Magic Markets #251: How Sports Brands Win (And Lose)

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Description:

On Holding might have an awkward name, but the company counts Roger Federer among its early investors and biggest endorsements. Thanks to Nike’s missteps during the pandemic, On was able to win market share in core categories like running and tennis shoes. Once that foundation is established, the opportunity is there to expand into apparel.

With On Holding as our research topic in Magic Markets Premium this week, we decided to dedicate Ep251 of Magic Markets to discussing how its story compares to the likes of Nike and Lululemon – and what we can learn from those names about the risks of this sector. Names like Dick’s Sporting Goods also made an appearance in this show.

This podcast is for informational purposes only and is not financial or investment advice. Please speak to your personal financial advisor.

 

Transcript:

The Finance Ghost: Welcome to episode 251 of Magic Markets. I’m sitting in Joburg, that’s our old stomping ground, Moe. Now we live very far apart after we knew each other so well in our Joburg days. Me in Cape Town, and you all the way in Canada. But, at least – well, I don’t know what it’s like for you on that side. The nice thing is when it rains in Cape Town, the robots still work. I don’t know what it is with Joburg robots, they all stop working when it rains. It is one of those great mysteries.

But, it is interesting to see all the G20 banners out, and a jet flew over Sandton today, which was pretty rad. You know how I feel about jets. So, welcome Moe, and what’s the story in Canada? Do the robots work when it rains? Do they call them traffic lights there? What is the vibe?

 

Mohammed Nalla: Yeah, I was going to say, we can’t call them robots. I gotta be like, “Yeah, it’s traffic lights, it’s not robots. What are robots? That’s Elon Musk.”

 

The Finance Ghost: It’s an Elon Musk product, exactly.

 

Mohammed Nalla: Yeah, but thankfully, I guess, the traffic lights work, no other issues around your electricity or your water situation. We’ve discussed my bad bandwidth, so that obviously goes without saying. And at present, I think over the course of the last week or so, we’ve had a bit of snow. So, I’m glad you’re enjoying at least the better weather in Johannesburg and then Cape Town, when you go back home.

Let’s not get sidetracked, because we’re talking G20, lots of jets flying over South Africa. There’s a lot of exciting stuff happening down there. But again, I just don’t get the sense, maybe as a last point on that, that any foreign dignitary is going to even notice the issues that South Africa has. Because, remember, those roads that they travel on have been freshly paved or repaired. The areas they go to probably have backup power. So, yeah, it’s a sad look, but let’s not get too sidetracked there. 

Ghost, what are we talking about this week?

 

The Finance Ghost: So Moe, we covered On Holding in Magic Markets Premium this week, which is the Swiss brand that is giving Nike something to really think about. One of the things that I found most interesting is that Roger Federer is on the shareholder register and is also, of course, one of their big brand partners. You’ll struggle to find a better endorsement than Roger Federer – just an all-round gent and, obviously, absolute great of the game. It’s hard to imagine Roger ever getting himself into something controversial, I must be honest.

And On, yeah, pretty interesting business to look at. Obviously this comes in a year where the Lululemon share price has been a disaster – unfortunately, a dip that I caught the wrong end of and continue to scratch my head a bit about what to do. And we’ve seen how badly Nike has done in the aftermath of the pandemic.

So, I guess the point today is to just talk a little bit about some of these up-and-coming apparel stories. For those who are interested in Premium, you’ll find the latest research there is on On Holding. Such an awkward name, actually – on On. That’s actually also the stock ticker, right? It’s $ONON. It’s so weird. But, it’s such an interesting company.

 

Mohammed Nalla: Indeed, Ghost. We’re not going to give away what we’ve actually put in the Premium report. That’s for our Premium subscribers – it’s only R99 a month and again, you’re going to get a detailed, deep-dive, bottom-up look at what’s happening at that company. But we’ll touch on a couple of the key points, right?

The company’s name is actually On, it’s On Holding. The brand is On, but I agree with you. I think the brand was very confusing for me the first time I saw it. Even if you look at the logo, the “O” looks like an upside-down “Q”, and the “N” looks like a “C” on its side, and so I was struggling to find out what it was. A lot of people confuse the brand. They think it’s “On Cloud” because their technology is this CloudTec® technology.

