On Hold: A Growth Stock to Buy (NYSE:ONON)

Following a transition period for Nike, at the end of December 2023 our team decided to update On Holding AG (New York Stock Exchange: UNO) to a buy rating. This optimistic view was mainly influenced by the Vital product innovation, favourable demand trends and favourable results. On Holding AG was also confident in its ambitions for fiscal 2026 targets, with plans for higher sales, new store openings and a key advantage in operating leverage to support its earnings growth story. Since then, the company’s share price has appreciated by almost 65% (Fig. 1), making On Holding one of the best investment ideas for 2024.

Figure 1

Second quarter results and our positive outlook

Very briefly, the company reported Strong second quarter sales and adjusted EBITDA exceeded expectations. In figures, net sales increased by 27.8% to CHF 567.7 million, with an outperformance of 140 basis points compared to Wall Street’s growth forecast. Negative currency developments were a 160 basis point drag on the quarter. Excluding that, ON’s wholesale and DTC channels increased 28.8% and 30.4%, respectively.

In terms of geographic footprint, On’s sales in APAC increased by 84.7%. That said, those in EME and Americas (excluding FX) increased by 22.2% and 25.8%. By category, On reported solid sales in footwear, but apparel sales increased by 66.6%. In terms of results, gross margin widened to 59.9% and operating expenses as a percentage of sales reached 48.6% and were down five basis points compared to last year. For this reason, the company’s adjusted EBITDA increased to CHF 90.8 million with a margin of 16%. This was also above consensus estimates. On a positive note, inventory was down 8% on a year-over-year basis.

Aside from the strong results, On’s strategy is progressing well. In fact, we see multiple factors driving our favorable capital trajectory:

1. First of all, the company continues to innovate. There are new developments in footwear that support innovation. For example, the company has launched Spray of light Technology. This new product is environmentally, safety and governance (ESG) friendly, but more importantly, it offers high racing performance;
2. The company is making the leap into new sports, such as tennis, Hiking and outdoor activitiesand training and gym;
3. In addition to new sports, the company is successfully expanding into new product categories, primarily apparel and accessories. This reinforces the company's focus on its EU business. The company successfully leveraged the Olympic Games to consolidate its brand momentum among local EU consumers. For the occasion, On open Its Paris store, which is its largest retail outlet. These initiatives will likely increase brand loyalty and awareness, increasing its total addressable market;
4. Finally, there is a favourable expansion into new geographies, particularly in the APAC region. Turnover in Asia is less than 10% of the company's total sales (Chart 2), so there is room for growth.

Fountain: Press release on the second quarter of Holding – Figure 2

While Nike has emphasized consumer weakness and macroeconomic pressures, here at the Lab, we believe the global sportswear industry could achieve high single-digit growth over a multi-year period. Sportswear market The report also supports this. Before the COVID-19 outbreak, the average industry increase was in single digits; however, we believe that the pandemic has amplified Consumer trends are moving towards wellness, health and casual wear. For this reason, we believe that On will likely increase its market penetration.

By category, On’s footwear division has already proven that it can achieve a large market share. In the lab, we believe that it is rare to find a brand with global characteristics. We are now pricing a multi-sport, category-matched brand to Puma, Adidas and Nike. At On Holding, global awareness also remains low, which could indicate that there is room for growth as customers discover the new brand.

Changes in earnings and valuation

Following the second quarter results, we expect third quarter sales to grow by 28% to CHF 620 million. For the 2024 financial year, our total sales reached CHF 2.26 billion. According to the forecasts presented, the company expects “at least“Sales growth of 30% excluding FX in 2024. Our reported sales are down due to FX headwinds; we would expect an unfavorable impact of 350 basis points at current spot exchange rates.

In addition, considering expectations of higher freight costs, we lower the gross margin estimate by 20 basis points. On a positive note, we forecast a gross margin benefit from higher DTC share and, on the P&L side, we forecast higher marketing expenses due to the Paris Olympics.

Combining these negative effects, our net profit projection is reduced by 7% to CHF 260 million, with an EPS of CHF 0.8. That said, our target price is derived from our long-term assumption. In detail, we believe that the company could achieve 2% of the sports market with a high EBIT margin of 15%. This is due to its premium pricing and DTC business. Therefore, we believe that further market penetration will increase On's margins in the long term.

Our team expects sales growth of 25% over the next five years, with a positive EPS appreciation of 45%. This takes into account an achievable EBIT margin of 16.5% in 2028. Taking this into account and the company's visibility (Fig. 3), in 2026, based on a P/E target of 40x and an EPS of CHF 1.4, we increase our target price to $55 per share. This overweight price takes into account an exchange rate of $1.10/CHF.

Fountain: Presentation on Investor Day – Figure 3

Risks

In our view, downside risks include disruptions in global trade, which could impact the company's supply chain. In addition, the company's products are mainly manufactured by third-party partners. Any disruption in On's logistics operation would be a risk for the stock. Compared to Nike, On Holding has a direct-to-consumer business. Therefore, On Holding's products are not primarily sold through third-party retailers, which could influence sales in the end market. This supports our target price. The company still shares many risks within the sector, and we report 1) tariff changes, which may have an adverse impact on earnings and operations, 2) foreign exchange fluctuations, 3) inability to maintain a rapid pace of new product innovation in the market, 4) slowing growth in China, and 5) increased competition. In addition, sporting goods are sensitive to fashion risk and economic cycles.

Conclusion

Our team continues to believe in On’s focus on innovation, direct-to-consumer sales and premium pricing. The company is one of the fastest-growing sportswear brands in the world and, following strong second quarter results, our Buy rating target is confirmed.