2023-03-13 05:52:24 ET
Summary
- I've been writing about On Holding for most of 2022 and had my eyes on the company before then. The RoR since my last article has been phenomenal.
- The stock has "popped" a bit, going against the grain in consumer discretionary. It remains a very risky stock overall, but here is my thesis update.
- On Holding at this time, is a "HOLD" as I see it. There's a decent amount of risk to the investment and we should approach it with care.
Dear readers/subscribers,
When I last wrote about On Holding, I made it clear that I've initiated a small position in the company. This is a speculative investment to be absolutely clear, and I don't see that part of the investment changing soon. But On Holding ( ONON ) isn't the only speculative investment that I own, and being speculative isn't a disqualifying factor for investment for me.
I just want successful businesses with good models.
Can you guess what one of my primary requirements for such a business is?
Profit.
On Holding has profit - and the company has great returns in a short time.
Seeking Alpha On Holding (Seeking Alpha)
This isn't a large holding for me, to be clear. It's still at a small position sizing, and I don't see that changing soon either. But I know some investors and readers who took a far stronger position in the company and likely have seen some great returns.
Here is the thesis to be considered for On Holding in 2023.
On Holding - Considering the Valuation and the results for 2023
We've been through the difficulties and challenges faced by this company before. Being an up-and-comer in a field like shoes is like asking for trouble because you're going up against incumbents like Nike ( NKE ) and Adidas ( OTCQX:ADDYY ). Even if both of these have significantly underperformed, also somewhat contrary to my 2022 expectations, they're still market leaders, and this isn't going to change anytime soon.
On Holding is neither small nor insignificant, however. 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 (opinion, somewhat anecdotal given that I own them and have tried my fair share) - because the company is Swiss.
Are the products for everyone?
I still 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, and for people who aren't even doing sports, the company's products might not even be that interesting. The company does offer the so-called All-day wear shoe options...
ON IR (ON IR)
...but speaking as someone who has a fair share of shoes, these products don't meet my everyday wearing requirements, and the company lacks any serious sort of all-weather shoe for tougher climates. The Hiking series is decent, but it only goes up to a certain degree of snow, rain, or weather. The serious hiker that also encounters snow, sludge, and other things, is probably going to be wanting different products.
The company's marketing is also tilted towards these running and sports segments. This makes the company's thesis both less simple, and more simple - less because there's a limit to the market, and it's constantly evolving (even moreso than everyday wear), and more because it limits the markets the company really needs to compete in.
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, based on price and reviews for the products. 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.
This also resulted in immediate adoption by pros, which has helped out a lot. My latest report on the company detailed immense sales growth - over 50%. We don't have FY numbers here yet, but I'll update this article in case this materially changes the forward thesis for the company.
To put it simply, I expect ON to continue to outperform despite a problematic macro. When I last wrote about the company, the share price was below $17/share. We're almost at $20.5/share. More on what this means in the valuation section.
On Holding is at a precipice of profitability. 2022 is expected to be the first year of GAAP profit , which is why I invested in the company. Take a look at where the company is expected to go.
On Holding EPS Forecast (TIKR.com)
Revenues, in the same timeframe, are expected to more than double to around $3B, or a CAGR of 34.4% until 2026E. So far, the quarterly numbers have done nothing to disprove this assumption, and neither have the trends that the company is seeing in expansion. Both wholesale and the company's online/DTC sales are growing.
Yes, ON is taking inflation and cost hits on the bottom line. Yes, those costs are more than the competitors are seeing because ON is a smaller company in the end. As an example, the company's gross margin back in the last quarter 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.
This represents one of the primary things we need to keep an eye on when we get the full-year results, as this will likely dictate one of the primary impacts on profitability.
Given that the growth thesis for the company is still intact, and I don't see any massive new impacts for this company on the negative side for the past 3 months, I expect ON's 2022 results to come in line with overall expectations, with perhaps somewhat below or above the target - fully in line with margins of error. I also continue to believe in the company's pipeline and its ability to push sales and results going into 2023.
