On Running ... The New luluLemon Story
*Disclosure: I own shares of On Holding AG*
This is my first (somehow lousy) attempt to publish my own thoughts which I believe will mature over time, if you want to keep getting notified of my next post, don’t forget to subscribe
The first time I came across a very thorough valuation of On Running Shoes was from
and I was completely drawn into it ( full piece right below)
This prompted me to delve deeper into the company's financials and market position. Hoping to deliver some new insights without the need for another repeated post.
Why have I titled this post "The New Lululemon Story"? Simply because it echoes a similar narrative!
Certainly, many enthusiasts rave about the exceptional quality of On Running Shoes (and I can attest to this, owning several pairs myself). However, my fascination isn't just with their comfort or the performance they enable during runs. After all, there are other shoes at similar price points offering comparable benefits.
What truly captivates me is the brand story and the sense of belonging to an exclusive community that On fosters. It's about their clean, niche approach and their direct, unambiguous messaging.
To draw a parallel, consider Lululemon (Ticker: $LULU), which reached its first $2 billion in revenue in 2016 and is expected to surpass $9 billion in 2024, boasting a current market cap of $44.4 billion as of this writing.
On the other hand, On Holding (Ticker: $ONON) just wrapped up 2023 with revenues of $2.1 billion and a market cap of $10 billion. If you believe that On could follow a trajectory similar to Lululemon's (despite the differences in their products), the potential growth path for On becomes quite intriguing.
On Running Shoes really started to trend when they teamed up with tennis icon Roger Federer. Roger didn't just rock their sneakers; he became a full-blown ambassador and even snagged about 3% ownership in the company. This move was a total game-changer, creating that elite squad vibe that reminds us of the legendary partnership between Michael Jordan and Nike.
But On isn’t just chilling. They’re pushing into the apparel game too, though it's still just a small slice of their pie, making up about 4% of their total revenue. While I'm not totally sold on their apparel expansion blowing up big, I'm all in for their continued domination in the sneaker world. They know shoes, and they do it incredibly well.
Understanding the market in the big picture
As the lines between sports, casual, and lifestylewear blur, and sports-inspired clothes are worn for a broader range of occasions, Athleisure is becoming the battleground where sporting goods and other fashion players compete.
McKinsey & Company - Sporting Goods 2021 Report
To grasp the potential of ON and similar brands, we need to consider two key factors: (1) the growth of the athletic/athleisure market and (2) the market shift from non-sport to sports goods.
A pivotal trend driving the Athletic Apparel Market is the ascent of athleisure. This hybrid style, which merges athletic functionality with leisure comfort, has dramatically transformed the fashion landscape. Consumers today are increasingly drawn to versatile sports gear—including clothing and footwear—that can easily transition from vigorous workout routines to casual daily activities. This shift not only meets the demand for practicality but also caters to a stylish, on-the-go lifestyle.
Data strongly supports this shift, highlighting a significant increase in the demand for athleisure. According to studies by Grand View Research and Expert Market Research, the global athleisure market, which encompasses footwear, has experienced substantial growth recently and is anticipated to keep expanding. The market size for athleisure was valued at approximately USD 386.68 billion in 2023 and is projected to grow at a compound annual growth rate (CAGR) of 9.20%, reaching around USD 853.79 billion by 2032. This growth trajectory underscores the robust and sustained interest in athleisure as a lifestyle choice that blends functionality with fashion.
This high compound annual growth rate (CAGR) likely stems from a shift from traditional casual wear to a greater reliance on athleisure footwear for purposes that extend beyond their original design, truly embodying the blend of athletic and leisure functions.
An interesting study from Arris Composites highlights this growing demand for athleisure footwear and its expansion beyond traditional sport performance uses. The study surveyed 1,100 people in the U.S., revealing that 60% wear athleisure shoes to casual dinners and 10% even wear them to more formal dinners.
What's particularly striking is that approximately 30% of respondents wear athleisure footwear to work, demonstrating a significant dependency on this type of apparel for daily activities, which likely leads to owning multiple pairs to suit different settings and styles. Additionally, the survey found that 56% of people own at least one pair of athleisure shoes for purposes other than workouts, indicating a broadening of their functional appeal.
Valuation..
Here at "Without A Rush," we're all about the slow and steady approach. The goal? To uncover that multi-year gem that's worth your investment patience.
While I usually apply both absolute and relative valuation methods to my investment choices, I feel it's a bit premature to draw direct comparisons between On and established players like NIKE, Puma, Skechers, and Crocs. Given that On only went public in October 2021, we simply don't have enough data to avoid potential biases in our analysis.
My complete analysis of On involved a detailed Discounted Cash Flow (DCF) analysis, guided by the esteemed valuation principles of Aswath Damodaran. The DCF method is a core financial model that estimates the value of an investment based on its expected future cash flows. By adjusting these cash flows for the time value of money, it provides a present value estimate that is essential for making informed investment decisions. Damodaran’s approach is particularly meticulous, emphasizing the importance of realistic assumptions about growth, risk, and long-term sustainability. This rigorous framework allowed me to deeply understand the intrinsic value of On, offering a solid basis for assessing its potential as a worthwhile long-term investment. (I plan in the future to do a separate post about it for clarity purpose).
I've calculated the fair value of On Holding to be $24.00.
Let's break down the numbers and assumptions that led me to this figure. Each component of this valuation has been approached with a conservative mindset. I aimed to avoid excessive optimism, providing a clear and methodical walkthrough of a proper Discounted Cash Flow (DCF) analysis. This method ensures that each assumption is carefully considered and grounded in realism, aligning with best practices in financial forecasting and valuation. Analysis as of 10th of Feb 2024 excluding most recent financial statement of Q1 2024
Revenue:
Since 2019, On Holding's year-over-year revenue growth has fluctuated impressively between 45% and 70%. They've just announced their 2023 earnings, showcasing a strong 46.6% YOY growth, and an even more robust 55% when adjusted for constant currency effects.
