Harrow Health And Its Interesting 11.6% 2027 Baby Bond (NASDAQ:HROW)

Introduction

At our Conservative Income Portfolio service, we cover the universe of preferred stocks, term preferred stocks, baby bonds, and traditional bonds. Generally, we consider the safety of utmost performance as we look to find the highest yielders that also offer a strong level of safety. We also focus on securities that not only offer high yields but a lot of capital gains potential as well. We are total return investors. But sometimes we come across super high yielders with decent risk/reward profiles, and today’s article is for investors who are willing to take a bit more risk in order to achieve a very high yield.

Harrow Health

Harrow Health (NASDAQ:HROW) produces eye care pharmaceutical products, which they market to ophthalmologists and optometrists. It is looking to be the big player, and may already be the biggest player, in this space but is still currently under a $1 billion market cap with a $717 million market capitalization.

Here is how the company describes itself, and here is a link to a 15-minute video about the company for those interested.

“Harrow is a growing leader in the ophthalmic healthcare market. Our success-to-date is directly tied to our unique approach to serving patients and supporting eyecare professionals. We make pharmaceutical products for the over 8 million annual ophthalmic surgeries in the U.S., as well as medications prescribed to treat patients managing chronic and acute eye conditions such as dry eye disease, glaucoma, allergies, infections, and other ophthalmic inflammatory conditions. We serve over 10,000 doctors, hospitals, and ambulatory service centers (ASCs) and regularly ship to over 1,500 institutional accounts each month. We are supported by an integrated national sales and customer service organization, as well as an efficient, scalable, and tech-enabled national production and distribution platform licensed to do business in all 50 U.S. states.”

Not long ago, HROW received FDA approval for a new medical treatment which the company believes will be big. Investors seem to agree, taking the price of HROW much higher over the last year, first on expectations of FDA approval and then on the actual approval.

As you can see from the 1-year price chart above, HROW’s price has been soaring. We saw a bit of profit-taking recently but even more recently the company announced that they expect to beat their previous EBITDA estimates, and that news along with news of an acquisition took the stock up close to 20% in just the last 10 days. And the price has almost tripled from 1 year ago.

HROW’s Balance Sheet

From one standpoint, the balance sheet of HROW looks very leveraged. Their assets are mostly products in development or not yet to market as well as intellectual property. The value of these assets may be hugely undervalued on their books relative to their future earnings power.

A much better way to look at leverage is the amount of debt relative to the company’s enterprise value. The enterprise value of HROW is around $913 million, with a debt of only $169 million. This puts leverage at only 19%. Of course, the company’s price could be overvalued, but even if the stock price dropped 40%, leverage would still be very low at only 27%. Additionally, current assets are 3 times current liabilities, so liquidity is not an issue.

The 19% leverage number includes stock that will be sold by HROW soon. HROW recently announced a secondary offering of 3.38 million shares of stock to raise funds for an acquisition, with the remaining money used for general corporate needs. From a bondholder’s perspective, the fact that they are now using their high stock price as currency to grow the company, rather than using debt, is very good. It will increase the size of the company while lowering leverage. This was the catalyst that made me decide to 1) write about HROWM, 2) increase my position size in HROWM, and 3) why I feel that the safety of the company has improved even more. And while normally the announcement of a secondary stock offering drops the price of the stock, HROW has rallied strongly since the announcement of a secondary offering.

HROW’s Baby Bonds

It appears that baby bond HROWM was issued to raise funds to get their newly approved medical treatment to market, for marketing, and for funds for the continued development of other products in the works. It is the second baby bond issued by HROW with HROWL being an older baby bond than HROWM. Here are the details:

HROWM

YTM 11.62%

Last Price $25.20

Maturity Date 12/31/2027

Current Yield 11.84%

_______________________________

HROWL

YTM 9.02

Last Price $24.75

Maturity Date 4/30/2026

Current Yield 8.74%

I don’t usually put in current yield when I write about bonds, just the YTM which is the key metric for a bond. But I know that some investors do put importance on current yield, even for bonds, and HROWM has a very high current yield of 11.84%. Most baby bonds trade well below par and have relatively low current yields. OXLCZ is one example where although the YTM is 8.32% the current yield is only 5.55% with future capital gains making up the rest of the return.

One last thing to mention is that I think that HROWM is a very good value relative to their other baby bond HROWL. Here is a comparison:

HROWM HROWL

YTM 11.6% 9.05%

Maturity Date 12/31/2027 4/30/2026

Current Yield 11.79% 8.74%

As you can see, HROWM is longer in maturity than HROWL by 20 months, but the yield to maturity (YTM) is enormously better at 11.6% versus 9.05%, and the situation with current yield is even better with HROWM at 11.79% versus only 8.74% for HROWL. For me, at least, HROWM is the bond to buy. Those owning HROWL should consider swapping.

Conclusion

While HROW common stock is interesting and the company has been creating massive shareholder value in its short history, the common stock is very hard to value. I am not a pharmaceutical analyst and really have no idea what kind of growth this new product will produce, nor do I know the growth profile of their other products or the recent acquisition. Therefore, I cannot recommend the common stock.

But given HROW’s low level of debt (19% of enterprise value), the YTM looks very strong at 11.6% for a bond that is relatively short term – maturing 12/31/2027. Finding this kind of yield on a company with such low leverage is nearly impossible. And additionally, in my eyes, HROWM is also quite undervalued relative to its sister bond HROWL.