Ferrari: A Luxury Automotive, In A League Of Its Own (NYSE:RACE)

The automotive industry generally repels long-term passive investors due to its cyclical nature and capital intensity. However, there could be potential outliers. High-end automakers like Tesla (TSLA), Ferrari (NYSE:RACE), Mercedes (OTCPK:MBGAF), Porsche (OTCPK:DRPRF), Stellantis (STLA), and BMW (OTCPK:BMWYY) are presumably less cyclical as they are targeting a higher class of consumers which are more resilient and less sensitive to the economy. A closer look leads me to conclude Ferrari is the only real outlier. While the other companies on the list are targeting a higher class of customers, they are not in Ferrari’s league when it comes to pricing power and long-term prospects. Thus, I believe Ferrari is the only automaker that is really immune to cyclicality and will provide investors with steady sequential growth.

Ferrari is one of the very few companies that control the number of products they sell. With a never-fulfilled demand and the rising popularity of Formula 1, I find Ferrari to be a potential long-term compounder that is trading slightly below its fair value, which I estimated at $305 per share, reflecting 12.5% upside. Thus, I rate Ferrari as a Buy.

Company Overview

Ferrari is among the world’s leading luxury brands. The company owns Scuderia Ferrari, the most successful racing team in the history of Formula 1. Ferrari reports under three operating segments – Cars and Spare Parts; Engines and; Sponsorship, Commercial, and Brand.

Under its Cars and Spare Parts segment, Ferrari designs, manufactures, and sells cars under four categories: Range, Special Series, Icona, and Supercar. Ferrari’s current product portfolio is comprised of 10 Range models, including the first-ever four-door four-seater Ferrari model, 2 Special Series models, 1 Icona model, and 1 limited edition Supercar. The company is unique with its low-volume production strategy, seeking to maintain a reputation of exclusivity and scarcity among purchasers. Similar to companies like Hermès (OTCPK:HESAY), Ferrari is carefully managing its production volumes and waiting lists in order to keep its reputation.

Under its Engines segment, Ferrari produces and sells engines to third parties, mainly Maserati. This segment is decreasing as the contract between the two companies is due to expire in 2023.

Its Sponsorship, Commercial, and Brand (‘SCB’) segment includes revenues from Formula 1 racing through sponsorship agreements and Ferrari’s share of the Formula 1 commercial revenues, as well as revenues from merchandising, licensing, and royalties.

The Problem With The Automotive Industry

As a product with a long life cycle, any small deterioration in the economy usually results in a significant decrease in demand for cars, as drivers lean into keeping their old car a little longer in order to avoid spending a large sum on a discretionary improvement. This characteristic of the auto industry is one of the reasons large automakers like Ford (F), General Motors (GM), Volkswagen (OTCPK:VWAGY), and Toyota (TM) are trading for low single-digit P/E multiples.

Another problem is the high capital intensity. Large automakers are forced to invest heavily in their manufacturing sites in order to keep up with the latest technology and innovation. Every small change is very costly when multiplied by the huge number of cars these mass-makers deliver.

However, as most ordinary automakers lack pricing power, they are forced to drop prices in order to sustain demand on down cycles, which results in lower profit margins and diminishing returns on their capital investments.

High capital intensity, lack of pricing power, and cyclicality are a recipe for bad long-term returns. All in all, it shouldn’t surprise anyone automakers are significantly underperforming the market:

Ferrari’s Differentiation

Ferrari is not an ordinary automaker. Ferrari is the only company that is a pure-play luxury automaker. While many automakers own luxury brands like Volkswagen’s Lamborghini, BMW’s Rolls-Royce, and Mercedes’ Maybach, they all manufacture additional lower-class vehicles, which are a significant part of their business. As such, Ferrari has shown its unique ability to grow volumes at just the right pace, and with less volatility compared to its competitors:

Another major differentiator for Ferrari, which I believe will become a significant portion of the company, is its non-car activities. Ferrari’s participation in Formula 1 provides a diversified revenue stream which many of its competitors do not have. The pinnacle of motorsport is one of the most watched annual sports series in the world, with approximately 445 million unique viewers in 2021. The Formula 1 fanbase is in a hyper-growth stage, with Netflix (NFLX) playing a major role in the rise of the sport’s popularity.

As it currently stands, Ferrari’s non-car segments play a small role in the company’s results (9.4% of Ferrari’s 2022 total revenues):

Even though the SCB segment grew by 11.1% in 2022 compared to the prior year, Ferrari experienced a few issues with its sponsors during the year. These issues were certainly temporary, as there’s plenty of demand for sponsorship deals with a brand like Ferrari. At the beginning of 2023, Ferrari signed a new sponsorship with Genesys, a software company, and on the day of writing this article, another major sponsorship deal with VGW was announced, sending Ferrari’s shares up 3.0%.

Overall, with the rising popularity of Formula 1 and Ferrari’s unique brand, I believe its SCB segment will see significant growth in the upcoming years.

