2023-05-17 09:00:03 ET
Summary
- Shares of On Holding declined despite the company reporting very strong Q1 2023 results and raising the full-year revenue guidance.
- The reaction is likely the consequence of what the market views as conservative guidance and concern about inventory levels.
- On Holding remains well-positioned for strong growth and value creation in the following years.
Shares of On Holding ( ONON ) declined yesterday despite the company delivering very strong numbers and raising the full-year revenue guidance.
I wrote a Q1 2023 earnings preview earlier this week and my estimates were above the Street consensus and the company met or exceeded my expectations:
- On Holding guided for CHF380 million ($415 million) in revenues for the first quarter, the consensus was $426.8 million, my estimate was CHF395-400 million ($432-437 million), and it delivered CHF420.2 million ($459.2 million).
- EPS was CHF0.14, or $0.15 per share and it exceeded my $0.13-0.14 estimate range and the $0.11 consensus.
- Gross margin was down 20 basis points sequentially to 58.3% and the company reiterated the full-year guidance for 58.5%. The gross margin has improved by 650 basis points over the same quarter last year. Increased use of air freight caused last year’s margin compression, and management also said foreign exchange headwinds are still having a 60 to 100 basis point impact on the gross margin. The gross margin looks well on its way to the company's long-term goal of 60%.
- The full-year revenue guidance was raised from CHF1.7 billion to CHF1.74 billion. I expected at least a CHF20-25 million increase for the full-year guidance and potentially up to CHF35-45 million.
Analysts had some concerns on the earnings call and I believe these concerns are unfounded:
1. The full-year revenue guidance. Analysts wondered if it is too conservative or it is management building some weakness into the guidance. Based on management comments and prior history of execution, I am firmly in the too-conservative camp. And they specifically said on the earnings call they are being cautious due to the overall macro picture this year:
We continue to embed an element of caution in our outlook for the second half of the year in the light of the many risks in the current macroeconomic environment.
2. Inventories are obviously a concern for analysts, and I believe this too is not a valid concern. Management explained the situation very well on the previous earnings call and said inventories will stay elevated in the next few quarters. From yesterday's earnings call:
Recalling what we shared on the last call, the increase in inventory that we see and the additional increase that we also saw now in Q1 was fully intentional and driven by the high demand that we saw and continue to see in the spring, summer and in the fall winter orders. So our inventory continues to be fresh and basically will allow us to fulfil the demand in the coming months at full price.
Now the increase of the inventory as we shared it last time is the result of shorter lead times transit times together with more reliable factory outputs that we have seen. And so back in December, we started to adjust our production orders going forward. But because you have a certain commitment towards your factories, those adjustments will only come into place at scale now in the second quarter.
And I do not really know why anyone is surprised. This is what management said on the Q4 2022 earnings call in late March:
In 2022, our production orders had factored in a higher level of security margin for tight production capacity of factory partners and for volatile sea freight lead times. A faster than expected normalization of both factors has led to a higher than expected cumulated inflow of inventory. We have already adjusted our production plans going forward in order to reflect the shorter lead times.
As a result, we expect to maintain the current absolute inventory levels as of Q2 despite the continued expected strong growth rates. For the end of Q1, we expect a higher inventory level, including first products for the fall-winter season.
And management provided specific inventory guidance – they expect to end the year with inventory levels in the CHF420-450 million range, so, below CHF465 million in Q1 and at a much higher revenue base. As mentioned, the actions on inventory levels were deliberate and the guidance suggests inventory levels will fully normalize by the end of the year. The increase in inventories really reflects the difficulties the company had last year.
Is it possible that a prudent and consistent management team has suddenly turned reckless in order to achieve growth at all costs? It is possible but seems highly unlikely.
3. The last question on the call is why is one of their larger wholesale clients in Switzerland doing a 20% discount promotion on all On shoes. On Holding is going for premium pricing and product offering and this sounded concerning and indicates the client has problems selling On products. However, management explained this was a promotion with a 20% discount for all running products and that the promotion is not specific to On.
Overall, there are no real reasons for concern or for the drop in the share price, but that is what we sometimes get during the earnings season.
Other than the obvious and strong growth trends, the overall comments about the strength of the business were also quite positive. The company is seeing good demand in the second quarter and strong pre-orders for the fall/winter season. The product offering expansion and international expansion are going well and the company expects strong momentum ahead of the 2024 Olympics in Paris.
Conclusion
On Holding is an innovative company that is building a strong and expanding product portfolio of attractive premium consumer products. I believe the company is well-positioned to continue to deliver both strong growth and shareholder value in the following years.
The company has embraced a combination of direct-to-consumer and wholesale approaches and both are working well and delivering strong growth that is coming from expanding product offerings and international expansion.
For further details see:
On Holding: Poor Market Reaction To A Strong Q1 2023 Earnings Report