Ferrari: Racing To The Finish Line (Part 1)

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About: Ferrari N.V. (RACE)
by: The Profit Hunter
Summary

Ferrari reported encouraging FY2018 results and fundamentals remain supportive.

In this 2-part report we chart Ferrari’s illustrious history and how the company may fare following the recent spin-off from Fiat.

Whilst categorised as an auto OEM, I believe the company should really be perceived as a luxury goods maker.

Although the shared trade is c. 30x 2019 earnings and the stock is by no means misunderstood, there are a range of value drivers which support upside potential.

An Iconic Brand

Ferrari (RACE) is a luxury car manufacturer which produces the Ferrari branded automobile, a genuinely scarce product and among the most iconic and instantly recognisable in the world. As an indication, in 2018 only 9,251 Ferraris were shipped. The group’s end-market is driven by the growth and spending power of the world’s high net worth community. Clearly, Ferrari is not completely immune to the vagaries of the economic cycle. However, over the last few years the luxury market experienced a dramatic shift in the manner in which business was traditionally conducted. This is to say, much of the world’s wealth has been concentrated in the United States, Europe and Japan. The retail locations of most luxury goods manufacturers have been positioned rather logically in these regions. Yet, the embracement of capitalistic economic policies has dramatically improved the standard of living in certain Asian countries such as India and China. That these populations combined are eight times larger than the United States provides the luxury goods industry with many years, perhaps even decades, of growth opportunities that never before existed.

Management is certainly aware of the enormous creation of wealth that is occurring. The company has been expanding rather aggressively its Asian dealer network in order to increase its dominant position. Dealers are trained through the Ferrari Academy for sales, after-sales and technical activities. Core areas of focus have been Hong Kong and Mainland China where the expenditure on luxury content per high net worth individual is estimated at around four times that of a Western high net worth individual. The company’s aggressive plans for expansion in the Asia-Pacific clearly coincide with the wealth that is being accumulated by the Chinese population.

The company tends to sell cars to a different demographic than other auto producers. The cheapest model was priced at $188,425 in 2016, with the highest-priced (ex-limited edition) running in the $400,000 range. Of significance and testament to the coveted nature of the brand, Ferraris have tended to sell for large premiums at auction and comprise nine of the top ten most valuable vehicles ever auctioned. A 1957 Ferrari 335S, driven to victory at the 1958 Cuban Grand Prix by Stirling Moss, achieved a sale price of $35.7 million at the Artcurial Motorcars auction held at Retromobile in Paris on February 5, 2016.

Ferrari trades at 30.3x forward estimate of 2019 fiscal year earnings, which clearly indicates the company’s merits are by no means misunderstood by the market. However, the product manufactured is truly scarce which yields tremendous pricing power. Perhaps, the only quoted luxury goods producer comparable in terms of quality and scarcity of product is Hermes (OTCPK:HESAY), which is best known for manufacturing the Birkin line of handbags. These handbags sell for in excess of £7,000 in skins from ostrich to crocodile. Top-of-the-range models may be priced at upwards of £35,000. Hermes trades on 37.6x earnings, or over 20% dearer than Ferrari. If the dramatic shift in the concentration of wealth in the World continues and Ferrari is able to strategically distribute in the appropriate regions, the company’s earnings have an enormous growth component that will be limited not by demand, but by management’s judicious rationing of supply.

Ferrari’s Illustrious History

Born in Modena in 1898, Enzo Ferrari discovered the irresistible allure of motor racing as a young boy commencing his career as a racer in the 1920s. He established Scuderia Ferrari in 1929 to race Alfa Romeo cars. He then moved on in 1939 to set up his own company, Auto Avio Costruzioni with headquarters in Maranello in 1943, where the majority of its employees are still located. In 1947, the first racing car (125 S) was developed and 1950 brought the launch of its first road car, Ferrari 166 Inter. In 1969 the company partnered with Fiat Group (NYSE:FCAU), which acquired a 50% stake. At the time the Group began entering into F-1 sponsorship agreements and in 1977 acquired Carrozzeria Scaglietti following a 26-year collaboration for the production and assembly of all cars’ chassis. Founder Enzo Ferrari passed away in 1988 which led Fiat Group to increase its interest in the company to 90% with the remaining 10% held by Piero Ferrari, Enzo’s son.

In 1997, Ferrari acquired ownership of Maserati from Fiat and built a new Maserati-dedicated engine factory in Maranello. Over the next few years the company internationalised its operations and began to distribute into the Middle East, Japan and China whilst consolidating its position in traditional markets (the US, UK and Germany). In 2002, the company began branding activities with the launch of Ferrari branded products sold in Ferrari network stores. Although Fiat Group re-acquired Maserati in 2005, Ferrari continues to supply engines for the brand. In January 2016, the company span out from Fiat and listed separately on the Borsa Italiana. The newly formed management team has significant experience within the automotive industry, although many members are still relatively new to Ferrari, including Chairman Sergio Marchionne.

Overview of Ferrari’s Operations

Ferrari is primarily known as a designer, engineer, manufacturer and distributor of luxury niche performance sports cars which are sold in over 60 markets worldwide. Vehicle and spare parts represent 71.9% of overall revenues with the balance accounted for by 1) the sale of engines to Maserati; 2) merchandising, licensing and royalty income from the brand; 3) sponsorships and commercial revenue from its Formula One racing team; and 4) interest income from Ferrari Financial Services.

