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Wednesday, September 18, 2013 - 14:30

Get 25% Upside With This 'Cyborg In The Operating Room'

Wednesday, September 18, 2013 2:30 PM

Even after the tech-craze and bubble of the '90s, technological leaps still change our lives drastically and offer the most compelling cases for amazing profits.

After researching stocks for my recent series on the "Graying of America," I was well aware of the demographic forces behind the health care industry.

The numbers forecast for the health care industry over the next decade are staggering. Total U.S. health care spending is projected to reach $4.8 trillion in 2021, 84% higher than current spending. More than 10,000 baby boomers turn 65 each day, and life expectancy has reached 79 years. These drivers are going to create a lot of opportunities in the sector, and technology is just beginning to play a part.

That is why I am so excited about one company in particular -- one I like to call the cyborg of the operating room.

Da Vinci Meets 'The Terminator'
Long recovery times and hospital stays associated with major surgery are a big contributor to the high cost of health care. The average hospital stay after invasive surgery is up to seven days, with the average cost per day approaching $4,000 in many states.

And the recovery time after hospitalization can take weeks because the only way to do many of these operations is to open up the patient, which leaves the patient at risk of infection and other complications.

That is, until this company invented a revolutionary new machine, one that combines the art of a surgeon's scalpel with 21st-century robotics.

Enter Intuitive Surgical (Nasdaq: ISRG) and Da Vinci, a robotic arm that allows surgeons to operate with just a single incision less than an inch in size.

Wikipedia/Antonu
With the Da Vinci robot, surgeons no longer need to remove organs to perform an operation, so recovery time is shortened, sometimes to as little as one day.

Surgeons no longer need to remove organs to perform an operation, so recovery time is shortened, sometimes to as little as one day. Research has also shown that surgeries using Da Vinci have a lower risk of complications and lower incidence of infection.

There were 2.6 million procedures done last year that could have used the Da Vinci technology, but only 450,000 were done using the apparatus. That amounts to 17% penetration of a market with some strong demographic growth drivers ahead.

Costly Procedures, Cheap Stock
While the technology helps to bring down costs and risks after the procedure, the equipment is not cheap to buy. In fact, the system costs between $1 million and $2.3 million with instruments, costing about $2,000 per procedure.

That's why the stock has taken a hit lately as the government rails against the high cost of medical care. ISRG is down 35% from its February high on fear that the Affordable Care Act will limit the amount paid for procedures and doctors' ability to recommend them.

Even with the slower capital spending environment, procedures were up 25% in 2012, and revenue growth has increased at a compound annual rate of 29% over the past five years. The equipment is expensive, but hospitals are still finding room in their budgets for Da Vinci's revolutionary potential. Once the spending cycle for medical equipment recovers, Intuitive's sales could jump.

The large base of installed systems provides an ongoing stream of instrument sales and service which should support the shares in the near term. Annual service agreements now account for 28% of total revenue at $343 million. With a net margin of 30%, the company could even lower its sales price to attract more purchases, which could drive instrument sales and service even higher.

A moderation in sales growth to 15% and slightly weaker margins should yield at least $16.77 per share in earnings for fiscal 2013. The five-year average price ratio for the stock is 34.3 times trailing earnings, well above the current multiple of 21.8 times. At a more realistic 28 times earnings, the shares should be worth $469 a share at the end of the current fiscal year -- a 25% upside to the current price.

Risks to Consider: The company faces considerable risk from the Affordable Care Act and the general push to lower the costs of medical procedures, which could lead to greater volatility in its stock.

Action to Take --> Intuitive is changing the way surgery is done and improving outcomes for patients. The revolutionary technology has little to fear from Washington, and investors should consider ISRG while it's still cheap.

P.S. -- If you think 25% upside on ISRG sounds good, you'll want to take a look at our latest report, "The 11 Most Shocking Investment Predictions For 2014." Our previous predictions have given investors 89%... 92%... 293%... and even 310% gains in a year. Click here to learn more.

Joseph Hogue does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.