On Holding (ONON 2.66%) has taken investors on a wild ride since its initial public offering on Sept. 15, 2021. The Swiss maker of footwear and athletic apparel went public at $24, and its stock more than doubled to an all-time high of $51.45 just two months later.
But today, On trades at about $27. The bulls retreated as inflation squeezed its margins and rising interest rates compressed its valuations. However, I believe that pullback represents a golden buying opportunity for three simple reasons.
Image source: Getty Images.
1. Rapid revenue growth
On develops shoes with its proprietary CloudTec technology, which forms interlocking "cloud" cushions under a runner's feet. These cushions, which were developed by researching the flexibility of garden hoses, stretch when a foot is airborne and contract upon hitting the ground to provide a firmer foundation for the next step.
That unique approach, along with the support of famous Swiss athletes like Nicola Spirig and Roger Federer, turned On into Switzerland's top footwear brand and gave it a firm foothold in overseas markets like the U.S. and China. As a result, it's now growing much faster than the market leaders; revenue rose 59% in 2020, 70% in 2021, and 69% in 2022.
On expects its revenue to have risen 46% to 1.79 billion Swiss francs (US $2.07 billion) for the full 2023 year -- which would equal a compound annual growth rate (CAGR) of 61% from 2020. The consensus forecast calls for 28% growth from 2023 to 2025, but UBS analysts believe it could grow at an even higher CAGR of 45% over the next five years.
By comparison, analysts expect revenue for giant competitor Nike to grow at a CAGR of 7% from fiscal 2024 (which started last June) and fiscal 2026. They expect Adidas' revenue to increase at a CAGR of 8% from 2023 to 2025. Therefore, On seems to have carved out its own high-growth niche in its crowded market -- and it could gradually pull consumers away from Nike, Adidas, and other footwear makers.
2. Expanding gross margins
On's gross margin dipped from 59% in 2021 to 56% in 2022 as it grappled with higher air freight costs and unfavorable currency exchange rates. But it expects that figure to rise to 59% in 2023 and head toward a "mid-term target" of 60%.
On's gross margin expansion is driven by its premium prices, lack of major markdowns, and the robust growth of its direct-to-consumer (DTC) channels -- which accounted for 35% of its total sales in the first nine months of 2023. Those strategies arguably make On more similar to Lululemon Athletica -- which also relies heavily on premium pricing and DTC sales -- than Nike or Adidas. It's also benefiting from lower freight costs and more favorable currency exchange rates this year.
For reference, Nike and Adidas -- which both face similar inflationary challenges as On -- posted gross margins of 45% and 49%, respectively, in their latest quarters. Lululemon had a much higher gross margin of 57%.
3. Soaring profits and a reasonable valuation
On wasn't profitable at the time of its IPO. But it turned profitable in 2022, and analysts expect its net income to more than double to 131 million Swiss francs ($152 million) in 2023 and grow at a CAGR of 42% from 2023 to 2025.
They also expect On's adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) to rise at a CAGR of 42% from 2023 to 2025. Based on those estimates, On trades at just 19 times next year's adjusted EBITDA.
That makes it cheaper than Nike, which trades at 22 times next year's adjusted EBITDA but is expected to grow its adjusted EBITDA at a CAGR of 15% for the following two years. In other words, On's stock got a bit overheated right after its public debut, but it looks like a screaming bargain right now as it hovers just above its IPO price.
Buy On if you believe it can maintain its momentum
On is still a young company -- but it's growing rapidly, has plenty of pricing power, and resembles a young Lululemon. If you believe it can maintain that momentum, its stock could head much higher over the next few years.
