On Holding Update: Still An Interesting Business (NYSE:ONON)

Dear Readers,

On Holding (NYSE:ONON) is a company I’ve written about a few times now and initiated a small position in. It’s small because it’s speculative – and I don’t see that changing soon. On Holding is a great business – both on its own, and if we start looking at it from a potential takeover perspective, which is not irrelevant here if we invest for the long term.

A very small portion of my portfolio is devoted to speculative plays with a much longer timeframe than my other investments. On Holding is part of that list.

So let’s update the company.

On Holding – The company, the upside, and the potential

On Holding, On, or simply “On Running”, is the holding company that owns the brand On. It’s an athletic shoe and sportswear company out of Switzerland, that designs, manufactures, markets, and sells its own sports clothing and running shoes.

This in itself is not unique. Plenty of brands, both large and small do this. Leaders in this category include adidas (OTCQX:ADDYY) and Nike (NKE), both of which I own some stock in, and both of which have underperformed this year. On Holding has not. Now, typically when a small business like this tells me that they’re going to “conquer the market” or do something extraordinary like challenge the hundred-billion dollar empires that are NIKE and adidas, I’d say “Good luck” and not be that interested, but On is different to me.

On Holding is neither small nor insignificant. It is what Switzerland often does with products – it might be a smaller, more niche company, but they also produce far superior products to the aforementioned ones.

Are the products for everyone? I would say no. For many runners and people more casual about their sports or more conscious about costs, the company’s products might be a tad too premium or too expensive.

Also, this is a massively challenged and brutal market. I know something about their value chains, their productions, their logistical and capital flows, and their operational management. There is a reason why the bigger ones have done extensive outsourcing of production and are capital-light compared to a company like On – but when it comes to producing something of really high quality to a niche market, you typically want to own the production yourself. Many high-quality products in many different spaces own their own production capabilities. It’s not necessarily a bad thing, as long as the numbers align properly.

While adidas or Nike aren’t necessarily “budget”, I would argue that most of their products don’t qualify in “luxury” or “premium” terms of segments as you would consider a “Rolls-Royce of X”. I would say that On products are closer to being the premium/premium name in recreational footwear.

I personally don’t often shop for budget clothes or shoes – my focus is quality first, price second. I make sure the products I buy are as manufactured in Europe as I possibly can, and that I buy things that last. On products do last. Not saying Nike and adidas don’t – but this is a simple fact.

This also isn’t a completely new sort of business. On has been around for more than 10 years, and the people that opened the business certainly have the know-how for their customers, because it was founded by a former Swiss Ironman Champion, Oliver Bernhard, with two partners.

Their products were immediately adopted, with winners wearing them in less than 2 years.

When athletes wear and market your products, you quickly get a place on the map – and On Holding/On is a very good example of this. The company reached a pre-pandemic Swiss market share of 40%, outperforming Nike and adidas, and has also captured almost 10% of the running shoe market in Germany.

That’s the base case we work from for this company – and this is also why I’ve been investing in the brand, both in products and in the stock. Because both of the indications here are that it works.

The company is present in 60 nations across the globe, with 17 million pairs of shoes sold over the past 12 years. 3Q22 results, which is the latest one we have, continued to report solid trends.

Sales were up 50.4%. Wholesale grew by more than 55%, with DTC up 40%, with exceptional geographical growth out of Asia with 85.2% in a single YoY period. 3Q22 was the strongest quarter in history for On, with sales of nearly 330M CHF – this has been a trend for On, which is reporting record after record. This is also what we want to see, given that the company is a growth-based business. If it failed to grow at these numbers, there would be little point investing in it, because it lacks a dividend, credit rating, and what makes investments attractive for me typically.

Top-line results were excellent – but as we move down the report, things start showing more impact. On is not immune to costs and pressures, and the company’s gross margin dropped by more than 300 bps YoY, down to around 57.1%. This is still impressive, but it was above 60% a year back. This was due to unfavorable FX but mostly due to freight and input costs, which are coming home to roost for On as well.

EBITDA margins are down to around 13.2% on an expected basis for the full year, and the guidance calls for net sales for 2022 of about 1.12B CHF, and from that the ability to squeeze around 150M CHF in EBITDA. For 3Q22, that number was around 56M CHF in adjusted EBITDA.

The positive here is the achievement of over a billion francs in sales – that’s what we wanted to see in 2022 if we look at my first article, and indeed that is what we’re seeing.

We’re also seeing continued growth from the company – impressive growth on the order of 40-85% from previous periods.

So, the growth thesis for On Holding is very much intact here. And given how small the company is, it’s quite followed and analyzed for a company of its size.

Let’s look at valuation.

