As the world's leader in robotic surgical technology, Intuitive Surgical (ISRG -0.56%) is a sophisticated competitor in a high-tech and rapidly evolving field. It's also strongly profitable, steadily growing, nearly debt-free, and a great growth stock with shareholders winning returns of more than 163% in the last five years. Much of this success is thanks to its widening moats, which protect its business from competitors.
But are Intuitive's moats capable of becoming even more powerful, given that they're already quite effective at retaining and aiding with the procurement of customers? In my view, yes, and it's actually very simple.
An ever-increasing array of tools for surgical robots
Intuitive's razor-and-blade business model is one of its primary appeals for investors, and it's also key to understanding its economic moat.
In short, the company sells hospitals its Da Vinci surgical robots, which surgeons operate to perform general surgeries. To keep their investment in good working order, hospitals also buy service contracts. And to expand the capabilities of their installed units, they also buy additional robotic tool heads, which surgeons can use to perform operations that they couldn't do with the basic package.
All the while, revenue trickles into the company's coffers -- and as much as 75% of that revenue is recurring, so a majority of its income is secure over time.
In 2021, the company made $5.7 billion in revenue. Over the last five years, annual sales of advanced instruments like robotic surgical staplers have grown at a compound annual rate of 33% in the U.S.
During that time, Intuitive launched between one and three new advanced instruments per year. Each of those made its moat a bit wider. After all, utilizing a wider range of instruments makes the Da Vinci capable of performing additional types of surgical procedures, thereby boxing out competing products that aren't as multi-functional.
Plus, surgeons need to be trained on each new instrument before they can use it in the operating room, so hospitals need to invest more resources into training them, which sinks more costs and therefore increases the difficulty of switching to a competitor.
Maintaining such a rapid tempo of new product launches requires a substantial investment, and it's clear that such investment will continue to be worthwhile if it keeps paying off with a wider and wider moat over time. And that's exactly what Intuitive is doing. Check out this chart:
As shown in the chart, the last five years have seen the business spend more and more on research and development (R&D) each year, both in absolute terms and as a proportion of its revenue. For reference, in 2021, it spent $671 million on R&D. And as long as revenue continues to grow, so can the research budget, which bodes well for the moat.
There's more than one way to protect the margin
Aside from investing in R&D, Intuitive has another powerful weapon that it can use to defend its fat profit margin of nearly 30% and also its market share: cash.
As shown above, the company's liquid holdings have grown by more than double since 2018, with its total annual expenses increasing somewhat as a portion of revenue and with net income growing steadily at the same time.
What this means is that its hoard of cash and short-term investments totaling $4 billion is likely to continue growing. And that makes for plenty of ammunition with which to buy up small or medium competitors long before they become a problem.
In fact, Intuitive has an entire venture capital arm that's equipped with at least $100 million in funding to do exactly that. Though its investments have only purchased a trio of companies so far, it could easily be funded more if there's a threat of some kind. Each additional dollar saved in its coffers is another dollar that's ready for acquiring disruptors.
Calm seas ahead
In sum, investors should indeed expect Intuitive Surgical's moat to grow wider over time, provided that management opts to continue with its proven strategy.
While it's a bit hard to imagine its profit margin getting any larger considering its formidable size, it's equally hard to imagine any kind of competition on the horizon that could pose a serious threat.
Should such a competitor develop, Intuitive is strongly positioned and, with its ongoing investments in new products and an ever-fatter pocketbook, it'll be well-equipped to win in the long run.