What's in my closet? A stock with 33% upside!

Today, I’m opening up my closet to you.

Literally.

Here’s what it looks like inside:

As you can see, I own several pairs of shoes. And if you look closely, you’ll find they’re mostly from the same company: On Holding (ONON).

That’s because I spent four years in ROTC back in the day, which meant a whole lot of marching. Then add in college basketball at the same time, followed up by recreational basketball up until six or seven years ago.

I’m therefore talking about more than four decades of putting significant pressure on my legs – all the way down to my toes.

The older I get, the more I realize my feet (and the rest of my body) didn’t come with unlimited warranties. Eventually, all the wear really does begin to tear.

In which case, all my brand-specific, expensive sneakers are less of a splurge and more about an investment into my health and continuing capabilities. That’s something I’m willing to pay for.

And thanks to this luxury-adverse economy we’re caught up in, On Holding’s stock is looking equally justifiable today.

I’ve mentioned the difficult scene companies like Nike (NKE) and Dick’s Sporting Goods (DKS) are facing these days.

Retailers in general are struggling to motivate consumers in this inflationary environment. And athletic and sporting goods businesses are no exception to the trend.

When budgets tighten, new running shoes of any brand can easily become luxuries instead of necessities. That’s why so many athletic footwear businesses are offering discounts to keep sales coming.

Switzerland-based On Holdings isn’t one to follow the crowd though. It’s built a reputation around innovation and distinctive designs that naturally come with premium pricing.

We’re talking about $140–$280 for a typical pair of adult shoes, with limited-edition models fetching far more. And while it will markdown older merchandise when necessary, that’s about the only concession bargain hunters are going to get.

On Holding believes the brand’s long-term value is more important than short-term sales targets. The way CFO Frank Sluis puts it, the company can’t always have it both ways. So, in this economic environment, it’s not even going to try.

That position might put me in a bit of a bind as a customer. But I respect it as an investor.

Knowing when to say no can be an enormous competitive advantage.

That’s not to say On Holding isn’t feeling some heat for this stance. During the second quarter, it reported revenue of 850.3 million Swiss francs (a currency that doesn’t have a symbol but is instead marked as CHF).

That rounds out to about $1.04 billion, which represents 13.5% growth year over year.

On the one hand, that’s a great number for such challenging times, with direct-to-consumer revenue rising a whopping 26%. So shoppers are still seeking out the brand online and in On Holding-specific stores.

But wholesale revenue, which normally grows at double-digits, rose a mere 4.8%.

Some of that slip should have been expected since management deliberately limited shipments to certain channels. It was either that or put retailers in the position to heavily discount overstock.

That’s certainly the situation Hoka parent-company Deckers Outdoor (DECK) and Nike are in. And it’s just as evident at Dick’s.

Circana footwear industry analyst Beth Goldstein recently reported that athletic footwear unit sales fell 7% between May and July. Some 44% of those shoes were discounted, up from 40% the year before.

Ipso facto, even though these apparel companies are employing discounts so heavily, they’re still selling fewer shoes. In which case, it’s hard not to see the value of On Holding’s way of doing business.

I may be a long-term On Holdings customer. But it took a Wall Street Journal article by Ben Cohen to clue me in on its fascinating origin story.

Titled, “This sneaker was inspired by iPhones and a vacuum cleaner,” it introduces Olivier Bernhard, a retired triathlete and Ironman champion. After all that punishment he put himself through, Bernhard wanted a running shoe with superior cushioning.

And when he couldn’t find one, he began experimenting with a garden hose, scissors, and glue.

I’m not kidding. That’s what the article said.

The creativity didn’t end there though, as Bernhard and several co-founders launched On Holdings in 2010 from a kitchen office. And as they continued to test out different materials, they studied iPhones, Eames chairs, and Dyson vacuums along the way.

As odd as those choices sound, the team wanted to combine the best of superior engineering, functionality, and design.

I’ll personally attest that the result is a truly excellent shoe that more and more consumers are beginning to notice. On Holding can now be found in running clubs, airports, and fitness centers along with traditional retailer stores as its reputation grows.

It’s hardly achieved Nike-like status, mind you. But brand awareness rose from 12% to 30% over the last three years.

Management aims to hit 50% over the next three in its pursuit of becoming a global premium leading sportswear brand. And, again, that’s without discounting its way into consumers’ good graces.

It’s also well worth talking about On Holding’s current valuation…

The company is currently guiding toward revenue of CHF 3.47 billion to CHF 3.56 billion. So let’s just go with CHF 3.5.

Meanwhile, management expects an earnings before interest, taxes, depreciation, and amortization (EBITDA) margin of 19.5%–20%. Using the midpoint this time, we come to about CHF 695 million in adjusted EBITDA.

That’s pretty good for a company of its size, scope, and ambition.

With a 15% tax rate, adjusted net income would therefore be around CHF 489 million. And we can then put estimated earnings per share (EPS) at CHF 1.40, or $1.71 per share.

Since the stock closed yesterday at $35.41, it’s trading at about 20.7x our estimated 2026 earnings. And applying a 27.5x price-to-earnings (P/E/) ratio to our projected EPS of $1.71 gives us a $47 price target.

That represents a near 33% upside from yesterday’s close and therefore an attractive opportunity on a premium global brand with considerable room to expand.

This outcome, of course, is dependent on the company expanding its operations further while protecting its already strong margins. But considering its past growth and significant, intended international potential, I believe it’s very possible.

There are some so-called premium products that aren’t worth the hype. I’m not so foolish as to think expensive is always better.

But when it comes to On Holding’s shoes, I’m a satisfied – and returning – customer despite the higher price tags. If paying more for this kind of quality means less wear and tear on my body, then so be it.

As my regular readers know, that philosophy rarely translates into my stock market evaluations though. I want it all when it comes to buying opportunities here: quality companies with durable competitive advantages, attractive growth opportunities, strong balance sheets…

And undervalued shares.

On Holdings looks like it offers that array of benefits for the time being – giving this loyal customer the chance to make some money back on the sneakers I’ve spent so much on.

Happy SWAN investing,

Brad Thomas
Editor, Wide Moat Daily