What Caused Intuitive Surgical (ISRG) to be a 9x Bagger in Less Than 2 Years?

Intuitive Surgical (NASDAQ: ISRG) shares started 2004 at $5 per share and ended 2006 at $45, a 9x return in 2 years.

What caused the explosion in the stock price?

The best I can tell looking back at the data: (1) an enviable market position with a very large total addressable market for its da vinci product and (2) accelerating revenue growth, an earnings inflection point, and EPS acceleration both year-over-year and sequentially.

If we look back at the results, starting in Q1 2004, Intuitive Surgical started posting incredible numbers.

Q1 2004 revenue was up 41% YoY, and earnings inflected to a 2c profit from a loss of 12c in Q1 2003, then the company followed up with 45% revenue growth and 14c EPS in Q2 2004.

If we look back just one quarter to Q4 2003, ISRG posted 30% revenue growth but lost 16c per share.

In my eyes, the Q1 2004 report delivered in late April 2004 caught the imagination of many investors because of the revenue acceleration and an EPS inflection point. The stock was finally ready to go: an enviable market position plus great execution leading to rapidly improving fundamentals put a significant tailwind behind the share price.

Following Q2, ISRG then reported 52% revenue growth and 17c EPS in Q3 2004. Meanwhile, ISRG also reported expanding gross margins from the low 50% range at lower revenue levels, increasing to 64% by Q3 2004 as ISRG enjoyed the benefits of higher margin consumables in its product mix and efficiencies of scale at higher levels of revenue.

It seems like revenue growth coupled with gross margin expansion and operating expenses that grow at a slower pace lead to a rapid expansion of pre-tax operating margins and, consequently, earnings growth which ultimately drives stock prices.

ISRG growth continued to accelerate when it reported Q4 2004 numbers in February 2005, with revenue up 64% and 32c EPS, up from that 16c loss in Q4 2003.

Q1 2005 ISRG revenue growth was 54% and 25c EPS (vs 3c Q1 2004. Gross margins expanded to 65.5%.

Q2 2005 ISRG revenue growth was 70% and 40c EPS (vs 14c Q2 2004). Gross margins expanded to 68%.

It appears like this Q2 2005 earnings report on July 26, 2005 was the catalyst for the next crescendo in ISRG stock price, driving it from $17 per share on July 26 to $24 just two days later on July 28, on its way to finish the year at $45 (nearly a triple in half a year).

More tailwinds to the share price ascent came in October 2005 due to the following Q3 2005 results: ISRG revenue growth was 72% and 55c EPS (vs 17c Q3 2004). Gross margins expanded to 69.5%.

In February 2006, ISRG reported 60% revenue growth and $1.31 EPS (of which there was a $24.1 million tax benefit) so those earnings weren’t totally comparable YoY to the 31c ISRG put up the year before. The stock cooled off from $45 to $30 per share in March 2006 (the CFO disclosed a plan to sell 18,000 ISRG shares), and stayed in that range until January 2007 when ISRG shares started its next ascent to $110 per share by year-end 2007, a 22x bagger in 4 years from the $5 stock price in January 2004.

Why is all this important?

I believe I’ve identified a stock that could start to accelerate revenue and EPS starting in Q4 2018, and this company is a tiny $80M market cap medical device manufacturer called Sensus Healthcare (NASDAQ: SRTS), currently trading at about $5.50 per share.

Not only is the company growing its core superficial radiation therapy (“SRT”) equipment (for use in non-melanoma skin cancer and keloid indications) revenue at 30% YoY, the company appears to be on the verge of inflecting to GAAP profits and a revenue acceleration on the back of a key corporate customer who is finding success in providing turnkey solutions to dermatology clinics across the country, and a product portfolio, geographic reach and sales organization that continues to expand.

Non-melanoma skin cancer and keloids are very large markets. In particular, NMSC affects over 4 million Americans a year alone and is expected to rise to 6 million occurrences per year over the next couple of years. The “gold standard” for removing skin cancers is Mohs surgery, but it is expensive and can cause significant aesthetic damage. Superficial radiation therapy, on the other hand, is less invasive, costs less and at one time, half of all the dermatology clinics in the United States had SRT equipment before it fell out of favor because there weren’t any material advancements to the technology.

Sensus reintroduced the technology in 2011, and has driven its install base to around 400 units. There are 14,000 dermatology clinics in the US, so if we use the 50% penetration rate achieved decades ago, there is a path to 7,000 SRT machines at dermatology clinics in the US alone. And that doesn’t include hospitals, radiation oncology clinics, plastic surgeons or any international opportunity which also dramatically expands the total addressable market for SRT equipment.

Moreover, Sensus recently published the results of one of its key opinion leaders which indicated that keloid recurrence was only 3% when coupled with SRT, which is a statistically significant variance versus the 71% recurrence rate using other methods. Given insurance plans only cover keloid removal when coupled with SRT treatments, I believe this could be a large growth driver for Sensus in the years ahead.

Sensus raised $15.9 million in growth capital in September 2018 to support inventory builds, and to expand its R&D and sales organization for the potential commercial launch of its disruptive Intraoperative Radiation Therapy product (IORT) called Sculptura which is pending FDA 510k clearance.

Analyst estimates call for $7.5M in Q4 2018 revenue, but based on some of my own scuttle research, I believe SRTS could put up a $9M+ revenue quarter which would drive 2-5c EPS (up from a 3c EPS loss in Q4 2017) and result in revenue growth nearing 40%. I think the magic number is 40%+ growth, then acceleration higher than that (as evidenced by the 2004-2005 IRSG results and share price appreciation), but a $9M quarter would provide another period of accelerating revenue growth YoY, Q2 2018 was 22% growth and Q3 2018 was 32%.

None of this $9M projection includes any sales of Sensus’ new IORT product which has a $1.45M list price. CEO Joe Sardano said the company is building 4 beta units, and is in discussions with key teaching institutions who have Investigational Review Board (“IRB”) status, and who can acquire the product before an FDA 510(k) clearance. To that end, Mr. Sardano did suggest that there is a potential to place up to 4 IORT units in Q4, but the company is guiding investors to expect IORT revenue starting in 2019. That said, this company has a history of under promising and over delivering, so I believe there is a decent probability Sensus reports at least one IORT sale before year-end which could provide a meaningful catalyst for the stock.

If we assume SRTS can record about $26 or $27M in 2018 revenue, and the core SRT business can grow 30% in 2019, that leads us to $35M in 2019 SRT revenue. Add in a few million revenue contribution from recently a introduced cosmetic laser portfolio, and we are at $37-$38M for 2019. Then if we add in 4 IORT sales at $1M to the teaching institutions and 4 commercial IORT sales at $1.45M, and it appears like there is a path to $45 to $50M in 2019 revenue. Assuming 62% gross margins and $22M in operating expenses for the year and 16M shares outstanding, it appears like SRTS has a path to earning $5+ million in 2019, or about 30c EPS.

The profitability is nice, but I think the stock will trade more on a revenue multiple if investors become enamored with Sensus’ market position and addressable market, both which seem solid and vast.

Disclosure: Long SRTS shares