One point I will throw in that we included in Premium was just so interesting, because we’re talking about Nike, we’re talking about Lululemon. It’s that one of the co-founders behind On was actually a triathlete. And before they created On as a whole separate company, he had developed this new technology – the CloudTec® – for a new sneaker. He took that to Nike, and Nike had a look and said, “Nah, we’re not interested.” So again, just so interesting to see the interplay between these various companies out there. 

But I’m not going to give away, like I say, the key points that we’ve got in On, because we’ve actually got a lot to discuss when we’re looking at players like Nike, like Lululemon as well. This footwear, this apparel market has been so super competitive. And that’s before we even go to other parts of the value chain, where we’ve covered stocks like Dick’s Sporting Goods – which has been a remarkably successful experiential retailer in the US. They’ve just gotten bigger and bigger, and they’ve recently announced an acquisition of Foot Locker. 

For those of you that do follow us on Magic Markets Premium, you’ll recall Foot Locker – a fairly large business – they started to struggle. And the bulk of Foot Locker’s sales in the footwear segment were actually tied to Nike. So, there is a very well-tied-up ecosystem and value chain out there, and there’s been a lot going on.

So, I’m going to jump into Nike, Ghost, because I know you’re going to discuss Lululemon – that’s one of your sore points. But I think Nike is a sore point for you as well. I think it was the first stock that we covered in Magic Markets Premium, it was a favourite of yours, but right now Nike has actually put the “dog” in Shoe Dog.

 

The Finance Ghost: At least I didn’t own it, Moe, I will say that much. Lululemon is one that has hurt me, actually. Whereas Nike, I think I just liked the business and what it stood for and Shoe Dog, but I never actually owned it at those crazy valuations. I was smarter about Nike than I was about Lululemon.

 

Mohammed Nalla: I’m glad to hear that, because other than Shoe Dog being a fantastic memoir of Phil Knight, the founder of Nike, in its heyday, I might add. It’s a fascinating read. If you haven’t read that, go and check that out. Nike itself, that’s really a company that’s had better days, and they’ve made a series of missteps.

So, let’s look past that, because we could argue maybe Nike is trying to turn a corner right now. The most recent results actually showed some growth in revenue, believe it or not. I say “believe it or not” because we’ve gone through a couple of quarters of shrinkage in that revenue number. The latest quarter up, wait for it…1%. So, you’re going to laugh. You’re going to snicker at that. But, revenue up, maybe they’re turning a corner, right? And if we look at that on an FX-neutral basis, yes, it’s slightly better. But Nike’s really struggling.

What went wrong at Nike is, a while ago through the pandemic, Nike decided to double down on its D2C. Now, D2C (direct-to-consumer) can be a very potent, very powerful strategy, but they did that at the cost of alienating some of their wholesale partners. Foot Locker was on the receiving end of that and it really ended up costing Nike shelf space. Because Nike said to players like Foot Locker and other players out there, “We can’t give you all the products you need.” And so, as a result, that created shelf space for new disruptors to come through. It’s not just On. You’ve had HOKA come through, that’s in a company called Deckers. Again, those players all occupied that shelf space. Nike’s now firmly on the defensive.

Now, if we jump into some of the more recent numbers there – like I say, pretty much flattish on the revenue side, but that masks what’s happening underlying the business. So, quick slice and dice on a regional basis.

In North America (arguably its core market), footwear was actually flat on a year-on-year basis, but apparel was actually up 11%. So, that’s a saving grace. They’re selling more Nike T-shirts. Again, they’ve got some strong endorsements. Nike, I think the one thing they do better than anyone out there, is their endorsements. Their athlete slate that they’ve got there is really unlike anything out there in the sports industry. And so again, I think that contributes to an overall brand cachet that has defended Nike. It contributes to the moat and it’s maybe why people are still buying apparel even if the footwear has been somewhat of a failure.

Now, outside of the US, if we look at EMEA. There, footwear was up 4%, but apparel, again, strong – 11%.

