2023-06-12 12:20:46 ET
Summary
- Harrow Healthcare is well-positioned to grow in the US Ophthalmology market, with a branded pharma sales strategy that could boost growth and margins.
- The company's medium-term earnings outlook is strong, with a 2-year earnings CAGR of 159%, potentially justifying a premium P/E valuation.
- Risks include heightened volatility, high net debt levels, and the stock being a target for short-sellers.
Harrow Healthcare ( HROW ) is a small-cap pharma stock that is well-positioned to build ample clout in the US Ophthalmology market. Broadly, we like the story here, but there are a few risks that should not be played down as well.
What's Good
BPP Strategy To Make HROW More Well-Rounded, And Could Catapult Sales And Margin Profile
The larger North American Ophthalmology market is currently worth $21bn and is poised to grow at 7% CAGR through the end of the decade. The leadership team of HROW believes that over time, the company could fill the " leadership vacuum " that is present in the American component of this market, where competitive intensity is relatively low (most companies are focused on other therapeutic areas), while the drug-servicing opportunity is quite high.
Take, for instance, the disease of glaucoma which looks set to spread its tentacles across America, given not just the ever-increasing level of aging in the country, but also the relatively low level of diagnosis. The Glaucoma Research Foundation estimates that three million Americans are experiencing Glaucoma, but the diagnosis rate is rather low at just 30-50%
It's worth noting that HROW already has a reliable ophthalmology-focused pharmaceutical-compounding business (ImprimisRX, or CPP) that has been around for close to a decade and has typically generated double-digit annual revenue growth in the recent past. For the uninitiated, pharma-compounded drugs are not FDA-approved, but these customized combinations of drugs serve as a cheaper alternative to non-customized commercial drugs.
In recent periods, HROW has sought to complement the CPP business by pivoting to a branded pharma ((BPP)) sales strategy, which could catapult the company both from a growth and margin perspective. In the medium term, much attention will be centered around the commercialization of ILREVO (eye drop associated with cataract surgery), NEVANAC (eye drop associated with cataract surgery, and MAXIDEX (adrenocortical steroid) for which HROW recently received NDAs. Next up on the agenda will be the commercialization of the antibiotic - VIGAMOX and TRIESCENCE (for visualization assistance during vitrectomy) once the NDAs are procured by the end of this year. Besides these five products, HROW already owns the commercial rights of four other branded ophthalmic pharmaceutical products (IHEEZO, IOPIDINE, MAXITROL, MOXEZA).
On account of this bump from the BPP side of the portfolio, HROW's revenue growth, which came in at a healthy 18% in Q1, will only improve going forward. For FY23, the company is expected to generate sales growth of 56%, and over the next two years (through FY25), sales will likely grow at a 2-year CAGR of 34% .
It isn't just the sales profile; HROW already had a compelling and ever-improving gross margin profile (see the image below where GMs have doubled from the 34% levels seen in FY14, but as BPP takes on a larger proportion of the sales mix, these margins are expected to trend closer to the 80% levels. Even if you don't account for the greater chunk of BPP, it's worth noting that HROW's GMs are better than the pharma sector median level of less than 60%.
Stupendous Medium-Term Earnings Outlook Helps Allay Premium P/E Valuation Fears
Based on sell-side estimates for FY24, HROW's forward P/E multiple works out to 15.3x; prima facie, that is not great, as it represents a whopping 70% premium over the stock's historical average which is around the high single-digit terrain!
Having said that, we'd urge investors to also consider the degree of medium-term earnings growth you'd be getting at that P/E multiple. Firstly, note that after three years of being in the red , HROW will likely deliver positive earnings this year (FY23 expected EPS of $0.41). However, next year, in FY24, that EPS will surge by 3.2x to hit $1.32!
Ordinarily, one would think it would be challenging for a company to deliver triple-digit growth yet again, just after having delivered 300% earnings growth in FY24. But that is pretty much what HROW looks set to deliver in FY25, where earnings will likely grow by 109% YoY. All in all, over two years, you're looking at a business that looks set to deliver a 2-year earnings CAGR of 159%. Given this threshold of stratospheric earnings growth, you're basically looking at a business priced at an inordinately low PEG (Price to earnings growth) multiple of just 0.1x.
Good Risk-Reward On The Charts
To conclude, we'll also highlight the attractive risk-reward on HROW's weekly chart. Our attention is primarily centered around the price action from late September 2022 till late March 2023; during this period, HROW had been trading in the shape of an ascending channel, with some healthy consolidation phases every now and then. However, from April until the first week of May, the stock went parabolic, breaking past the upper boundary of the channel, and looking quite overextended to the upside, suggesting a correction was due.
In the next stage, we saw a drastic reversal of fortunes, with the stock witnessing a series of red-bodied candles, until a climax in late May around the $18-$19 levels. What's intriguing is that those price levels coincide with the lower boundary of the ascending channel, a seemingly good terrain to initiate long positions. We can also see that the $17-$19 levels have previously served as an important consolidation zone (area highlighted in yellow), increasing the possibility of a near-term bottom.
Risks
Even though the investment case appears to be largely favorable, HROW is by no means faultless. Firstly, its heightened volatility profile may put off quite a few conservative investors who look to the pharma sector for some defensiveness. For context, the 30-day rolling volatility of HROW has been consistently high at over 60% on average and currently stands at 78%.
Then, given some of the investments HROW has been making to build its BPP infrastructure, it's fair to not expect too much cash-generation potential at this juncture. But when you combine that situation with sky-high net debt levels, it is a source of concern. Traditionally, the company has found it challenging to generate sufficient FCF to cover its debt (average FCF to debt is negative 0.2x), and now it's a lot worse at -1.5x
Finally, we'd also urge investors to be cognizant of the fact that this is a short-sellers' darling. As things stand, the percentage of float that is short recently hit double-digit levels and is at record highs of 13%. Some of you may be wondering about the prospect of a short squeeze, but for that, you'd need a relatively high number of days to cover of at least 10x. With HROW it is currently only at 4.8 days, so the short-sellers don't have an awful lot to fear and may continue to bludgeon the stock.
For further details see:
Harrow Health: Mostly Good, Some Bad