However, there's been a noticeable slowdown in their revenue growth over the past couple of years due to several logistical challenges. Notably, their main warehouse on the U.S. East Coast faced significant delays from a system upgrade by a third-party logistics provider. This disruption resulted in longer delivery times and a spike in order cancellations, impacting their direct-to-consumer sales significantly.
Additionally, currency fluctuations have played a role in dampening their financial performance. The strength of the U.S. dollar against a weaker euro and Swiss franc has had a negative impact, which is particularly problematic since over 97% of On's sales are conducted in foreign currencies, exposing them to substantial currency risk.
In my analysis, I've projected that On Holding's revenue growth will decelerate next year to about 29% YOY, slightly below the company's own 2024 growth guidance of 30%. Looking ahead to 2025, I anticipate further declines in revenue growth, which I expect the company to maintain for the next five years. After this period, I forecast a gradual reduction in growth, reaching a plateau by the tenth year at only 2.5% above a risk-free rate of 5%—totaling a growth rate of 7.5%. This conservative approach factors in the potential challenges and market conditions that could impact their performance over the long term.
ON current revenue growth rate is amusing, but not sustainable. Something to expect from a recently emerging new footwear brand, that’s positioning itself as a premium image among incumbent players. The assumed revenue growth lies within some of the more established players in the market. See below chart when i’m snipping the revenue growth rate for the like of ON (Nike, Deckers, Skechers, Adidas)
ON's current revenue growth rate is impressive but unlikely to be sustainable long-term—a common scenario for a footwear brand like ON, which is carving out a premium niche among established industry giants.
The revenue growth rates I've assumed for ON align more closely with those of some of the more established players in the market. Below is a chart comparing revenue growth of more mature high cap companies such as Nike, Deckers, Skechers, and Adidas, to provide a clearer perspective on the conservative side of upcoming Revenue growth rates I chose to stick with.
Operating Income (EBIT)
while by the time of valuation, EBIT margins were sitting at 9%, they are expected to increase by 13% within ~4-5 years time.
When examining the profitability metrics, specifically EBIT (Earnings Before Interest and Taxes) margins, for the footwear industry, it's insightful to look at established companies with over a decade in the market to gauge a baseline. Nike, a major player in the industry, currently holds an EBIT margin of around 11.5%. In contrast, Lululemon, which has successfully positioned itself at the intersection of high fashion and functionality, boasts a significantly higher EBIT margin of 23%. Deckers, another strong performer known for its stylish yet practical designs, maintains an EBIT margin of 18%. These figures compare to an industry average EBIT margin of approximately 11%.
During their investor Day back in Oct 2023, ON delivered their key point strategies on how they can achieve the required scaling aim, for 18% Adj. EBITDA margins by 2026.
However, as they expand their Direct To Consumer (DTC) channels through online conversions & further expansion through leased physical store, ON will have a wide EBITDA - EBIT gap that might stay consistent until proper economies of scale are achieved. that’s why sticking with a 13% terminal value seemed more rational on the conservative side.
3. Free Cash Flow
To calculate the Free Cash Flow to the Firm (FCFF) for ON, I used the industry average Sales to Capital Ratio, which is a key metric indicating how effectively a company generates sales revenue per unit of capital employed. This ratio helped estimate the reinvestment amounts that ON might need over the coming years. By subtracting these projected reinvestments from the EBIT, I derived a close approximation of ON's FCFF. Initially, the average sales-to-capital ratio was set at 2.0 for the first five years, indicating efficient capital use. This ratio is projected to improve to 2.25 as the company scales and optimizes its operations further.
4. The final piece, the discount rate
Relying to CAPM to calculate the proper cost of capital, I will leave the full working sheet for your consideration and criticism if any.
the below sheet summarized the final PV of all FCFF after consideration of calculated cost of capital, yielding final to a fair value of 24.23$/share, indicating a premium of current market price (at the time of writing) of 29.74%
Final Thoughts
In conclusion, our conservative valuation of On Running Shoes reveals a company poised for sustained growth, albeit at a moderated pace compared to its explosive recent history. Drawing on a comprehensive Discounted Cash Flow (DCF) analysis and leveraging the valuation principles of Aswath Damodaran, we have navigated through numerous financial variables with a conservative lens. Our projections have intentionally tempered optimism, aligning On's future with realistic market expectations and inherent industry challenges.
While On's current market position and innovative branding mirror the early successes seen in companies like Lululemon, our analysis suggests that its valuation requires a careful balancing of growth potential against emerging risks and competitive pressures. By setting conservative estimates for revenue growth, EBIT margins, and capital reinvestment, we aim to provide a valuation that withstands variances in market conditions and internal company dynamics.
With a projected fair value of $24.23 per share, our analysis suggests a cautious but optimistic investment stance, recognizing On's potential to capitalize on the athleisure trend while acknowledging the tough road ahead to maintain its current growth trajectory. This valuation offers investors a lens through which to view On not just as a popular brand of today, but as a potentially prudent addition to a diversified investment portfolio looking forward.
As On Running Shoes continues to expand its footprint in the athleisure market, investors should
monitor its ability to manage growth, navigate market challenges, and maintain operational efficiency. Our conservative approach underscores the importance of prudence in an environment where past success does not guarantee future results, but where calculated risks can lead to substantial rewards.
Appendix:
Full Valuation Sheet is right here
If you want a better understanding on how DCF works and how to utilize the sheet with its components, can’t recommend enough this video by Aswath