And then interestingly, China. Now, China’s a very large market. And while we’re on China and while we’re talking Asia, remember the bulk of Nike’s production, globally, actually sits in Vietnam. They tried to move a lot of that from China into Vietnam because they saw the geopolitical situation that was going on. But if we look at the sales side in China, footwear – down 11%. So, that’s a market where the disruptors have made significant headway. They’ve actually clawed market share away from a player like Nike. And then in China, apparel – pretty much flat, around 1%.

So overall, if we wrap that up across product and geographical verticals, we can see apparel is really doing the heavy lifting for Nike. Footwear – really flattish to down. And I don’t know about you, Ghost, but when I think of Nike, I predominantly think about footwear first, and then I think about the apparel. So, the fact that their footwear is really struggling pretty much in their core markets, and then actually going backwards in high-growth markets – that’s a very concerning look for a player like Nike.

I’m going to pause there, Ghost. I don’t know if you have any questions, or if you want to draw any analogues towards what you’re seeing in Lululemon.

 

The Finance Ghost: Yeah, so what’s quite interesting with Nike, just talking about the endorsements that you mentioned, it’s amazing how US-centric it is. If you read their earnings transcripts, they always talk about basketball – I was going to say baseball, but they never talk about baseball – though they certainly talk about basketball a lot. 

You just won’t see that if you look at a business like On, because On is Swiss and so they don’t actually care about basketball. They’re actually building from a place of running and tennis, which makes a world of sense, because that works really well in the rest of the world. And it’s super clever, because it means they’re not trying to take Nike on in their home market, in their home sport. It’s such a competitive bloodbath. Just leave that alone and go and pick away at Nike’s market share elsewhere in the world. Especially in something like running which, if you have read Shoe Dog, was actually how Nike started. So, for Nike to have lost so much ground in their core product, the genesis of their business – and actually, when you read the Nike transcripts with new management in place and talking about getting back to the core, they reference stuff like this. They talk about how disastrous it is, how badly Nike lost their way, to allow a competitor like On to come and actually take market share from them.

 

Mohammed Nalla: Indeed. We’ve spoken about On, but it’s not just On, and I think that’s the point. The bigger bear thesis around Nike is that other competitors that had their own respective tough times, like Adidas. Adidas has actually clawed market share away from Nike. If you look at Adidas’ results, they’re up 11% on footwear and 16% on apparel. So, in aggregate, Adidas is doing a lot better than Nike there.

And what’s interesting for me, Ghost, as an additional dimension here, is that the players that are clawing away at Nike’s market share are actually ex-US players. If you look at Adidas, Adidas is a European company. On is a Swiss-based company. And so this is telling you that perhaps there is a bit of a shift there. 

I think that very US-centric approach to the endorsements, I think that’s a very valid point. If we look at some of the other players that are being endorsed by players like Nike – a lot more global. The sports – arguably also a lot more global. And I get that, playing towards a global market, a global audience.

It’s only a matter of time, though, before some of these disruptors, after building significant momentum in the global markets, start to pivot towards challenging Nike in its core market in the US. We’ll need to see if that actually plays out the way they expect it to.

But again, this entire industry is littered with these success stories, and then a massive failure. If you look at a player like Under Armour, which again, we’ve mentioned it when we covered Nike as well – that was a stock and a company that did so well. They were behind this wicking technology with their apparel wear. They defined that entire space. They were a market darling at one point in time. I think you pointed out to me one of the early Under Armour adverts is very motivational, it gets you all pumped up. Now if you look at Under Armour, they’re sitting in the single-digit billions in terms of market cap. 

And that just shows you how tough it is in the space. You can be the darling today, you can be making significant headway, but if you can’t sustain that momentum, the incumbents do manage to swing back. So, just be very cautious.

Ghost, talking of cautionary tales, I want to hear a bit more about what you’re finding on Lululemon on the recent updates.

 

The Finance Ghost: It’s not good. It’s a dip that just keeps on dipping, unfortunately. Let’s dig into just some of the recent story at Lululemon, without going into crazy detail. 

So, here’s the single biggest problem. The five-year high on the price-earnings multiple is a casual 92x. That’s pretty high. Currently, just over 11x, which is pretty low. In fact, 11x is less than you will spend to go and buy yourself a South African apparel retailer. So, it really is a remarkable valuation unwind. It’s like the market just hates this thing now, it really is incredible.

