based of 5,669 systems. For all the years after purchase, Intuitive Surgical reaps a steady revenue stream since a hospital or clinic needs to purchase new instruments after each procedure. About 56% of revenue in the first quarter of 2020 came from instruments and accessories.
Intuitive Surgical’s business shows a pronounced network effect. Each time the company performs a surgery it adds to the data base that guides future robotic procedures. Each time it adds a new procedure, it adds to the number of procedures the robot surgical systems can perform. In 2019 the company’s systems performed 1.2 million procedures.
The stock isn’t cheap with shares selling at 62.5 times forward projected earnings per share. (Amazon, for comparison, sells at a forward PE of 64.)
The fifteen year record on compounded average annual returns from the shares is 23.44%. And Intuitive Surgical has a market capitalization of just $93 billion (instead of the $1.65 trillion on Amazon) so it should take less growth to lift the stock’s value.
And like Amazon, Intuitive Surgical looks to have a strong sector wind at its back. The value of the robotic surgical procedures market is forecast to grow at an average annual compound rate of 16.6% between 2018 and 2025, according to a report by Fortune Business Insights. The biggest growth will come in minimally invasive surgeries, a type of surgery well-suited to robotic procedures.
Now a word on risk. Back when the market plunged into a bear market in March 2020, shares of Intuitive Surgical fell to $367.75. In my opinion, the biggest risk in these shares isn’t from some hiccup at the company, but from a correction, or worse, in the market as a whole. With the last half of 2021 looking risky because no one knows if/when the Federal Reserve will start to reduce its $120 billion in monthly bond purchases–perhaps setting off another taper tantrum–there is some possibility of a big drop in growth momentum stocks like Intuitive Surgical.
I’d hate to miss one of the stock’s infrequent retreats, so my recommendation now is to buy half a position, whatever that might be for you, now and wait to see what August or so might bring from the Fed.
Intuitive Surgical is a member of my long-term 50 Stocks where it is up 59.4% since I added it to this portfolio on January 28, 2019.
Full disclosure: I own shares of Intuitive Surgical in my pe