Summary
- I wrote a basic article on On Holding where I described the company's fundamental upsides and a bullish potential thesis. However, the company is still very small.
- Still, as we look at how the company is moving and where valuation seems to be taking it, I believe it's time to change my stance on the company.
- We've reached what I believe could be a bottom for the company - and I'm growing more positive with regards to ON.
Author's note: This article was originally published on iREIT on Alpha/Dividend kings on 25th of September 2022.
Dear readers,
Buying quality is really what we want to do in this climate. There are never investments where analysts such as myself can "guarantee" returns in a specific timeframe. We can look at valuations and prospects and come to a conclusion as to how we see things.
When I previously wrote about On Holding ( ONON ), I considered it somewhat expensive and potentially not able to hold up to the pressure that comes with a rich valuation combined with a downtrend market. On Holding has proven that it indeed can hold up to this pressure of the market and that the company can, in some ways, continue to deliver on its current targets.
Let's look at updating on On Holding.
On Holding - An update
In my previous article, I established a thesis for why On Holding might be an interesting sort of Swiss "Spec buy", even in this environment. Some of the potential risks remain at this time as well - I can be very clear about that. The valuation hasn't exactly improved much.
What has happened is that On Holding has reported 2Q22 results, and these results were as I saw them, surprisingly positive all things considered.
Despite inflation, cost increases and COVID-19 remnants, the company's sales exceeded expectations by generating over half a billion Swiss francs for the first half, and 2Q22 results were up 66.6% in terms of sales growth. Those are some good numbers when we consider the environment we're currently in.
These numbers become even better when we start really breaking them down. The company managed to increase wholesale by 70%, even above DTC, and North America continues to grow at triple digits YoY, 102.5% for this specific quarter.
On the company's 2Q22 net sales of close to 300M CHF, the company made a net income of close to 50M CHF, and an adjusted EBITDA of over 30M - and that's despite ongoing challenges.
Margins are a bit of an "up and down". On a gross basis, they're up sequentially, but down YoY, to around 55%, which can still be considered a very good GM for this sort of company when you consider that ON is battling the same headwinds as adidas ( ADDYY ), such as logistics and freight costs, but without the scale to match.
So, let's be absolutely clear - macro is a massive issue for the company, as it is for many companies across the consumer space - and most spaces right now, with the exception of some extreme outliers.
But there are plenty of trends that speak in favor of ON moving towards higher and better results. Shoe companies live a lot off their victories and associations with sports stars and sports overall - and the quarter saw ON products winning Diamond League, as well as World championship medals.
Overall, demand for ON remains very strong across all regions. This is not a unique fluke for this business either - plenty of businesses in the same segments are reporting impressive growth, including adidas. The period even saw the first individual month ever topping 100M CHF in sales - and this during a period like the one we're currently seeing.
These results have caused the company to, once again, bump its outlook for the full fiscal, now expecting net sales of over 1.1B CHF and impressive EBITDA for the full year. That sales increase would account for a 52% YoY sales growth, with full-year EBITDA expected to come in around the 140-150M mark, resulting in margins around 13-14%. This isn't as good as some peers with more scale, but it's very impressive for a company such as this.
The company remains heavily NA-based, and this exposure is even increasing from the 55%+ we've seen in terms of net sales exposure. Its extremely limited APAC exposure insulates it from the continent/geographies current issues with lockdowns. Overall, the split is extremely attractive based on the current macro situation, putting ON in perhaps even a better situation than adidas and NIKE ( NKE ) for handling current uncertainties.
As I mentioned in my last article, the secret sauce for On Holding, and why it's supposedly better than other shoes and similar products on the market is a proprietary technology called CloudTec. This is a cushioning technology and comes in the form of a series of "clouds" that grant cushioning as the foot lands, before "locking together" in a way that offers the runner a solid foundation prior to pushing off for the next step.
This remains one of the primary arguments for investing in the brand if this is something you're interested in. The number of endorsements and positives from stars and other personas supporting the products speaks for themselves.
Remember though - all of the risks I mention do remain. From a fundamental level, On Holding does not have a credit rating. It does not have a dividend. Sales may be climbing to the 1M CHF mark, and it seems to be turning from a loss-making to a profit-making company, but the scale risks and downsides do remain.