If you look at their 2022 financial year (which was mostly the 2021 calendar year) sales were up 42% that year. Now, if we look at FY25, sales were up 10% (that’s pretty much last year, because their financial year ends very early in the calendar year). So, therein lies the explanation for the valuation unwind – once upon a time in the 40s, now barely in double digits. 

Gross margin’s a slightly mitigating factor. In 2022, it was 57.7%. 2025, 59%. So, it ticked higher. Healthy, good trajectory, that’s a solid number. Operating margin over the period, much the same. If you go back to that sort of “peak” year, they were at 57.7%. Now, it’s at 59.2%. So the funny thing is that since that year where the valuation was so crazy, the business is actually doing better. Net income has nearly doubled from FY22 to FY25, so it’s not like Lululemon’s business is collapsing. 

But the share price was priced for so much more than just an average performance – it was priced for absolute perfection. And the United States market is actually the problem, not least of all because of tariffs. So, obviously that really hurt the story this year. If you look at their guidance for FY26 (which is basically one more quarter to go) they expect revenue in the US to be down by between 1% and 2%. 

So, when we talk about On not getting involved too much in the competitive bloodbath that is the American market, it’s probably a big part of their success and why they’ve done so well.

In China though, Lululemon expects growth to be up between 20% and 25%. So, the rest of the world is doing well and that’s where On is actually focused, which is why they’re doing so well. As is so often the case, it’s really a macroeconomic story at the core, and it’s why you always bring the macro into these conversations – which I love, because you ignore that stuff at your peril. You really should not be ignoring it.

As we go into the last quarter of the year, there’s pretty much all to play for, because Lululemon is a very seasonal business. If you look at the last financial year, their sales in the fourth quarter were 50% higher than in the third quarter, so super seasonal. Lots to play for over Black Friday, Christmas, the holiday season in general. But all eyes are very much on those US sales. So, what would the catalyst be for the Lululemon share price to suddenly start behaving itself? It would be sales in the US. That’s where they desperately need things to work.

 

Mohammed Nalla: Yeah, Ghost, what I think is so interesting and important there is that you actually split out how the business is performing from how the share price is performing. The reason that’s important is, as you’ve indicated, Lululemon’s underlying business has actually done respectably, but the valuation was the pressure point there.

When you look at a player like Nike. We’ve spoken about disruptors like On and how they’re growing market share so aggressively, but they are still a much smaller player in the overall market. There’s an estimate out there that says that Nike sells around 26 pairs of shoes every single second. So, in terms of volumes, in terms of economies, they’re there. They’re just not making a lot of money by doing that.

Now, I want to backtrack a little bit, because we’ve mentioned the macro and how the macro is so important. I want to go back to the endorsement point, because I think endorsements and the various areas these companies are focusing on tell us where they’re seeing growth. 

We know, for example, you’ve mentioned Nike goes with all of the big NBA names. Basketball – very prominent there, very US-centric. But if we then look at what some of the other players are doing in that endorsement space as a macro indicator, that’s where it gets really interesting. Look at a player like Adidas. Adidas has gone with endorsements of certain sports that are out there, but then they’ve also gone with an endorsement in the lifestyle segment from a Bollywood Gen Z icon. And this is telling you, again, that macro point. They’re focusing on markets outside of the US. If you’re going with a Bollywood celebrity, you’re targeting that Indian market. And that’s showing you a macro point of where the growth is coming from and, arguably, where a player like Nike might be missing the beat.

Another interesting point, while we’re still on Nike – that pivot into apparel, for example, has also got them in a partnership with Kim Kardashian and her Skims brand. Lots of media around that now; Skims looking at an IPO. And this is, again, a fall from grace. Nike’s looking to arguably ride the coattails of Kim Kardashian and the Skims brand with a partnership coming through there. Again, showing you that they’re scrambling somewhat.

And then a last point, if you look at a brand like HOKA. HOKA has actually gone out there and they’ve targeted universities. What’s so interesting is if you go into the history of Nike, they targeted some of those university teams as well. They’re trying to effectively incubate some of the upcoming talent, and that’s showing you just another angle of attack that some of these smaller players are taking to a large incumbent like Nike.

