Few brands ooze as much prestige as Ferrari.
In 1939, Mr Enzo Ferrari created the infamous company out of Modena, Italy. To this day, millionaires flock to acquire the latest special edition, often commanding eye-watering prices for the limited production models.
The company recently debuted on the stock market (ticker aptly named RACE) after being spun off by Fiat Chrysler, to transform into the holding company, Ferrari N.V. Since it’s listing, the stock has performed tremendously well, both relative to its peers and the wider market.
Ferrari’s Pricing Power
One of Warren Buffett’s investing principles is that the company in question needs to have strong pricing power. It’s fair to say Ferrari ticks that box. Only a handful of the latest models, the LaFerrari Aperta and the GTC4Lusso, are being made, which reflects how demand for luxury cars has never been greater.
But although Ferrari commands high prices, this in itself doesn’t warrant giving the stock a ‘buy rating’. If something sells for a high price it often has very high production costs and specialist labour knowledge. Both these factors put a lid on margins for both a firm and its investors.
The Case For Growth
Moreover, how does RACE do on the growth front? Going by their latest earnings results for Q1 2017, the US is Ferrari’s largest single market. Year on year (YoY) sales rose 4.2%, with 545 units shipped, up from 523 in 2016. Ferrari does not come close to other automobile brands in terms of sales volume, but who cares? Ferrari has and never will compete on volume. The moment it does is when Ferrari loses its lustre.
Management admitted that this quarter was driven by robust sales of the F12 Berlinetta. In China, quarter on quarter sales were down 36% after Ferrari ended its partnership with a Hong Kong-based distributor. Taiwan shipments rose, which in the greater China region helped to offset the HK closure.
In their home market of Europe, YoY shipments to Italy, France and Germany rose by 23%, 18% and 16% respectively. Revenues for EMEA were up 22% YoY. Other manufacturers have found the European market difficult as political tensions have escalated. So much so, in fact, that GM opted to sell its European business to PSA.
In terms of profitability and margins, the firm reported a YoY Q1 EBIT increase of 3% from 26% to 29%, while EBIT margins increased from 18% to 21.6%. Ferrari says that margins tend to be higher for the V12 engine models rather than their V8 variants. In some ways this isn’t surprising because if one were going to buy a Ferrari, they wouldn’t be doing it on a budget.
A Sound Stock?
So what do all these accounting figures tell an investor? The market is pricing RACE at a lofty 30x forward price earnings multiple. For good reason, one might conclude, since its forward EV/ EBITDA is much higher than its peers. Moving forward, signs are looking good for Ferrari, both at a micro and macro level. It estimates that around 8,400 units will be shipped in 2017, 5% more than 2016. It has also set a target to reduce debt levels to €500bn from €653bn. Furthermore, from a marketing standpoint, it does help when the Formula One team is performing well, as is the case so far this season.
One potential trade for the coming quarters would be to go long Ferrari stock (RACE) and short BMW. A few reasons for this idea, other than hedging out market and sector risk, would be the strengthening Euro, as the ECB looks to unwind policy. As BMW is heavily exporting to nations outside the common currency, a stronger Euro gives a headwind to earnings translation and competitiveness. Ferrari does export but not to the same degree as BMW; Ferrari also has a listing in the US. Second, as economic figures improve and while the hard data continues to confirm the soft, demand for luxury cars should rise, as is the case in the US market. Granted that the sentiment figures in some respects don’t matter because not everyone buys a Ferrari, a strengthening Eurozone will aid, not hinder, sales. Third, from a trade structuring point of view, there would be no currency risk as both are denominated in Euros.
In many ways, Ferrari seems both highly cyclical and incredibly defensive. Whether in recessionary periods or boom times, there will always be people with money. Consequently, Ferrari has some protection from whatever shockwaves President Trump or the Brexit negotiations might send rippling across the macro picture.