Hold: Valuing Promising Growth (NYSE:ONON)

proposition

to (NYSE: Onon) is currently meeting all the needs of investors that can only be found in textbooks and is showing excellent growth in profitability. In some ways, On may be a fresher brand while following Nike’s (NKE) playbook. Premium strategies have the potential to pose a serious threat to market leaders.

• In this analysis, we approach the On company using its consolidated financial plan as the basis for a simplified discounted cash flow (DCF) assessment, from which we turn to discussing the qualitative and market aspects of On.
• You’ll notice that I’m involved in backend engineering in many ways. This is a way to understand market expectations by matching high growth with high valuation.
• Regarding these market expectations and possible limitations, On’s brand quality, highly competitive market and Nike, the market leader.
• To summarize this discourse, from my perspective, On has a cautiously positive Hold rating with an Intent to Buy.

Brilliant top line

On has achieved annual revenue growth of more than 67% since 2019. All segments grew at similar rates, with footwear still holding the largest share at 96%. The Swiss company, which has 60% exposure in the US, reports in CHF and is primarily affected by the exchange rate between USD and CHF. In 2023, the strength of the Swiss franc resulted in significant foreign exchange losses. However, in the first quarter of 2024, the opposite effect occurred as the value of the Swiss franc fell, resulting in significant foreign currency gains.

With respect to revenue targets, management has consistently significantly exceeded its own forecasts in the double-digit percentage range over the past two years. For the current fiscal year, management expects revenue of about $2.5 billion, according to analyst consensus according to Seeking Alpha. The analyst consensus at Aktienfinder.net, which uses FactSet as its primary data source, shows slightly more conservative estimates out to 2026, which I use for prudent planning. So we’re looking at $3.6 billion in 2026, compared to management’s own projections of about $3.9 billion. Management expects annual revenue growth of 20-25% after 2026. Personally, I rely on more conservative assumptions to incrementally approach a still-high final growth rate of 14-15% over 2027 and 2028. Alternatively, they could have extended the planning period and then set a lower permanent growth rate. The derivation of the permanent growth rate after 2028 will be explained in more detail later. Nike, its primary target competitor, naturally grows at a much slower single-digit rate due to its size. In terms of scale, it is highly likely that ON will grow to about 10% of Nike during the planning period. Nike’s margins will also play a role in On’s further plans.

Every investor’s dream: increasingly profitable growth.

On has very high gross margins of 60% and EBIT margins of 10%. On the other hand, Nike recorded an average of 44% and 12%, respectively, over the past five years. My model assumes that On will gradually approach these values ​​over the planning period and up to its final value in order to get closer to its well-established industry peers. In summary, this means that gross margins grow more slowly than sales because the marginal benefit of additional customers may decline as market penetration increases, but operating profits grow faster due to economies of scale. Tax rate determination in Switzerland is less straightforward than in some other countries, so I won’t go into detail about it. We discovered that Deloitte and Damodaran had different corporate tax rates, which were also different from On’s historical effective tax burden, so we planned to use the middle of the three values, 15%. This may be inaccurate. Overall, my projections for EPS levels are more conservative compared to analyst estimates out to 2025, according to Seeking Alpha. While the $1 mark will only be exceeded in 2026, analysts already expect it to be above $1 in 2025.

Technical Valuation Assumptions

As in the previous analysis, we will omit the details of further model planning in the areas of balance sheet and cash flow and only briefly summarize the main methodological points.

• The cash balance resulting from a total cash flow plan.
• Plan inventory, accounts receivable, and accounts payable based on historical turnover.
• Going forward, we plan PP&E based on our CAPEX plan, which will increase along with EBIT, assuming that growth is not possible without capacity expansion. From this we subtract the historically implied depreciation rate. On’s balance sheet essentially lists capital lease assets, which I simplified and treated as PP&E during the planning period.
• Plan your capital by adding net income. Because it is a young company still in the growth stage, no share buybacks or dividends were assumed. And now, I think we have reached a stage where the company can achieve greater growth on its own without additional shareholder dilution.
• Indirectly by adjusting or adding (non-)cash effects of balance sheet delta (operating portion), subtracting CAPEX required for growth (investing portion), and partially financing CAPEX assuming increased capital lease liabilities (financing portion). Calculated and planned total cash flow.