Ghost, I’m going to pause there on the endorsements, because I want to wrap this on some of the key performances over the course of the last while. Let’s start out with a one-year view because this has been a very, very tough market.

No surprises here that if you look at a player like Nike, that’s actually down close on 20% over the course of the last year. I would say, even if we look at all of these companies that we’ve covered here, the only one that actually comes through in the positive would be Dick’s Sporting Goods. That’s the retailer. They’re elsewhere in the value chain, but they’ve done a remarkable job. They’re also acquiring Foot Locker.

But if we look at the other players, Lululemon’s down almost 50%. That’s absolutely shocking. And then even a player like On (maybe a bit unfair, they did peak very early on in the year), they’re down around 20% on a year-to-date, maybe even a 12-month basis. That’s showing you that, despite the fact that they’re gaining market share, gaining some of this momentum, it remains a tough industry overall. And that is why you’ve got to also look at the very long-term performance.

Now, Ghost, as a five-year view, Dick’s Sporting Goods coming out as the clear winner there. And then Deckers, interestingly enough (they own HOKA as a brand), they come through as the number two player. The number three player over that time period is On. And then large incumbents (arguably of yesteryear), Nike, Adidas, down in the solid double digits, close on 50%. Lululemon, I’m not going to depress you. I think they’re the laggard there, down just over 50%.

So, wrapping that all up, it’s an interesting, competitive market. You’ve got to look at where the disruption is coming from – that’s one of the reasons why we looked at On with a detailed deep dive in Magic Markets Premium this week.

 

The Finance Ghost: And Moe, I think one of the things that I like most about On really is just that Roger Federer alignment. I really think that’s got to be one of the best sporting endorsements you could ever imagine having. And he’s a shareholder, so that’s not going to go away. I just think that’s a brilliant piece of alignment. It really is, because these endorsements can go really well and they can also go really, really badly. And we’ve had lots of examples – you’ve touched on some of the endorsements there.

And Moe, even looking at something like On, they’ve also stepped outside of that core sporting endorsements area. They’ve partnered with Zendaya, they’ve partnered with Burna Boy. In that case, they’re actually targeting big Gen Z names to try and just bring people into the funnel. And that’s what makes apparel so interesting, right? You’ve got to try and constantly balance off growing the funnel for the brand versus losing the core identity.

And that’s why you’ve got to be careful overpaying for these brands. Because if they run out of growth, they sometimes do things that backfire. Then, like in Lululemon, you can ride that multiple all the way down, and it’s not pretty.

As an aside, Lululemon really does feel like it’s almost impossibly cheap now – a double-digit, low double-digit P/E for that brand. I just want to see some semblance of a turnaround in the US market before I average down again. I think that’ll be the third time I’ve bought the dip, so I am nervous at this point of doing it. And that’s the behavioural finance coming through – if I was happy to buy it before, I should be happy to buy it now. But I would still like to see some confirmation that they can stop the slide in the US.

 

Mohammed Nalla: Yeah, Ghost, I don’t know if that’s throwing good money after bad. For me, we probably need to wait and see. I was a lot more gun-shy on Lululemon, certainly the last time we covered it, and I think that’s been the right move. I would have been very grumpy if I actually got into that stock and then it continued to fall.

But again, if you are interested in a detailed deep dive into any of these stocks that we’ve spoken about, On is the most recent report, but you have access to the full library. We’ve covered Lululemon, Nike, Dick’s Sporting Goods. We even covered Foot Locker before they got taken out by Dick’s Sporting Goods. 

You can then weave all of those insights together to give you a much more well-rounded view of the industry as a whole – how these businesses operate, who makes money, who doesn’t make money – and use that to contribute to your overall knowledge base as an investor. That’s my shameless plug for Magic Markets Premium. We think it’s actually the best value you can find out there at only R99 a month. Go and check that out if you’re not a subscriber already. 

Ghost, that’s where we’re going to leave the show this week. To our listeners, we hope you’ve enjoyed this. Let us know what you thought of the show. 

Hit us up on social media. It’s @MagicMarketsPod (one word), @FinanceGhost and @MohammedNalla all on X, or go and find us on LinkedIn and pop us a note on there. 

Until next week, same time, same place. Thanks, and cheers.

 

The Finance Ghost: Ciao.