With its shares down by more than 33% in the past 12 months, Intuitive Surgical (ISRG 1.61%) has been hammered by the brutal bear market. Despite rising revenue and earnings over the last three years, the robotic surgery company's margins are still below their pre-pandemic level, and the market's sour sentiment toward growth stocks certainly isn't helping to boost its share price.
Yet demand for its robotic surgical suites, as well as related services and accessories, remains quite strong, and there's no indication of a lasting slowdown which might portend a decline. In fact, Intuitive's valuation might well be approaching a point where investors will start to pile into the stock once again, assuming that they believe more growth is still on the way.
Let's examine what's going wrong so that we can put its chances of a rebound in 2022 into context.
Why the road is bumpy
Intuitive's razor-and-blade business model is to sell its Da Vinci robotic surgical suites to healthcare systems and then provide them with the training, maintenance, and replacement robotic tool heads that they need to operate the systems to perform a number of different and relatively common minimally invasive abdominal surgeries.
Due to the pandemic, Intuitive's management holds that it's facing supply chain disruptions as well as clinical disruptions that reduced the number of surgeries performed using its robots. Since the first quarter of 2021, its quarterly revenue has grown by scarcely more than 1.6%, reaching more than $1.4 billion, whereas its quarterly net income has fallen by more than 29.3%. In the same period, its cost of goods sold (COGS) and its selling, general, and administrative (SG&A) expenses have risen as a proportion of quarterly revenue, resulting in a sharp rise in its total expenses as a share of sales.
But none of that is as bad as it might sound. Because Intuitive makes around 75% of its revenue on a recurring basis from sales of services, replacement parts, and accessories for its robots, each additional installed robot and each additional procedure performed implies a long tail of revenue spread over the future.
And from 2019 through the end of 2021, the number of installed surgical suites grew at a compound annual rate of 10%, whereas the number of procedures performed with Da Vincis grew at a 14% rate. In other words, despite the contracting margins caused by pandemic-related issues, the company continues to seed its future income at a rapid clip.
Valuation could make all the difference
Given that Intuitive is going to keep building on its base of recurring revenue and that it has very little debt, its future is likely bright. So the question is when its stock price might recover. Importantly, its valuation is significantly more appealing than at the start of the stock's decline a year ago. At the end of June 2021, its trailing 12-month price-to-earnings (P/E) multiple was above 94, whereas now it's less than half that at about 43. In fact, it's cheaper now than at nearly any point in the past five years, with the exception of the coronavirus market crash. And, its revenue-making potential has only increased in that time.
The other factor at play is the Federal Reserve's mandate to fight inflation by raising interest rates. Because growth stocks like Intuitive tend to borrow money to expand while unprofitable, growth-stage companies are getting their shares completely creamed -- whether or not any individual business in question actually plans to borrow cash in the near term. But Intuitive is profitable, and its trailing 12-month free cash flow (FCF) is more than $1.4 billion. So, it isn't directly negatively impacted by rising interest rates as of yet. And that's one more reason why it's positioned for a rally.
Finally, the company also has a couple of potential catalysts to ignite a rebound, starting with any announcements pertaining to the development of new robotic tool heads or software tools for surgery, both of which are among management's priorities for 2022. If things go as planned, it's likely that an improvement of general economic sentiment could spur a rally in Intuitive's shares when combined with the looming launch of some new accessories.
Even if it might not happen this year, the stars are aligning for Intuitive, and its probable comeback will be lucrative for those who are willing to invest in it now.