October 21, 2015 | 10:38 AM by Fahad Khalid | fkhalid@jaguaranalytics.com

Unlock: Intuitive Surgical (ISRG) Earnings Play

Impressive +7% move after ISRG posted solid quarter showing da Vinci procedures grew +15% y/y resulting in Q3 EPS of $5.24 vs. $4.23 estimate on Revenues of $590M vs. $580M estimate. More importantly in Q3 the FDA approved Single-Site instruments and EndoWrist stapler, both of which our research shows are not built into consensus views on the street. That means we expect to see more analyst upgrades and hikes in price targets in coming days.

The installed base for da Vinci Systems continues to grow at steady and healthy rate, now approaching 4,000 after finishing at 3,398 on June 30, 2015. An important point to note is each system post installation requires annual service agreement at average price of $170,000, resulting in gradual rise of recurring revenue stream that provides cushion to downside in terms of financial stability, cash flows and stock performance, plus creates a case for higher multiple.

With all this said, we believe the stock is winner in long run. It has been at least four years of sideways chop fest, which is understandably due to the fact that growth curve flat lined with annual EPS around $15.50 from 2012 to 2015. Going forward this story has potential to improve with rising adoption rate, higher installed base and recurring cash flows.

On October 1 we suggested our clients to get long ISRG into the print using November 475/525 call spread for $12.00 with stock trading at $455. Trade was closed today for $31.00 or 158% gain. Here is our note:

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Intuitive Surgical (ISRG) – Unusual buyer of 900 October 485 calls paid $3.40 asking price today with stock currently at $453. An aggressive bull with $300,000 bet when the bid on these calls was only $1.45. These calls are about 8% out of money and have little over two weeks to perform, hence it caught our attention. We can’t find any particular catalyst in short term but we like owning November 475/525 call spread, which is currently going for $12.00, into next earnings release on October 20 which is after October expiration. ISRG posted a blow out quarter in July:

– Q2 EPS $4.57 vs. $3.98 estimate
– Q2 Revenues $586M vs. $567M estimate
– Instruments $296.8M vs. $287.4M estimate
– Systems $176.0M vs. $163.3M estimate
– DaVinci Systems Placed 118 vs. 112 estimate
– Procedures Performed +14% vs. +9.7% estimate
– Gross margin 68.0% vs. 65.0% estimate

Stock jumped $60 on that report from $500 to $560. As margins trended higher in Q2, management commented that cost reduction and efficiency initiatives should bear more fruit in quarters to come while top line revenue growth to maintain at 12-18% YoY stemming from 1) momentum in new procedure growth areas, 2) stabilization of mature procedures; 3) improving capital sales performance (and fertile opportunities to come) in the US and OUS, highlighted by Xi sales in the US and new product approvals in Japan.

There was everything to like in that report. Recent market sell off now has stock trading at $455 without any stock-specific news. There is no reason to believe the growth story has changed, hence we like it while its cheap ahead of next earnings.

ISRG Chart

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