ONON - Unlocking Potential: 3 Retail Stocks Poised For Growth

2023-09-21 16:15:53 ET

Summary

• This article provides short summaries of the three companies that we believe have meaningful upside catalysts in the next 2-3 years.
• On Running has a long growth runway ahead, reminding us of Lululemon five years ago.
• There has been a noticeable shift in behavior with consumers willing to pay for quality eggs, and Vital Farms is the category leader.
• Crocs is one of the most profitable footwear companies worldwide, popular among kids and teenagers, and it now trades at less than 8x forward P/E and 7x forward EV/EBITDA.

This article covers the three stocks in the consumer and retail sectors that we believe offer meaningful upside potentials, albeit with different catalysts. First, On Running ( ONON ) is a growth machine that is on its way to making a splash in the athleisure world. Second, the pasture-raised egg space carries a strong secular tailwind versus conventional eggs, and it is a consumer behavior change in the making. Vital Farms ( VITL ) is the category leader that shouldn't be missed. Finally, we view Crocs ( CROX ) as a shoe brand with sticky popularity and moat that's not going away anytime soon. Management is reducing debt and buying back stocks. With valuation compressing since its last quarterly earnings, it has become attractive in our eyes.

ON Running

ON is a Switzerland-based footwear and apparel firm founded in 2010 by former Swiss Ironman champion Olivier Bernhard. It primarily caters to the athletic market and positions itself as a premium shoe company, with prices generally in line with higher-tier products from competitors such as Nike ( NKE ) and adidas ( ADDYY ). We have been following this company since its 2021 IPO and view its products and growth story as remarkable. Coming into 2023, ON grew its annual sales by approximately 70% in 2022 while achieving a gross margin of around 60%, both of which are impressive metrics. Since the start of the year, ON has delivered two more record-setting quarters while increasing profitability. The brand momentum is strong across all regions, and it is finding success in both direct-to-consumer and wholesale channels, arguably boasting the best pricing power in the footwear category.

We have long been searching for an up-and-coming brand like ON, whose products can divert consumers from their existing shopping behaviors. We believe this company has a long growth runway ahead, especially with the introduction of apparel and untapped potential in Asia; its growth trajectory reminds us of Lululemon ( LULU ) five years ago. We see a potential path to doubling in stock price over the next three years.

Vital Farms

Vital Farms is known for its pasture-raised eggs and egg-related products, currently sold through more than 24,000 retail stores in the US. The question of "What type of eggs should you be eating?" has been widely discussed in recent years. Consumers are now highly informed about the distinctions between cage-free, free-range, pasture-raised, organic, and non-organic eggs, and there has been a noticeable shift in behavior with consumers willing to pay for quality eggs. Vital Farms is the category leader, having initially gone public in 2020, but its share price declined from $35 post-IPO to below $10 during the 2022 low, even though it doubled its revenue over that period. According to our calculations, it is now trading at less than 1x this year's revenue and approximately 10x next year's EBITDA.

The company has a clean balance sheet with no outstanding debt. During its recent earnings announcement, management upped its current-year revenue and adjusted EBITDA forecast, while also reiterating the company's strong momentum in its retail distribution and the growth in the pastured-raised eggs category versus conventional eggs.

The brand recognition and momentum, combined with a secular tailwind in the space, are too strong to ignore. Projecting the financials into 2025, we expect Vital Farms to generate over $620mm in revenue (~15% CAGR from this year's expectation) and achieve a 10% EBITDA margin. At 12x EV/EBITDA multiple, it certainly has the potential to be a ~$800mm company once it reaches this scale and margin.

Vital Farms just hosted a very positive Analyst Day on September 19th. Management expects annual revenue to top $1B by the end of 2027 (20% CAGR the next 4 years), gross margin of at least 35%, and Adjusted EBITDA between 12% to 14%.

Crocs

Occasionally, the market presents opportunities to buy quality companies at attractive prices, and that's how we were drawn to Crocs following its Q2 2023 earnings results when the stock sold off sharply. This is one of the most profitable footwear companies worldwide, popular among kids and teenagers, and it now trades at less than 8x forward P/E and 7x forward EV/EBITDA. The drop in valuation is primarily due to two main concerns: the longevity of the Crocs brand and skepticism surrounding the acquisition of the casual footwear brand HEYDUDE for $2.5 billion.

As parents of a 2-year-old and a 5-year-old, we have observed that nearly all children (and some parents) universally adore their slip-on Crocs shoes, whether at schools, parks, malls, or theme parks. This is how we recognized the strength of the brand and became opportunistic about this investment. We don't see any evidence suggesting that Crocs is a passing trend. This is a brand that has been around for more than 20 years and has only strengthened its brand recognition and profit margins over time.

While we may not be the biggest fans of the HEYDUDE acquisition, we are seeing signs of execution in the latest quarterly earnings report. The HEYDUDE brand grew its direct-to-consumer revenues by approximately 30% and digital revenue by about 37%, and management has paid off over $800 million of the $2 billion debt it incurred for the purchase.

Immediately after the earnings selloff, multiple insiders reported share purchases, which is likely a good indication of an attractive share price.

For further details see: