Intuitive Surgical: Q2 Could Be Bad, 2H Worse

Intuitive Surgical (ISRG) makes automated, or robotic, surgery devices. The company has long been a growth stock, paying no dividend, but ramping revenue year after year. However, 2020 could be different, mainly because of the impact of the COVID-19 pandemic on hospital budgets. Intuitive will report Q2 results on July 21, 2020. Because the stock price has not been impacted significantly by the pandemic, Q2 results have more downside risk than upside potential for the company. While I believe that in the longer run the company is likely to return to significant revenue growth, I think it is too risky to buy or accumulate before July 21. If sales have been seriously impacted in Q2 and continue to be impacted in future quarters, it could become a Sell.

Data by YCharts

Notice in the chart above that the stock price did dip in March, but is lately trading around $570, near the 52-week high of $619.00. At present, it has a GAAP trailing 12-month PE ratio of over 49. Normally, a PE in that range indicates strong revenue and profit growth expectations from investors. Those would be expected from past patterns but may not be warranted in 2020.

Risks to Intuitive’s Three Revenue Components

Intuitive Surgical reports on three segments: robotic systems; instruments and accessories; and services. Pressures on hospital capital budgets could cut into system sales, both in Q2 and as the year progresses. Hospital budgets have been seriously impacted by the pandemic. Most of the reporting on this issue has been local or regional, but in aggregate, it is bound to be bad. For instance, in May, the University of Washington Medicine system furloughed 1,500 employees. While some government aid is going into the medical system, one of the easiest ways to make budget cuts is to delay capital (equipment) spending. Intuitive’s robots are quite expensive, averaging over $1 million each. The need to buy other capital equipment, specifically for treating coronavirus, like ventilators, could also squeeze out relatively optional items like Intuitive’s robotic systems. If elective surgeries are being postponed, that gives further incentive for delaying adding more robotic systems.

Because of the need for sterility, every robotic surgery involves the use of disposable instruments and accessories (it is a razor and blade model), about $2,000 per procedure in Q1 2020. Delays in elective surgery probably hurt instrument and accessory sales in Q2, but in theory, that demand should roll over to later quarters. If sales of robotic surgery systems are postponed that would mean slower growth of instrument revenue, even if procedures continue at the old pace.

Services demand should be relatively steady this year, but future growth could be impacted if robot sales decline. If robot sales decline significantly and instrument and services grow slowly, we could see a year/year revenue decline. It is hard to justify the current high PE when revenue has stalled or is declining for a significant period of time.

Q1 2020 results and 2020 Guidance

It is not just my opinion that sales might not be headed in the right direction in 2020. In its guidance for the year, issued on April 9 with Q1 results, Intuitive stated:

“Due to the uncertain scope and duration of the pandemic, and uncertain timing of global recovery and economic normalization, we cannot, at this time, reliably estimate the future impact on our operations and financial results.”

Headwinds had not shown up, not significantly, in Q1 results. Q1 revenue was $1.100 billion, down 14% sequentially from $1.278 billion and up 13% from $0.974 billion in the year-earlier quarter. The sequential decline was within normal seasonality, as buyers tend to finish annual capital spending in Q4 but are slow to make capital equipment allocations in any Q1. GAAP net income was $314 million, down 12% sequentially from $358 million, but up 2% from $307 million year-earlier. GAAP EPS (earnings per share, diluted) were $2.62, down 12% sequentially from $2.99 and up 2% from $2.56 year-earlier.

Looking at the revenue segments, revenue from da Vinci system sales was $283 million, down 32% sequentially from $416 million and up 14% y/y from $248 million. Revenue from instruments and accessories was $612 million, up 12% y/y from $552 million. Revenue from services was $199 million, up 14% from $174 million year-earlier. All three segments showed strong growth y/y.

At the end of Q1 2020, Intuitive had cash and equivalents of $5.90 billion and no debt, so there is absolutely no risk of bankruptcy in 2020 or 2021.

Conclusion: Be Careful

If the price of Intuitive’s stock had declined significantly, I would not be worried about buying now with a long-term view in mind. I believe the stock price has stayed level because of investor psychology. Investors have done extremely well with Intuitive over the past 10 years, so most are disinclined to sell when Intuitive suffers a short-term setback from a clear, external cause. I think Intuitive is a great company that has brought a lot of value and innovation to doctors, patients, and hospitals. Still, the risks at present are higher than at any time since 2009, so I expect a decline in the stock price unless Intuitive can give firm, strong guidance for the rest of 2020. Despite my pessimism, I would not short the stock, because it is more of a story stock than a price-it-to-earnings stock. The story is still a good story: at some time in the future, likely most surgeries will be aided by robots.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.