On Running Is Firing On All Cylinders And The Stock Is A Strong Buy

The macro disruptions of the past few years have impacted not only the stock markets but also the FX markets. Countries that are considered safe havens like Switzerland have seen their currencies appreciate significantly due to capital inflows seeking refuge from volatility. As a result, the Swiss Franc (CHF) has experienced substantial upward pressure. CHF has now reached a nine-year high against the USD, which has negatively impacted the financials of Swiss companies listed in the US. Premium running shoe brand On Running ($ONON) is one of them.

The company reported virtually flawless earnings results a few days ago, but the stock plunged as much as 15% due to the strong CHF. The FX headwinds negatively impacted the company's growth rate in Q2, and these headwinds are expected to last for the remainder of the year.

As you can see above, $ONON is still up nearly 80% this year, which is a very strong performance. While the FX headwinds may be impacting its financials in the near term, the underlying fundamentals are stronger than ever, making the stock a great buy at current prices.

Outperforming In The Performance Sportswear Market

On is probably the fastest-growing brand in the performance sportswear market. The company's continued commitment to product innovation and its successful growth strategy have positioned it as one of the top names in the space. In Q2, On launched Cloudboom Echo 3, a long-distance running shoe that was well received by the running community as it features even more cushioning than previous models. It costs nearly $300 but consumers are willing to pay a premium for the quality and are becoming increasingly loyal to the On brand. In the most recent quarter, DTC sales increased 54.7%, outpacing the wholesale growth of 51% over the same period. This shows that On is successfully connecting directly with consumers and building a strong bond, which is very important for the long-term success of the brand. The increasingly loyal customer base will allow the company to collect more first-party data and launch more products that resonate with consumers.

On is growing very rapidly globally, which is a very encouraging sign that its products resonate with consumers around the world. The fastest-growing region in Q2 was Asia-Pacific, where sales jumped 90% y/y, highlighting the brand's global appeal. Its localization initiatives, such as localized websites and social media channels, are paying off, resulting in accelerated global growth. UK revenues doubled y/y in Q2, exemplifying the effectiveness of the localized approach.

While DTC sales play an important role in the company's strategy to build strong customer relationships, its wholesale channel is still the main growth driver. The company is rapidly increasing its wholesale partnerships as existing wholesalers are experiencing very strong sell-through. The company is seeing strong momentum with partners such as JD Sports, Footlocker ($FL), and Dick's Sporting Goods ($DKS), resulting in a 51% growth in the wholesale channel, as we saw above.

Solid Top & Bottom Line Performance

On is firing on all cylinders, and its financials reflect that. Total sales jumped 52% y/y in Q2. The growth was driven by rapid expansion across all geographies and product categories. This is quite impressive considering the tight monetary environment in most Western countries at the moment.

All the company's metrics improved significantly in Q2 compared to the year-ago quarter. Its gross margins hit 59.5% in the second quarter, up 4.4% y/y. That was the highest quarterly profit margin since the company's IPO and was primarily driven by the discontinuation of extraordinary air freight usage and strong full-price sales. Being able to increase its sales rapidly without having to offer discounts shows that On has successfully positioned itself as a super-premium brand.

Even more interesting than the top-line performance is the bottom-line performance. Adjusted income nearly doubled in Q2 to CHF 62.7 million, translating to an adjusted income margin of 14%, up from 10% a year ago. This strong performance is quite rare, as very few companies combine high growth and strong, increasing profitability. On's premium positioning, increasing brand recognition, and financial discipline are the main reasons it successfully combines growth and profits.

Revenue growth would be even faster if not for the FX headwinds. The strength of CHF versus nearly every other currency around the globe negatively impacted revenues by around CHF 23 million in Q2. Absent those negative currency effects, on a constant currency basis, On's Q2 sales growth was about 60%.

What About Valuation

On's recent selloff has made the stock very attractive again. At current prices of around $30 per share, it trades at a PS ratio of 5.5x. As you can see below, this is one of the smallest spreads between On and Nike ($NKE), the leading footwear brand, meaning that On's stock has multiple expansion potential given the very high growth rates and increasing profitability. Assuming the stock exits 2023 at a PS ratio of 6, and based on expected full-year sales of around $2 billion, the stock can rise 26% from current prices to $38.

What Else

On's Q2 financial performance couldn't have been any better, as the company delivered very strong growth in all regions, highlighting the continuous strong growth momentum, which is rare in the current environment. On top of that, profitability surged during the quarter as the company continued its successful and efficient omnichannel growth strategy. The FX headwinds have impacted its growth significantly, but this is an external disruption unrelated to the core operations. In fact, if the CHF depreciates in 2024, it will provide a growth tailwind to the company and help sustain its high growth rates for longer. In other words, the currency headwinds that caused this week's selloff have created a great buying opportunity for On's stock.

ON HOLDING RATING

Short Term: BuyLong Term: Buy

🎯 Year-End Price Target: $42.6 ➡️ $38

I've no positions in the stocks mentioned.

The boring Disclosures: Newsletters express the opinion of the authors. Nothing in this email is a buy or sell recommendation. I'm not a financial advisor; make your own decisions.