I'm specifically talking about Cloud X3, which is being introduced in the coming year - a new tech platform assisting to choose the best form factor and pricing for your needs. The company has also continued to work with world-class athletes and their organizations, such as Gustav Iden Athlete and other athletic clubs tied to specific sporting professionals. There is also further development in the company's Cyclon platform, which will use very, very advanced foam combined with bio-based Speedboard. Essentially, the company is well ahead of its competitors in pushing circularity , and this is set to continue in the coming years.
Specific worries and risks do exist. We need to look at the company warehouse and inventory specifics, FX continues to be a risk due to Europe. Still, the upside is higher than any risk here, and there are already strong indicators that 4Q22 is actually going to be a very strong quarter.
We started the quarter very strongly. We had a good start into the holiday season. We spoke about the success during the Double 11 festival in China with 135% growth. We have a strong order book. We see continued strong demand from our retail partners as well as from our end customers. So we feel that the 41% growth that is implied in our quarter -- in our guidance for the fourth quarter confirms that.
And we also feel that we go with a similar strong momentum into the next year. We have a strong order book for the first half of the year. We are currently in the selling season to basically get the orders on book for the second half of the year, which will then also allow us to give a more precise outlook on the full year in the -- in our next call.
(Source: Martin Hoffmann, On earnings Call)
This brings us to valuation.
On Holding Valuation - Plenty to like here
What has been going on with ON's share price means that this is now primarily a valuation play, in the sense that we need to make sure we're not paying too much for a non-dividend, qualitative Swiss footwear company.
My last price for the company was $16.5/share. That means that based on the current share price, I would consider the company potentially overvalued.
The current set of analysts following and forecasting the company are 13 in total, and as of this article, their target has been reduced by over $1/share based on my previous article. The range starts at around $15.2 and goes up to around $28.75, with an average of about $24.5/share. The fact that the analysts are lowering the price targets is something I view as confirmation of my overall more conservative thesis on the business. Remember, I started out at less than $15-$16/share. if you had followed my advice and avoided the company at overvaluation above $25/share, you could have made a decent RoR here. After all, 22% annualized for 3 months time comes to 121.53% , which is beyond market beating. It's amazing.
I have several investments like that. That's why my overall portfolio outperformance by far goes above the S&P 500 on a YTD basis, and I'm still up close to double digits including FX and dividends.
Valuation is what saves me from making the most costly mistakes - valuation and keeping a firm eye on quality.
Remember, if you look at the analysts here and start thinking that $25/share doesn't sound bad, these analysts have been successively wrong in their estimates for the company for a very long time.
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.
That's more than double the current share price, even after advancing massively.
The positive outlook on the company has not changed. 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 continue to view this as a realistic forecast.
The impact on gross margins has been noticeable, but not massively detrimental or value-destroying for the company. I expect these impacts to continue as costs and costs of debt keep ratcheting up as well, but it's all about how well the company manages these things - and ON seems to manage very well.
Remember, quality discretionary businesses trade at around 30-40x P/E - and I've been known for paying those multiples for quality businesses. However, at this time, with the company climbing significantly, I find it much more difficult to come to a positive conclusion for the company here.
While it is entirely possible that the company will climb further, the fact is that when I bought the company, I did so at a high 40x multiple, and that was as far as I could stretch things. Even with earnings growth, the company is currently trading above 50x P/E normalized for both 2022 and 2023. That's not a level I can consider to be acceptable.
So, for that reason, I'm changing my thesis here. I'm providing On Holding with a PT bump - but only to $19/share, realizing its growth potential, but also discounting it in the face of higher borrowing costs, and increased turmoil.
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. That makes it a "HOLD"
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", it may have an upside, but I no longer view that upside as enough. I'm now a "HOLD".
For further details see:
On Holding: 22% RoR Since December, Thesis For 2023