On Holding AG

Moat: 3/5

Understandability: 2/5

Balance Sheet Health: 4/5

On Holding AG is a Swiss-based performance sports brand, primarily known for its innovative running shoes and apparel, catering to a premium market through independent retailers, its own stores, and online channels.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

On Holding AG, often stylized as “On”, is a Swiss athletic footwear and apparel company that has positioned itself in the premium performance market. They are known for their innovative technologies like CloudTec cushioning and design that has gained a strong following among running enthusiasts and athletes. They are actively expanding their presence through various channels including independent retail, their own stores, and e-commerce platforms.

Business Overview:

  • Revenue Distribution: On’s revenue is primarily derived from the sale of its performance running shoes, apparel, and accessories. They operate through a multi-channel distribution strategy, including:
    • Wholesale: Selling through retail partners like sporting goods stores.
    • Direct-to-Consumer (DTC): Selling directly to consumers through their own physical stores and e-commerce platform.
    • Retail: Their own stores.
    • Within their wholesale channel, they have strategically chosen partners to elevate the brand and not dilute its appeal, as well as to reach areas where they might have trouble having their own locations.
  • Industry Trends: The athletic footwear and apparel market is highly competitive and brand-driven. Key trends include increasing focus on:
    • Innovation in materials and design.
    • Sustainability, with an emphasis on recycled and sustainable materials.
    • Personalization in customer experiences.
    • Direct to Consumer (DTC) growth.
  • Margins: On generally achieves higher gross profit margins than the industry average, largely due to its premium pricing and focus on performance-oriented, high-quality products. However, recent pressures like an increase in supply costs have lowered their Gross Profit Margins.
  • Competitive Landscape: On competes with a mix of established athletic brands, such as Nike, Adidas, and Under Armour, as well as smaller, emerging brands. They differentiate themselves through innovative technology, a focus on running, and strong branding. However, there is strong competition in the market.
  • What makes On different? They have a unique approach to branding by presenting themselves as “premium performance” without relying on celebrity endorsements.
    • They position themselves in the higher price-point segment of footwear.
    • They focus heavily on sustainable material usage in their production.
    • They have a loyal fanbase among runners and fitness enthusiasts.
    • They are attempting to grow their brand with their own stores while also managing their wholesale operations very efficiently to target specific demographics.

Financials Deep Dive:

  • Income Statement:
    • In 2022 and 2023, On has demonstrated a significant increase in net sales, especially via the DTC channel (direct-to-consumer), signaling an expansion of the brand and its consumer-facing strategy.
    • However, profitability has fluctuated. Net income decreased from CHF 57.7 million in 2022 to a loss of CHF 170.2 million in 2021, and CHF 79.6 million in 2023.
    • Gross profit has been maintained at a high level, around 59% in the past few years, before decreasing to 55.6% in the current fiscal year. This implies the brand’s ability to command premium pricing while their cost of sales stays relatively contained. But there is concern regarding their profitability as net profits are showing poor results.
    • They are able to maintain their operating profits in most years in the last few year, however, this hasn’t been consistent.
    • Their effective income tax rate has ranged from 16% in 2022 to negative 142% in 2021. The latest tax rate is 25.9%.
    • Their earnings per share have been fluctuating quite wildly.
    • Their sales increased by 48.8% and 46.6% in 2021 and 2022 respectively.
    • The decrease in operating profit margin between 2022 and 2023 was a result of increased promotions, marketing spend, and increased cost of goods.
  • Balance Sheet:
    • On maintains a relatively strong balance sheet.
    • The cash and cash equivalents are around 450 million CHF in 2023.
    • They have a working capital of 300 million CHF in 2023.
    • They are not heavily leveraged.
    • They have 46.2% net-debt-to-equity ratio, and a healthy quick ratio above 1.
    • They have a significant inventory balance which is expected from their manufacturing strategy.
    • They hold around 250 million CHF in leases.
  • Cash Flow Statement:
    • Cash from operating activities was 232 Million CHF in 2023 compared to -227 million in 2022.
    • The cash outflow from investing activities is due to acquisition of machinery and for R&D investments, amongst others. This is expected of a growing business.
    • Cash outflow from financing activities are due to repayment of loans and leases as well as buyback of treasury stock. They have a continuous share-based compensation program.
  • Recent Concerns and Problems:
    • They recently had an oversupply in inventory, which resulted in discounts and lower sales. They have also struggled with supply chain disruptions and increased raw material and transportation costs, which may decrease their gross profit margins.
    • Currency fluctuations had a large impact in their earnings.
  • Management Comments: Management are aggressively reducing marketing spend and trying to resolve inventory issues. They have increased their focus on direct to consumer sales, as well as improving customer experience.