As a luxury brand with a very small customer base, Ferrari does not experience cyclicality. Its order books are always full a few years in advance, as its annual deliveries number is relatively very small. The company’s capital investments provide industry-leading ROI and are a small portion of the company’s revenues. I find Ferrari to be differentiated, and in my opinion, its shareholders could expect a much better outcome than what we saw with other automakers.

Competitors & Comparisons – Converting Words Into Numbers

Saying Ferrari is different is nice, but the question that arises is two-fold – (1) do Ferrari’s numbers back the thesis, and (2) are there any companies that share the same attributes as Ferrari?

In order to answer that question, I’ll compare Ferrari with other higher-class automakers in Porsche, Mercedes, Tesla, BMW, and Stellantis, based on metrics that I find to be the most important to assess the quality of the company. Those metrics are units delivered, average selling price, gross margins, ROIC, and capex as % of sales.

Unit Deliveries

Well, this paints quite a picture. Ferrari delivered 13,221 units in 2022, while every other company besides Porsche delivered more than a million units. When looking at units delivered, Ferrari clearly is unique. To make things clear, there are probably other car brands that provide purchasers with an exclusive feeling as Ferrari does. However, none of those brands are separate entities. Thus, the only pure exclusive car company which I can think of is Ferrari. Since Ferrari is selling only a very limited number of cars per year, I find it to be immune to cyclicality, as it only needs a very small number of customers every year.

Average Selling Price

This shouldn’t come as a surprise. No company comes even close to Ferrari’s average selling price, as most of them offer lower-class vehicles. The more important information we can learn is that Ferrari and Porsche are the only companies on the list that have raised prices sequentially and consecutively between 2019-2022. It’s important in order to understand the companies’ pricing power.

Recently, we see a lot of headlines regarding price cuts in the industry. Tesla plans to cut prices by up to 20%, Mercedes is cutting prices as it’s seeing sales lag, and Stellantis forecasts prices will fall.

In some cases, the ability to sell a product for a cheaper price could represent a competitive advantage. In the car industry, however, dropping prices is a definite sign of a decrease in demand. When companies are forced to cut prices, this means they will see a diminishing return on their production capabilities. This also means such companies are due for the occasional down cycle, like any other ordinary automaker in the industry.

When it comes to Ferrari and also somewhat to Porsche, I believe investors can be confident a decrease in demand won’t occur anytime soon.

Gross Margins

The gross margin comparison again proves that Ferrari is in a league of its own. In second and third place, we see Porsche and Tesla, which also provide decent gross margins. As Ferrari and Porsche have shown their resilient pricing power, I believe their gross margins are safe. I do worry about Tesla’s margin, as the drop in prices could send the company closer to the lower tier.

Overall, I estimate Ferrari’s gross margin will remain around 50.0% in the foreseeable future. Although I don’t think there’s even a small chance for a price cut at Ferrari, the fact that the company has such high levels of excess profits provides comfort.

Return On Capital Employed

In the automotive industry, growth in units usually requires capital investments. Thus, ROCE is a very important metric to assess the companies’ quality. This metric does have some flaws (high short-term liabilities make it go up), but we can still learn from it.

As Tesla and Ferrari have the highest ROCE, it should be noted that both companies are still growing their production capacity, as demonstrated by their delivery and revenue growth in 2022. Tesla’s deliveries increased by 40.3% in 2022, and revenues grew by 51.1% compared to the prior year. Ferrari’s deliveries number went up by 18.5%, and revenues grew by 19.3%. In essence, the rest of the companies have reached somewhat of a peak regarding capex and capacity enhancements, whereas Tesla and Ferrari are still in growth mode. Therefore, these companies have less capital employed compared to the rest. Yet, their respectively high ROCE reflects the potential these companies have. As long as this metric is close to the 30.0% mark, I believe the companies will continue to invest in an above-industry level, and provide above-industry growth as a result.

However, it remains to be seen if Tesla is able to sustain such elevated levels, as price cuts are already happening. On the contrary, it is reasonable to assume Ferrari’s ROCE is on the way up, as it lowers its capex (see below) and brings new higher-priced models into the market.

Capex as % of Sales

As we can see, Tesla stands out as it spends the highest amount on capex as a percentage of sales. This supports the company’s growth in production capacity, which translates to revenue and delivery growth. While Ferrari is second, it’s pretty close to the rest of the group. However, Ferrari outgrew the rest of the group significantly in recent years, in terms of volumes, revenues, and profits.

Overall, the higher capex combined with the high ROCE explains Ferrari’s results in recent years. I believe this capex level to be sustainable and expect Ferrari to continue to invest slightly above the industry average, as long as it sees industry-leading returns on its investment.

In A League Of Its Own

To conclude the comparison, I find Ferrari’s numbers to be the best in the industry. The company’s low delivery volumes reflect the non-cyclical nature of its business, which is a characteristic no other company in the auto industry has. Ferrari is able to constantly increase prices and still fill out its order books many years in advance, while others are having to cut prices in order to maintain demand. Ferrari’s gross margins are incomparable to other automakers, which represents its exclusive offering to its customers. In addition, Ferrari is getting industry-leading ROCE and controls its capital expenditures to manage the correct product scarcity.

