HROWL - Despite Q3 Earnings Miss Harrow Is Still Appealing For 2024

2023-11-15 00:33:34 ET

Summary

• Harrow is a company focused on eye health with a strong distribution platform and CEO ownership.
• Q3 earnings were below expectations, and guidance was lowered, raising concerns about operational performance.
• However, the company has lots of opportunities for 2024, and even partially delivering on this could cause the shares to re-rate materially from current levels.

Harrow ( HROW ) is focused on eye health with a strong industry distribution platform and material CEO stock ownership. However, recent Q3 2023 earnings came in below expectations and guidance was correspondingly lowered.

However, assuming the long-term trajectory remains broadly intact, now may be a reasonable entry point to build a position in what may prove to be an attractive potential long-term compounder over the coming years.

What Went Wrong In Q3

Harrow recently acquired 5 new products to slot into its distribution network. Four of these delivered below expectations due to a slower ramp in sales and marketing than planned, the fifth has stalled entirely due to primarily manufacturing issues. They were unable to manufacture the product successfully and, as such, they can't sell it. Also, their legacy compounds business underperformed during the quarter too. That said, the launch of their IHEEZO product was ahead of expectations, it may be that their operational capability is currently overstretched and is not able to handle all the acquisitions and launches optimally currently.

A Quick Valuation Looks Attractive

In 2024, the business expects to deliver $180M of revenue on management guidance. Now, for the first 9 months of 2023, EBITDA margin is 25% so that implies $45M of EBITDA in 2024 at the same margins. At a 12x Multiple that implies the following:

Essentially there may be material upside if management's 2024 forecasts hold, and indeed the stock hit those levels in 2023, though of course, some skepticism is fair given the recent earnings miss.

As a sanity check, the current stock price of just under $8/share implies roughly an 8x estimated 2024 EBITDA multiple and valuing the equity/debt stakes at 50% of management's value. That may be too cheap for a growing pharma business with a lot of optionality for 2023, which we'll get to next, but only if management can deliver on the acquisitions as expected.

Bridging To 2024

Now let's look at 2024's potential in more detail, on very rough numbers. These are certainly not precise estimates but do help scope the business performance:

Please take the above numbers with a large pinch of salt as not much detail is supplied at the product/segment level. Still, we can conclude there is a lot of optionality in Harrow's 2024 business with, broadly, five levers to accelerate growth next year whether through business improvement, scaling, or product launches.

Even if Triesence delivers nothing, there is still a clear path for EBITDA growth across multiple products and the VEVYE launch could be a material contributor to EBITDA, with management's ultimate revenue target of $100M, albeit with some time required to get there. IHEEZO too may have large potential as well depending on the share of procedures it can capture.

Resulting Valuation

Now here are a few 2024 scenarios depending on possible outcomes. I assume 12x EV/EBITDA.

Risks

• The main risk is that Q3 numbers are not merely a blip in operational performance, but the start of operational underperformance reflecting overpayment for recent acquisitions. We may not know that with certainty until we've seen at least full 2023 results and maybe Q1 2024 earnings.
• In addition, some of Harrow's recent re-rating was predicated on the company moving into branded products, if that move proves unsuccessful, then maybe the multiple sees further contraction.
• There are also risks from the technical setup, the share price has crashed after Q3 earnings, and so now is highly unlikely to be the perfect entry point as holders diagnose the bad news.
• There are some moving parts with milestone payments depending on launch success and other factors that are not captured in the above.

Conclusion

Even though 2023 has disappointed, Harrow has a lot of optionality for 2024 with the launch of VEVYE and likely continued growth from IHEEZO and 4 acquired "fab five" products. Then if Triesence can be successfully manufactured it should contribute to earnings too.

As such 2024 could see a material step-up in profits even if some aspects of the business continue to lag. Then the business makes sense strategically as a platform to serve eye doctors with limited competition, and additional protection from patented products. Lastly, the CEO holds material equity so incentives are broadly aligned with shareholders.

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