With respect to WACC, the risk-free interest rate is dependent on the spot yield on 30-year U.S. Treasury notes. This is because the available estimates are calculated in USD. Some analyst estimates may have been projected in CHF and then converted to USD, so there may be some discrepancies. Since I want to avoid planning on FX effects, this approximation seems good enough to me. Of particular interest is On’s high beta factor, which averages 2 based on Seeking Alpha’s values ​​over 24 and 60 months. This results in a high cost of equity of almost 16%, while low leverage reduces WACC to 15%. This is slightly lower than the return on investment (ROIC) of about 15-25% that I had anticipated during the planning period, and is a level the company has already been close to reaching profitability for over the past two years. As a growing company, I assume almost complete reinvestment of profits, which could enable the high perpetual growth of 14-15% mentioned earlier.

Now I’m going to be completely honest. Specifically on the technical valuation piece, I did some reverse engineering to arrive at On’s current valuation size to see what the market is assuming about this startup. A consistent, integrated planning model. The reason I did this is because this growth makes the parameter assumptions too sensitive for me to evaluate. When the WACC is around 15% and the long-term growth rate is nearly as high, the number of decimal places you assume has a huge impact on value. So my conclusion is that with a WACC of around 15% and similarly high perpetual growth assumptions, On can actually be fairly valued. My valuation result is US$45. This means a one-year forward P/E ratio of 74 based on its more conservative own projections and a one-year forward P/E ratio of 49 based on analyst estimates. Both are acceptable multiples for at least five years of earnings growth, and certainly could be around 20% or more. The question remains whether we want to attribute such growth potential to On. The history and success on paper will certainly support this, but the road ahead is unlikely to continue as easily as before.

What Nike is doing – Indistinguishability or a podium opportunity?

And here I would like to take a closer look at the qualitative and market aspects of On. On is one of those brands that we believe, with its high-quality branding, is potentially competitive enough to pose a threat to Nike in the long run (pun intended). Therefore, in some cases, we feel very comfortable using giant Nike as a comparison company.

On is adopting a strategy of cutting out middlemen, a key distribution strategy of its largest competitors. Nike is following a strategy of selling its products directly through its own stores and online channels instead of cutting its margins through intermediaries. Nike currently generates 44% of its sales through direct sales, with a still larger portion handled by third-party sellers. For On, 38% of its revenue currently comes from DTC and the remainder comes from wholesale. However, there are positive trends for DTC. This is because this channel is growing significantly and earning greater revenue than the wholesale segment.

And it is these direct customer relationships, brand building and marketing that are so important in this competitive market. Because at the end of the day, it’s about the shoes, not irreplaceable rocket science. Nike recognizes this, too, and according to executives, a new multi-year cycle of innovation and growth is about to begin. This means a new focus on sharp, targeted brand identity, closer customer relationships and improved storytelling about the brand. Nike products are designed to be nothing less than a “must-have,” and the process of shopping directly with Nike, whether online or in-store, should be an experience. It’s unclear whether this plan will succeed, but Nike has the ability to achieve it.

Piper Sandler’s biannual survey of the average American 16-year-old provides a snapshot of the brands that are most popular among this important young age group, which is critical to sustainable market positioning. On the one hand, Nike’s DTC strategy appears to be effective given that Nike is already one of the most popular clothing shopping websites. This ultimately validates On’s strategy. At the same time, the survey results show that in the US market, Onn dominates Nike, a shoe and clothing brand that is very popular among young people. However, the slightly reduced approval rating in the short term suggests that Nike’s position is not unassailable and may in fact be challenged. Within these risks are opportunities for On.

Ambitious or megalomaniacal?

ON’s goal is to become the best premium global sportswear brand. The following graphic summarizes where On sees further growth. This is partly to expand its applications beyond running. It all takes place within the premium segment. Of the $25 billion market focused on running, of which On currently holds nearly 10%, the market is expected to expand to $70 billion by leveraging other apparel. On aims to significantly increase its clothing market share by more than 10% after 2026. The second growth driver is global expansion, as seen in the second graphic below. On aims to increase its market share in China to more than 10% after 2026. In the short term, the Paris Olympics may act as an additional catalyst for ON, but it will undoubtedly also be the stage that all other sportswear will exploit. This is a brand that puts these opportunities into perspective.

Another Nike – maybe better, maybe not

This investment opinion is interpreted as ‘buy’. Currently, there is little room to dispute On’s fundamental operating performance and potential, and considering this growth, the valuation may be reasonable. But all of this is built on a large marketing system that is not yet as established as a large company like Nike. At the end of the day, some may argue that On’s product quality isn’t great, but at the end of the day, they all offer high-quality, irreplaceable sportswear. Moreover, the size, long-standing presence and inertia of large companies like Nike can open the door for On in this vast market and seriously threaten the market leaders. But personally, in this scenario, I would bet on Nike, a slow-growing but attractively valued industry leader. However, this is a personal preference, and at the same time, I see On as one of the most promising challengers.