5. Love the Shoe, Question the Share Price: A Valuation Perspective on ON Holding

1. SUMMARY

This report presents a comprehensive valuation of the sport shoe company ON Holding (ONON). I have forecast its future cash flows and estimated its intrinsic value. The calculated equity value is CHF 4.5 billion, a figure 48% below the current market value of CHF 8.59 billion. This discrepancy indicates that the current stock price may be excessively high to present a compelling buying opportunity.

*Note: This is NOT a financial advice or recommendation

2. INTRODUCTION

ON Holding's origins can be traced back to Olivier Bernhard, a seasoned Swiss Ironman triathlon champion. In his quest to revolutionize the running experience, Bernhard found inspiration in a seemingly mundane object: a water hose.

In 2010, he joined forces with David Allemann and Caspar Coppetti to establish ON Holding. The cornerstone of their shoes was a cushioning concept known as CloudTec, designed to deliver what they envisioned as the ultimate running experience.

In 2012, the company launched its flagship product, the Cloudracer.

By 2015, it had introduced the Onyx brand, catering to more casual wear. The brand quickly gained recognition for its quality and unique design from various top runners.

In 2019, Roger Federer joined the team as an investor and brand ambassador, actively participating in product development and marketing with the goal of creating the best tennis shoe ever.

The company went public on the New York Stock Exchange in September 2021 under the ticker symbol ONON. At an IPO valuation of $7.34 billion, the company raised $746 million, with shares opening at $35, significantly above the $24 IPO price."

3. OPPORTUNITY

The company has experienced phenomenal growth. In 2023, its revenue is expected to reach nearly CHF 1.8 billion, demonstrating a 60% CAGR over the past five years.

ON Holding, though still a small player, operates in the global sportswear market, which is estimated to be worth around $300 billion—comprising $120 billion in sports footwear and $180 billion in sports apparel.

The company is poised to continue benefiting from the overall sportswear market trends, which are projected to grow by about 10% annually over the next few years.

Adhering to its original vision of producing the best running shoe, ON Holding has indeed created a product renowned for its exceptional comfort. The brand has attracted the endorsement of many top-class sport men and women, helping it to gain global recognition as a high-end sports shoe brand.

The company actively collaborates with other brands to develop a variety of shoe types and sportswear, while maintaining a focus on its brand image, which highlights a healthy and cool lifestyle, and on technological innovation in terms of shoe quality, comfort, and sustainable production methods. ON Holding has also introduced innovative sales models, including subscription-based services and a shoe recycling program."

4. RISK

The company is enjoying strong tailwinds as the brand continues its rapid growth. However, there are significant risks that investors may be underestimating.

Competition:

ON Holding operates in an extremely competitive market. It competes against large brands such as Nike and Adidas, as well as specialized shoemakers like Under Armour, Dockers, Puma, and Asics, etc. As it enters the sportswear market, the competition intensifies further, with players like Patagonia and Columbia vying for customers. For ON Holding to succeed, it may need to allocate a larger portion of its budget to marketing, which could impact its profitability.

Technology:

While the technology behind its shoes is innovative, competitors also offer high-quality alternatives. Many of them having significantly larger R&D budgets and are likely to keep pace in the race towards the perfect shoe.

Shoe Design:

The eye-catching design of ON Holding's shoes, with their 'wow' factor, may become less desirable as customer preferences change. As the brand pursues growth, it risks losing its uniqueness.

Product Diversification:

Entering the sports apparel market may prove less successful and more costly, as the company does not possess a competitive advantage in this segment.

Financials:

The cost of production is likely to increase due to both labour and materials. With an increasing variety of products, the benefits of scale may be limited, potentially affecting profit margins.

Operational:

The company is exposed to geopolitical risks, as its production is primarily in Vietnam. Any disruption in that region could directly impact its supply chain. The supply chain itself may be at risk as the company adjusts to growing demand."

5. FINANCIAL PERFORMANCE

Balance sheet:

ON Holding became profitable in 2022 and is expected to further improve its profitability as sales grow.

The company boasts a strong balance sheet, bolstered by over $746 million in cash from its IPO.

It has minimal debt, primarily in the form of Capital Leases, and possesses a high borrowing capacity.

However, it is not a cash-generative business. The requirements to invest in Working Capital and Capex are substantial, likely keeping the company cash flow negative in the coming years.

Revenue & Growth:

The brand is expected to continue growing, albeit at a slower rate. I will assume a 35% growth rate in 2024, decreasing by 5% annually. According to this projection, the company's revenue will grow from $1.2 billion in 2022 to $6 billion by 2030—a fivefold increase. Subsequently, it is projected to grow at 2% perpetually. This represents a very optimistic expectation.

Margins:

ON Holding’s Gross Profit Margin (GPM) of close to 60% is relatively high compared to other sports shoe brands, benefiting from its premium market status. However, this margin is likely to be under pressure as the company aggressively expands. Maintaining rapid growth while preserving its premium status and pricing will be challenging.

Additionally, the current product variety may lead to stockpiling of items requiring discounting, which could negatively impact the GPM.

Consequently, I anticipate ON Holding will achieve an Operating (EBIT) margin of around 9%, aligning with standard margins for successful sports shoe companies.

Reinvestment:

ON Holding’s growth required investment in Working Capital and Fixed Assets. Excluding leases, the company invests at a ratio of about 2.5, meaning $1 of investment for every $2.5 of revenue increase. While they have established branded standalone stores, their primary sales channels remain the outlets of their partners. With Direct Sales comprising approximately 40% of total sales, the company appears to be emphasizing this channel.

Considering both, a 2.5 revenue-to-investment ratio seems reasonable and consistent with industry standards.

Cost of Capital:

Given the current market conditions (high interest rates, risk of recession, etc.), I will use a 13% cost of capital for the next 10 years. This is approximately 1.5 x beta x market premium (6%) + risk-free rate (4%).

At maturity, I will apply an 11% cost of capital in perpetuity, anticipating lower interest rates and a larger business size.

6. VALUATION

Input Variables and Valuation: ON Holding AG.

Using the earlier defined variables, the equity intrinsic value calculated is CHF 4.5 billion. This is 48% below the current market value of CHF 8.59 billion.

7. CONCLUSION

ON Holding is an exceptional brand that has achieved phenomenal success since its inception in 2010.

The comfort and visual appeal of their shoes are notable, and the brand shows promise in its efforts to diversify into sportswear, even though this currently represents only a small fraction of its revenue.

?It is clear that most investors share a positive outlook, as reflected in ON Holding's stock price. However, I believe these expectations might be overly too optimistic, with the stock currently priced approximately 50% above its intrinsic value I have estimated.

In my assessment, it does not present a good buying opportunity at the current price level.

*Note: This is not investment advice and expresses solely my personal opinion.