Valuation & Near-Term Projections

I used a discounted cash flow methodology to evaluate Ferrari’s fair value. I assume Ferrari will see revenues grow at a CAGR of 9.96% between 2022-2028, which is above the company’s long-term guidance. The management guided for net revenues of €6.7B in 2026, while I project revenues of €7.7B in that year. Ferrari’s guidance has been repeatedly way below its actual results. Just as an example, 2022’s sales guidance was €4.8B, and actual results came out at €5.1B. I base my much more optimistic projections on the huge demand for Ferrari’s new models, specifically the four-door Purosangue and the yet-to-be-revealed electric car, which will lead the company to increase prices. In addition, I project the SCB segment will see accelerated growth due to the success of Formula 1 and the new sponsorship deals.

I project EBITDA margins to increase incrementally to 40.3% due to higher prices, lower material costs, and a growing portion of high-margin revenues from sponsorships. This is at the high end of the EBITDA margin guidance management provided for 2026.

Overall, my assumptions result in EBITDA growth which is slightly faster than revenue growth, reflecting operating leverage and product & price mix.

Taking a WACC of 7.25%, I estimate Ferrari’s fair value at €52.6B or $305.9 per (RACE) share, which represents a 12.5% upside compared to the market value on the day of writing. While this does represent a high EV / EBITDA multiple on 2023 EBITDA (24.7), I believe Ferrari is one of those companies you’ll probably never find at a reasonable valuation due to the quality of its growth drivers, and the stability it provides.

In order to check the reasonability of my DCF model, I assigned a 37.5 P/E multiple, which is slightly below the 5Yr median, on my projected 2025 EPS of €7.75. This brings me to a fair value of $308.0 per share, slightly higher than my DCF valuation.

Overall, I do believe Ferrari looks overvalued on paper. However, I believe its quality is extremely unique. Therefore, I feel comfortable with the higher valuation and rate the stock as a Buy.

Let me be clear, there could (and probably would) be drawdowns in the stock, especially as it’s trading at such high multiples. Yet, in the long term, I believe today’s price would be justified and patient investors will be rewarded. On the contrary, waiting for the stock to contract could be a frustrating endeavor, as positive news continues to stack.

Near-Term Projections

In the near term, I believe the consensus is slightly off. For some reason, Ferrari does not get enough credit for constantly beating its own guidance and market expectations, which the company has done every year since it went public, except once. While management is guiding for revenues of €5.7B at the high point, I project Ferrari is going to beat its guidance once again. Specifically, I forecast 2023 revenues of €5.8B (€100M above guidance), and Q1-23 revenues of €1.4B. My EBIT forecast for the year is €1.5B, in line with management’s guidance. My forecast is mainly based on historical seasonality, using Q4-22 and Q1-22 as a baseline, and my assumption margins will improve gradually throughout the year. After the company’s May earnings release, we’ll find out who came closer to actual results, and I’ll update my model accordingly.

Risks

The most obvious risk when it comes to Ferrari is valuation. Even though I find the company to be trading slightly below its fair value, it is still trading for a P/E multiple of 40.4, which is more than twice as high as the S&P 500. This means there are very high expectations from the company, and even good results won’t be enough to justify its price. Investors are expecting no less than great results, which are far above the management’s guidance. While I firmly believe Ferrari can deliver on these expectations, this is still a risk nonetheless.

Another risk regarding Ferrari is that its management will not control supply correctly and damage the brand. As an extremely exclusive product, greedy management with a short-term sight could decide to significantly increase deliveries and hurt the brand’s reputation. I find the current management to understand that balance very well:

What I can tell you is that for us, what is important is that we [stay] always unique and we keep always exclusivity for our cars. What our founder said – we want to sell always 1 car less than the market demands, was true, is true, and will be true. So concentration is happening. Yes, it’s up to us what we are doing to manage properly the demand to keep it always exclusive

— Benedetto Vigna – CEO & Executive Director, FY22 Earnings Call

The last risk I would address is an increase in labor costs. Some of Ferrari’s workers are unionized, and it was published that the Italian unions are requesting a wage increase of 8.0%. Ferrari’s management said its guidance is reflective of what they think will be the probable increase, however, negotiation is still ongoing. In my view, this risk isn’t material, as we’ve already established Ferrari has very strong pricing power. I believe the company is more than capable to maintain its margins through price increases, if necessary.

Just as a cleanup, Ferrari has a really low net debt, with 0.8X net debt to EBITDA. So leverage is not an issue.

Conclusion

Ferrari is a member of a very unique group of companies, as it is able to fully control the number of products it sells. Its order books are filled well into the future, and its management has demonstrated a great understanding of Ferrari’s brand value. The company signed major sponsorship deals and is well-positioned to ride the rising popularity of Formula 1. While it may seem overvalued on paper, qualitatively, Ferrari is in a league of its own. Therefore, I rate Ferrari as a Buy, with a fair value of $305 per share.