$ISRG Q4 Earnings Preview

by Enis January 23, 2014 8:13 am • Commentary

Event:  ISRG reports its Q4 earnings today after the close.  The options market is implying about a 6% one day move, which is in line with the 4 qtr avg of about 6% and the 8 qtr avg of about 5.75%.

Sentiment:  Wall Street analysts have been relatively mixed on ISRG, with 10 buys, 7 holds and 6 sells, with an average 12 month price target of $417.  The stock is down 22.5% over the past year, though it’s off to a strong start in 2014, up almost 15%.  Short interest is at around 6% of float, near the midpoint of the past few years.

Options Open Interest:  Calls and puts are about equally split among the total open interest.  1 month average daily volume has favored calls to puts by a ratio of 1.4 to 1, reflecting the strong start for the stock to start the new year.  The only strike with over 1k of open interest is the April 340 puts.

Price Action / Technicals:  We took a Deep Dive look into ISRG in a post last week.  Since then, the stock has regained the 200 day moving average, though it continues to find resistance at the important $450 resistance level (which was support throughout much of 2012 and 2013:

ISRG daily, 200 day ma in yellow, Courtesy of Bloomberg
ISRG daily, 200 day ma in yellow, Courtesy of Bloomberg

That’s the crucial level to watch after the earnings number tomorrow.  Support on the downside comes into play around the psychologically important $400 area.  The stock closed 2013 at $384, which is also near the rising 50 day moving average.

Fundamentals/Valuation:  We discussed the valuation and fundamental story extensively in the Deep Dive post.  This was my main takeaway:

With a controversial back story, I’m surprised that ISRG has kept a relatively full valuation.  It’s a 25 P/E name with 3-10% earnings growth expected over the next 2 years, and 5-15% earnings growth expected.  But the risks are numerous.  While ISRG’s business model of selling the $1-$2 million system up front, and collecting $100,000-$200,000 per year in service revenue off each system is a nice razor/blade model that improves with a greater installed base, the legal issues, questions about efficacy, potential U.S. saturation, and overall cost of the systems are all overhangs for the business.

Given all of that, I’m actually surprised the short interest is only 6% of float.  If the stock does make another run above $450, a fade the strength structure might make sense.

The company jumped in January after stronger than expected sales numbers disclosed mid-month.  However, I’d rather wait and see how the company assesses the 2014 outlook before taking a position on the name in either direction.

Volatility:  Implied volatility in ISRG is close to where it has been prior to its last few earnings events:

30 day implied volatility in ISRG, Courtesy of LiveVolPro
30 day implied volatility in ISRG, Courtesy of LiveVolPro

The implied move is also right in line with recent history.  Given no major catalysts for the stock after the earnings event, implied volatility is likely to fall to the mid-20’s after the announcement.

Our View:  In many cases, significant analysis on an individual name can result in a takeaway that implies no trade.  That’s where we ended up after scrutinizing ISRG’s business model, recent history, macro trends, and stock valuation and technicals.  This former high flier has significant road bumps ahead of it.  If management can steer through that rough terrain (particularly in the U.S.), then the company still has a bright future ahead of it given its innovative technology.  But with a valuation that is only fair, we’ll be looking elsewhere for opportunities on either side of the ledger.