Representing 14.5% of sales in 2017, Ferrari licenses its brand name to various product manufacturers for which Ferrari receives a licensing fee based on total sales. Key licensees include Oakley (eyewear); Puma (sports fashion); Microsoft (NASDAQ:MSFT), Sony (NYSE:SNE) and Electronic Arts (NASDAQ:EA) (video games); Hublot and Movado (watches); Tod’s (leather goods); and Lego and Bbuargo.

In addition to producing vehicles, Ferrari designs and manufactures engines for Maserati, primarily the V6 for the Ghibli and the V6/V8 for the Quattroporte. This accounted for 10.9% of Ferrari’s revenues in 2017 though this could increase with limited risk of brand dilution, as Maserati volumes grow and Ferrari expands its engine offerings to other OEMs.

Finally, Ferrari retains a stake in the company’s captive finance arm – Ferrari Financial Services – which was majority acquired by a joint venture between Fiat Chrysler and Credit Agricole (OTCPK:CRARY) for €18.6 million in November 2016.

Segment Analysis

Description

% of Revenue

Cars and spare parts

Revenue generated from shipments of vehicles, including personalisation income, as well as sales of spare parts. The company provides substitution of spare parts during the life of its vehicles, as well as parts to models currently out of production. Through this division, Ferrari also generates revenue through the maintenance of classic and antique cars, as well as restoration services (its “Ferrari Classiche” service), which is small financially, but huge in support of the brand.

71.9%

Engines

Ferrari produces engines for Maserati, primarily for the Ghibli and the Quattroporte. In addition, the Engines segment includes rental of Ferrari engines to other Formula 1 racing teams. The company has a multi-year agreement with Maserati to provide V6 engines (beginning in 2011) for a production run of up to 160,000 engines in aggregate through 2020 (about 17,000 units per year). Ferrari expects this may increase to 275,000 engines in total through 2023, as Maserati expands its model line-up and production volumes (38,000 units per year). We estimate its current capacity between 20,000 (one shift) and 40,000 units (two shift). If Maserati volumes expand beyond this level, Ferrari would likely have to add capacity.

10.9%

Sponsorship, Commercial and Brand

Ferrari’s Sponsorship, Commercial and Brand segment includes revenues earned by its Formula 1 team, Scuderia Ferrari, through sponsorship agreements and the company’s share of Formula 1 World Championship commercial revenues. Ferrari also generates revenues in this division through the Ferrari brand, including merchandizing, licensing and royalty income. F-1 performance is a key driver of brand marketing and technology and “losses” within the segment should be considered more as advertising expense and R&D.

14.5%

Other – Ferrari Financial Services

Minority stake retained in its captive finance arm plus revenues generated from the Mugello race track from renting to event organisers and promotional activities.

2.8%

Management is renowned for its strategy of producing and distributing vehicles in limited quantity, thereby creating extensive waiting lists and time involved in the purchase process such that demand exceeds supply. Through controlling and limiting supply, particularly of limited edition models, the vehicle’s scarcity value and demand over time are supported. The exclusivity of the brand makes the cars that much more valuable to an elite global customer base. This strategy provides management with visibility and control over future sales, enhances the luxury status of the company and provides considerable pricing power and value resilience. The company delivered just 7,225 cars in 2014 and modestly surpassed 9,000 units in 2019 roughly in line with the growth in global high net worth individuals.

Ferrari has a history of launching at least one new model every year. In the last five years the company has released the following key models.

Production by Model (2013-17)

Model

Year

Price

Limited Series Circulation

Notable owners

Ferrari Portofino

2018

$216,034

GTC4Lusso T

2017

$302,650

812 Superfast

2017

$339,020

GTC4Lusso

2016

$322,136

LaFerrari Aperta

2016

$6,000,000

209

Gordon Ramsay

F60 America

2016

$2,500,000

10

488 GTB

2015

$244,160

488 Spider

2015

$293,827

F12tdf

2015

$454,093

799

Cristiano Ronaldo

FXX K

2015

$3,000,000

40

Aaron Kwok, Joseph Chan, Frank Kanayet, Jim Clark, Chris Ruud, Jamie Davies

California T

2014

$210,000

Flo Rida, Tyga, Kevin Durant

458 Speciale A

2014

$278,787

Floyd Mayweather

LaFerrari

2014

$1,400,000

499

Justin Bieber, Floyd Mayweather, Gordon Ramsay, Ian Poulter, David Lee, Philip Shields, Paul Bailey, Khalid bin Hamad al Thani

458 Speciale

2013

$278,720

Chris Evans, David Lee

Sources: Company Reports; Ranker

Ferrari is unique in that its business is fairly resilient to fluctuations in the business cycle. During the most recent and more severe economic downturn in 2009, Ferrari’s unit volumes only declined by about 4%, revenue by 7%, and EBITDA by 12%, while the company still operated profitably. To put this in perspective, numerous companies were forced into bankruptcy during that period, including General Motors (NYSE:GM) and Chrysler, while many luxury companies experienced significant declines. Ferrari’s financial resiliency is largely a product of vehicle scarcity, where demand materially outstrips supply and provides management with considerable visibility and control over sales. This is important as the business structure is ultimately more defensive than the typical automotive manufacturer and most luxury goods companies.

In Part 2, I discuss Ferrari’s competitive advantages and product cycles; industry dynamics and valuation.


Disclosure: I am/we are long RACE. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.