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Rising earnings estimates on the back of strong third quarter results - including a 28.2% earnings surprise - helped Intuitive Surgical (ISRG - Analyst Report) achieve a Zacks #1 Rank (Strong Buy) on January 1, 2013. Moreover, this pioneer of robotic surgery has delivered a positive earnings surprise in each of the last five quarters with an average beat of 13.7%.

The Rank Driver

We expect a number of procedures that are currently completed either in an open surgical manner or with laparoscopy to be eventually replaced by da Vinci surgery, as robotic surgery becomes the standard of care in many instances. The company enjoys a virtual monopoly in robotic surgery with little competition.

Intuitive’s recurring revenue stream continues to be robust and provides a shield against cyclicality of revenues arising from the sale of discretionary capital equipment to hospitals. Recurring revenues continue to grow as a proportion of total sales. It increased 24% year over year in the third quarter and constituted 57% of revenues.

However, we believe that until the global economy fully recovers, the stock may come under periodic pressure as investors ponder whether lingering macro economic uncertainty weakens hospitals’ commitment towards investment in high-cost robotic systems. In the interim, the installed base of Intuitive continues to grow as hospitals are compelled to upgrade their systems.

Overall, a reasonable valuation is appropriate given positive factors such as Intuitive’s leading position in robotic surgery, a growing list of emerging procedures, barriers to entry, sizeable cash and no debt.

The company tweaked its guidance for revenues and operating income for 2012 along with its third quarter results. For 2012, revenues are forecast to grow in the range of 21.5% to 23% compared with the earlier guidance of 20% to 23%. Operating income is expected at about 40% compared to approximately 39% to 40% of net sales earlier. The company lowered its procedure growth at 24% (earlier in the band of 25% and 27%) for 2012.

Earnings Estimate Revisions

The Zacks Consensus Estimate for 2012 increased 0.3% to $14.85 per share based on 6 out of 8 upward estimate revisions over the last 60 days. The current estimate implies year-over-year growth of 20.6%.

Valuation

Intuitive currently trades at a forward P/E of 33.4x, a 77.8% premium to the peer group average of 18.8x. Also, on a price-to-book basis, the shares are trading at 6.0x, a 42.9% premium to the peer group average of 4.2x. Given the company’s strong fundamentals, the premium valuation is justified.

Intuitive has a trailing 12-month ROE of 18% compared with the peer group average of 12.3%.

About the Company

Headquartered in Sunnyvale, California, Intuitive specializes in minimally invasive robotic surgery. Its systems find application in gynecology and prostatectomy procedures besides a host of emerging procedures. The company has a market capitalization of about $19.5 billion.

Other Zacks #1 Rank (Strong Buy) stocks include Myriad Genetics Inc. (MYGN - Analyst Report) and Cantel Medical Corp. .

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