Moat Assessment:

A moat is defined as a company’s ability to maintain a competitive advantage over its rivals, protecting profitability and market share over the long term.

  • Moat Rating: 3 / 5
    • Brand Loyalty: On has built a strong brand, with a loyal following, particularly among performance-oriented runners. However, their brand is relatively new and not as established as that of larger players like Nike or Adidas.
    • Innovative technology: On is known for technologies like CloudTec, which gives them some competitive advantage. However, it’s unclear how long they can maintain their technological superiority.
    • Pricing Power: They have some ability to command premium prices, which suggests that they have some differentiation, but their high price points mean they may lose sales if competitors introduce similar or lower-priced alternatives.
    • Scale: They are growing and gaining scale, but they still have a ways to go to compete with giants like Adidas and Nike.
    • Switching Costs: While loyal runners may have a preference, for most consumers there are minimal switching costs.
    • Economies of Scale While On’s ability to manufacture and market a better brand at scale may allow it to earn a higher ROC than its competitors, it is still not clear if they will be able to leverage the scale.

  • Risks to the Moat:

  • Competitors: The market is highly competitive, with established brands and new entrants constantly innovating and vying for market share. Competitors may develop similar or even better technologies and products, reducing the competitive edge that ON currently holds.
  • Product life-cycle: A strong focus on product innovation is important for ON, but if it fails to continue developing new products at the right pace, it will lose out to rivals who can move faster. There is also a risk that demand for current products decreases over time.

  • Supply Chain Issues: Any issues with suppliers could cause major problems in production, delivery, and overall quality. This could cause a substantial negative affect on the moat. * Brand dilution: If ON over-distributes products through multiple channels and dilutes their brand equity, they might lose out on their premium pricing power. There is always a risk of expanding too rapidly and spreading the brand too thin. * Over-reliance on Innovation: On is known for its innovative technology; if the innovation dries up, it might be hard to continue differentiating from the competition. * Macroeconomic Conditions: Economic downturns may lead to reduced consumer spending on nonessential premium goods.

  • Business Resilience:
  • On’s direct to consumer channel gives them some control over their brand presence and retail experience. * They have a loyal consumer base among runners and outdoor enthusiasts, which helps generate a base level of sales. * Their innovation in design and technology have allowed them to charge premium prices, which can be a strength in volatile economic conditions.

Understandability: 2 / 5

  • The business is fairly easy to understand in terms of its overall operations. However, the financial models, inventory handling, pricing mechanisms, and other operational details are not very easy to comprehend without a lot of financial knowledge. The company itself is also relatively new, which means that there are lots of variables at play.
  • The interplay between DTC, wholesale, and retail channels adds a layer of complexity to the operations and forecasting.
  • They are a growth company and there is a lot of ambiguity surrounding their growth prospects, as well as the overall market for premium apparel and footwear.

Balance Sheet Health: 4 / 5

  • Their balance sheet is in great health. They have a good amount of cash reserves with minimal debt, which protects them from unexpected short-term issues and financial distress.
    • They have an adequate quick ratio.
    • They have a low-debt structure.
    • They are cash-positive.
  • They have a large and increasing inventory balance. It could become an issue if they are not able to move this inventory fast enough, but this seems to be an intentional decision.