Is Intuitive Surgical Cheap After the Recent Plunge?

Anh is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Recently, Intuitive Surgical (NASDAQ: ISRG) experienced a significant decline of more than 11.3% in after-hours trading, from $500 per share to only $443.50 per share. The dramatic fall was due to its disappointing outlook for its second quarter results. Should investors consider this recent significant drop a buying opportunity? Let’s take a closer look and find out.

Fast and consistent operating performance growth

Intuitive Surgical is the manufacturer and designer of da Vinci Surgical Systems, which provides surgeons with intuitive control, range of motion, fine tissue manipulation capability and 3-D vision. Most of its revenue, $1.84 billion, or 84% of the total revenue, was generated from product sales, while the service revenue came in at only $342.6 million in 2012. The company reported that the recurring revenue was nearly $1.25 billion, accounting for 57% of the company’s total sales.

In the past five years, the company has managed to consistently grow its revenue and net income. Revenue increased from $875 million in 2008 to nearly $2.18 billion in 2012, while the net income rose from $204 million, or $5.12 per share, to $657 million, or $15.98 per share, during the same period. The company also had quite conservative capital structure. As of March 2013, it had $3.77 billion in equity, $1.36 billion in cash and short-term investments, $1.76 billion in other equity investments, and no debt.

The company expected that its second quarter revenue might experience a 7% growth, from $537 million last year to $575 million this year. while net income rose slightly from $155 million in the second quarter of 2012 to $160 million in the second quarter this year. Those operating results fell short of analysts’ expectations of $178 million in earnings and $630 million in revenue. Gary Guthart, the company’s CEO. said

While we are disappointed in our performance this quarter, particularly with respect to our capital sales in the U.S., overall procedure performance was solid in a difficult environment.

Highest EBITDA multiple among its peers

At $443.50 per share, Intuitive Surgical is worth $17.8 billion on the market. The market still seems to value the company quite expensively, at 16.8 times its trailing EBITDA, and around 1.53 times its PEG. Compared to its peers Accuray Incorporated (NASDAQ: ARAY) and Medtronic (NYSE: MDT), Intuitive Surgical has the highest EBITDA multiple among the three.

Accuray is trading at $5.70 per share, with a total market cap of nearly $422.50 million. Because of its negative EBITDA and earnings, the EBITDA multiple and PEG ratio are not valid. Its price-to-book ratio is quite high, at 3.45. Accuray is the provider of a full range of radiation therapy and radiosurgery treatments, with several manufacturing sites in the U.S. and China. Accuray has been trying to expand its market with two main new products: TomoTherapy H series, covering the full spectrum of radiation therapy treatments, and CyberKnife M6 Series, the premier solution for full-body radiosurgery. Moreover, it has also had ongoing business restructuring to keep growing revenue and gross profit and reduce its operating expenses, so that the business could turn profitable. For the full year 2014, the company expects to deliver a gross profit of $13-$15 million per quarter in 2014, and reduce its non-GAAP operating expenses to around $38 million per quarter by the last quarter of fiscal 2014.

Medtronic, at $52.80 per share, is worth $53.20 billion on the market. The market values Medtronic at 9.4 times its trailing EBITDA, lower than the EBITDA multiple of Intuitive Surgical. However, its PEG ratio is higher than Intuitive Surgical, at nearly 2. The company has laid out several near-term drivers to sustain its top line and bottom line growth, including key business stabilization, several meaningful product launches, focusing on emerging market growth, product cost savings and SG&A leverage, and a disciplined capital allocation. For the full year 2014, Medtronic expected to grow its revenue at around 3%-4%, with the SG&A operating leverage reduced about 30-50 basis points. Medtronic estimated that it could generate more than $25 billion in free cash flow in the next five years. Within that $25 billion free cash flow generated, it could return more than $12.5 billion in cash via both form of buybacks and dividends to its shareholders.

My Foolish take

Among the three companies, Intuitive Surgical seems to be the most profitable with the highest operating margin at 41%, while the operating margins of Accuray and Medtronic are much lower at -25% and 29%, respectively. Intuitive Surgical seems to be a good growing business to hold in a long run. However, at this current price, it still seems to be quite expensive. I would rather wait for an additional price correction before initiating a long position in this stock.

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Anh HOANG has no position in any stocks mentioned. The Motley Fool recommends Intuitive Surgical. The Motley Fool owns shares of Intuitive Surgical and Medtronic. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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