On Holding Valuation

Valuations have slowly been normalizing for this business. From analysts being exuberant and shouting from the rooftops that this company is worth $50/share easily, we’re now back to earth. No analyst following the business from S&P Global believes the company is worth more than $31, and more than one believes it’s worth less than $18/share here.

The current set of analysts following and forecasting the company are 13, and their range starts at $15.56 and goes up to $30.69, with an average PT of $25, give or take a couple of cents.

However, these analysts more or less agreed that On Holding has dropped enough. 10 analysts give the company a “BUY” or an “Outperform” rating here, which means a vast majority of the current analysts believe the company will go places.

However, these analysts have been successively wrong in their estimates for the company. The last 1-2 years have been a never-ending set of analyst PT downgrades, from where they considered the company worth close to $50/share.

The fact is, if you bought in On too early, you’re now in the red – significantly so.

Me though, I bought it at what I view as an attractive price. The stock price then shot up to $55 – around 200X P/E and is now trading at $16.21/share.

Things are looking attractive for the company here, with a realistic expansion based on forward growth estimates, calling for the company’s growth rate to pace itself to around 30-50% for the next few years. I view this as a realistic forecast. The impact to gross margins has been noticeable, but not massively detrimental or value-destroying for the company.

I view the company’s prospect in the following manner.

On’s competition, including adidas and Nike, don’t have the growth upside that ONON has. adidas won’t grow 80-90% in a year. On actually might do that. The growth expected for 2022E is now no less than 152%, and beyond that we’re still at 30-50%.

While the company is still inarguably premium-valued to current results at just below at $16.5/share, with those growth expectations and the double-digit growth expectations of the years to 2024E, it’s no longer as crazy to consider that there might be an upside here.

Remember, quality discretionary businesses trade at around 30-40x P/E – and I’ve been known for paying those multiples for quality businesses. In this case, I’m willing to maintain, and potentially even expand my small position in On somewhat, for the promise that it holds.

At premium multiples, we get a current annualized upside of pretty much exactly 8-9% on a conservatively adjusted forecast estimate – expecting only 18-25% EPS growth or so, which the company has traditionally beaten and I expect the company to be able to beat going forward as well.

I am therefore repeating my stance that On Holding AG has a definite upside here. The EPS growth rate estimates are what I lean on to support my thesis here, which is rare for me. But this is a company that I see has proven, and will continue to prove what seems to be a long-term appealing case for shoes here.

I said in my previous article that If ONON were to crash to 12X P/E, that would imply a share price of $6.36. And that’s not for 2022E, but for the 2024E with $0.53E EPS. For 2022, it would be $3/share. Street targets were elevated, but since my last article, my own targets and the targets of the typically-exuberant analysts have come to go nearly hand-in-hand here.

There is a high risk to be had here, and I wouldn’t go into On Holding unless you’re really sure that you have the money you can do without – because there are better opportunities out there – and safer ones.

But it would be completely unfair to call On Holding anything except a speculative upside at this point, given the strength of its results and forecasts.

On the back of 3Q22, I’m raising my guidance PT to $16.5, which makes this now a weak, nearly-fair-value “BUY”.

Thesis

• There are plenty of ways to view a brand like this. As a consumer, I view the brand with a very favorable perspective – because I use, and love the products. I was wearing a pair of On shoes for my runs this summer – though now I’m in an environment where the products don’t make much sense for me to wear. Still, I remain in this positive stance here.
• The company’s negatives still remain and are worth mentioning. It’s a small player in a global field trying to make a name for itself in an environment that’s as logistically and financially challenged (and like to be) as we’ve seen it for decades. If ADDYY and NKE are struggling, you can bet that ONON doesn’t have it easy either.
• But I’ve added to my first shares, and I think you could do the same at this price – because I believe the company is likely to appreciate over time.
• I give the company a $16.5 PT.

Remember, I’m all about:

1. Buying undervalued – even if that undervaluation is slight, and not mind-numbingly massive – companies at a discount, allowing them to normalize over time and harvesting capital gains and dividends in the meantime.

2. If the company goes well beyond normalization and goes into overvaluation, I harvest gains and rotate my position into other undervalued stocks, repeating #1.

3. If the company doesn’t go into overvaluation, but hovers within a fair value, or goes back down to undervaluation, I buy more as time allows.

4. I reinvest proceeds from dividends, savings from work, or other cash inflows as specified in #1.

Here are my criteria and how the company fulfills them (italicized).

• This company is overall qualitative.
• This company is fundamentally safe/conservative & well-run. *
• This company pays a well-covered dividend.
• This company is currently cheap.
• This company has a realistic upside based on earnings growth or multiple expansion/reversion.

The company does not pay a dividend, nor can it be called “cheap”, but it is quality and there is an upside here.