On Holding uses a multi-channel distribution system, with a complimentary online DTC business, and working wholesale business, and while the company's new targets are now calling for 100M higher sales than previously, we still need to treat it like the recently-IPO'd business it is.
It may be extremely cash-heavy - but those impacts we're seeing in adidas and other businesses are hitting the company as well. Supply chain and production challenges are continuing to impact here. Like ADDYY and NKE, most of the company's production is based in Vietnam, which causes sort of a triple impact from production costs, freight costs and other cost increases.
To re-summarize ON Fundamentals - On/On Holding is a sportswear/shoe company based and founded in Switzerland. All of the company's products are engineered in-house in Switzerland, and the company owns several proprietary technologies such as CloudTec, Helion Superfoam, and Speedboard. It does not manufacture its own products, but it nonetheless has managed to deliver superb growth over a number of years at this point.
The new facts for this update are the recent results, which confirm what I would consider the bullish thesis on ON for the shorter term in terms of operating dynamics.
Owing to a few facts, the market also seems to be treating ON differently than it does adidas, which also delivers good results, but has a worse mix and some different impacts.
Let's look at valuation.
On Holding - The valuation
The main problem with ON remains its valuation. But as of this article, I'm willing to account for this a little differently. On Holding IPO'd in what will likely be known as a frothy, free-cash, zero-interest rate environment. The IPO share price was set at a massive $24/share, which for a 2022E $0.25E EPS implied an IPO P/E of 96X. adidas trades at around 25-30x -as does NIKE.
The amount of growth that would have to be realized for this to make sense on a pure-earnings basis is massive.
We haven't really moved down massively in terms of overall multiples - but neither are we up where the company is all that much more expensive. Indeed, if we consider that the company is expecting better forecasts here, we can argue that the forward multiples have actually dropped somewhat, and ON is cheaper here than it was.
The stock price then shot up to $55 at its peak - around 200X P/E - before falling to a post-IPO low of $16.38 in May and recovering to $18.99/share. Today ONON is trading at around $17.35 - somewhat lower, but not a massive drop.
The company is still at a premium to most comps here - but the comps also 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%. While the company is still inarguably premium-valued at $17/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.
30-40x P/E is as high as I'm willing to go for any discretionary company - and so for forecasting ON, we go up to 40x. At that multiple, we get a current annualized upside of pretty much exactly 9% on a conservatively adjusted forecast estimate - expecting only 18-25% EPS growth or so, which the company has traditionally beaten.
It is therefore now fair to say that ON has an upside. The principal bull argument for On Holding remains this EPS growth rate - with some analysts forecasting a CAGR of 70% on a 5-year basis that could justify a 30-40X P/E ratio even in this environment. Yes, even with this inflation and these results.
This is because such growth would make the company the fastest-growing athletic wear, and well worthy of such a premium.
The question is, whether it is realistic.
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.
It's obvious to me that's not where we are moving with this stock. Street targets remain elevated for ON. While we are no longer close to $30-$40+ as we were around 8 months ago, we're still at 13 analysts calling for a PT of $28/share on average, with 9 at "BUY" or "outperform" targets. These recommendations have not exactly yielded killer returns - more along the lines of killing returns.
Analysts currently consider the company 65% undervalued - though where they are getting those assumptions, I can only say that I do not agree with them. They would require long-term EBITDA growth rates that I see being very uncertain or premia that I consider to be unjustified for this business.
For myself, I find justifying any investment that does not have an attractive, inflation-offsetting, well-covered dividend in today's environment hard to justify. But I can see that this company, with its growth profile, can offer at least equal levels of upside, provided you have a strong risk tolerance for the risks associated with a relatively freshly-IPO'd business.
However, the company's valuation and multiples are no longer as insane as they once were. Take a look.
I can get on board with such an investment in the right environment - unfortunately, this isn't the right environment.
At best, I would now call this a "Speculative buy".
There is an upside to be had - but it comes at a high risk. I don't see the company moving "suddenly" lower very quickly - talking double digits here. If you want it even cheaper, you could wait here - but if you want to stake out a position in high-growth qualitative shoe business, this could now be done.
My low-value target PT is still around $13-$14 - that's where I'd put serious money in ON to go with my investment in adidas. But I have bought a small starter in On Holding and give this a spec buy here.
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 run this morning. It's a great product. 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 bought my first shares, and I think you could do the same at this price.
For further details see:
On Holding: The Advantage Calls For A 'Speculative Buy'