2023-11-15 03:31:09 ET
Summary
- On Holding AG reported solid Q3 earnings and raised the guidance for the remainder or the year.
- ONON stock is trading at a slight premium to Nike and Lululemon, but it's justified given its growth rate.
- If the global economy doesn't fall off a cliff in 2024, On Holding will continue to perform well and take market share from competitors.
Investment Thesis
On Holding AG ( ONON ) shoes have quickly become very popular in the running market. The company went public in 2021, and despite its high growth rates, shares have not performed well. On reported solid Q3 earnings, but not well enough according to the markets, as shares are down 2-3% as of the writing of this article . The stock is trading at a reasonable valuation, and if it can continue to perform well, the stock will follow. We like the fundamentals of the company, and the dip after earnings presents a nice opportunity to get in and a reassurance to continue holding shares.
Business Overview
On Holding AG was founded in Switzerland in 2010 and became publicly traded on the NYSE in 2021. The company aims to revolutionize running with its CloudTec® innovation, offering premium footwear, apparel, and accessories for running, outdoor activities, and daily use. On operates in over 60 countries, with the majority of its sales coming from North America.
On Holding AG 2020 10-K
The company does not own manufacturing facilities and relies on approximately 22 suppliers, with five contributing around 70% of products in 2022. Footwear is produced by eight suppliers across 12 sites in Vietnam and Indonesia, while apparel and accessories come from 14 suppliers in various countries.
Q3 2023 Financial Results
The company reported Q3 2023 financial results on November 14. Revenue came in at CHF 480.5 million, up 46.5% YoY. The DTC sales channel increased by 54.6% to CHF 164.7 million, while the wholesale sales channel increased by 42.6% to CHF 315.7 million. EMEA growth has slowed to just 20% YoY; however, the US and Asia are still growing at 60-70% YoY.
The gross profit increased by 53.5% to CHF 287.7 million, representing a 59.9% gross margin. This is 280 bps higher than a year ago. Net income increased by 184.4% to CHF 58.7 million, with a 12.2% margin, compared to 6.3% a year ago. Lastly, adjusted EBITDA increased by 44.3% to CHF 81.3 million. However, the adjusted EBITDA margin decreased to 16.9% from 17.2%.
The company also continues to hold a strong financial position. Cash and cash equivalents increased by 16.4% to CHF 432.0 million from CHF 371.0 million; and net working capital was CHF 581.7 million as of September 30, 2023, which reflects an increase of 26.7% compared to December 31, 2022. They don't have any form of debt.
Outlook
On raised its guidance for the remainder of the year. They now anticipate sales of CHF 1.79 billion for the full year, vs. 1.76 billion the previous quarter, implying a 46% YoY growth rate. This is below the CHF 1.80 billion the analysts were expecting, so a small miss. The updated outlook further implies a reported growth rate of only 21% in the fourth quarter of 2023, driven by On's DTC channel. Due to a number of transitory impacts, On anticipates a high single-digit wholesale growth rate in the fourth quarter.
The higher DTC share, alongside On's premium positioning and ongoing high full-price share, will further support the achievement of higher gross profit margins in the future. The very strong gross profit margin YTD(59.3%), as well as the outlook for a further increase in DTC share in the fourth quarter, gives On Holding additional confidence to exceed its previously stated gross profit margin ambition for the full year 2023. On now expects to reach at least a 59.0% gross profit margin for the year vs. 58.5% in the previous quarter guidance.
The increased net sales and gross profit margin outlook allow On to invest in additional brand building opportunities in the fourth quarter while maintaining the full year outlook on adjusted EBITDA margin at 15.0%.
In addition, the fourth quarter will see the initial impacts of the announced strategic wholesale door closures in the EMEA region. In my view, this makes total sense. I am based in Argentina and was surprised when I saw they were operating here because I never saw even an ad about On. In the Argentinian store right now, they only have one model of shoe and ONE size. They literally only have one shoe in Argentina. I haven't researched other Latin American countries, but I suspect the situation may be similar.
Valuation
At the time of this writing On shares are falling 2-3% after the earnings report. On currently trades at $26 dollars per share, which translates to a ~$8.5 billion market cap. This means that the stock trades at 52x P/E and 27x EV/EBITDA(using 2023 estimates), according to Seeking Alpha. For comparison, Lululemon (LULU) trades at 34x P/E and 20.7x EV/EBITDA and Nike (NKE) trades at 28.5x P/E and 22x EV/EBITDA. It makes sense that On trades at a premium because its growing faster.
For 2024, analysts estimate that revenue will growth between 20% to 30%. If we take the midpoint, revenue will be CHF 2.250 billion. EPS is expected to be $0.81. Assuming EBITDA margins of 15%, EBITDA should be CHF 337 million. Taking this assumptions, the stock is trading at 32x P/E and 21x EV/EBITDA . These ratios look more similar to the ones of Lululemon and Nike, and not expensive given the growth rate of the company.
Risks
The shoe, apparel, and accessories industry is intensely competitive, with a focus on brand image, product quality, innovation, design, sustainability, distribution, and pricing. Although On has positioned itself uniquely through a premium brand image and specialization in running, they have to continuously invest in community-based grassroots marketing to strengthen brand awareness and customer loyalty.
The market is highly competitive and fragmented, with established and emerging players. Key competitors include Nike, Adidas, Under Armour, Hoka One One, Asics, New Balance, and Lululemon. On has already managed to become one of the top 5 running brands in major markets like the United States, Germany, and Japan, but maintaining that position will not be easy.
Apart from competition, a recession is also on the table for 2024. A slowdown in consumer spending could bring down revenue estimates for the company, hurt margins, and quickly make it seem overvalued.
Takeaway
On had a great Q3, but given the slight premium at which it trades and the potential risks, the market was expecting more. Nonetheless, the company will continue to grow at higher rates than its competitors and take market share. If the global economy doesn't fall off a cliff in 2024, On will be a great stock to have in your portfolio.
For further details see:
On Holding AG: Solid Q3 Earnings And Compelling Valuation