Ferrari: The Stock May Decline But I Am Optimistic

Summary

• Ferrari announced that it expects to increase its target market by offering a larger product range.
• With more cars in the market, customers may not perceive the brand as exclusive. As a result, they may not be willing to acquire that many cars.
• I used a WACC of 7.5%. With a lower EV/FCF and exit multiple of 78.5x, the implied fair price would equal $175.
• With that, if the engineers successfully develop electric cars that can compete with the new models from the United States and China, sales will most likely spike.
• I am also quite optimistic about the new hybrid engines included in the new SF90 Stradale and SF90 Spider. The new electric engine technology that RACE is preparing could dramatically change the driving experience.

cagkansayin/iStock via Getty Images

Ferrari (NYSE:RACE) is not only launching many new models in the coming years, management is also designing electric vehicles. In my view, with sufficient marketing efforts and a growing number of independent collectors, the exclusivity of RACE’s brand will not disappear. In the best-case scenario, I believe that the fair price could be worth $500. There are some downside risks because the company may be producing too many units. With that, in my view, future free cash flow justifies a position in the company. I am buying.

RACE Is Signing Another Record Year

Headquartered in Maranello, Italy, Ferrari is a luxury sports car manufacturer signing some of its best years in history.

In the last quarterly report, RACE reported 19% sales growth q/q, and management also upgraded its guidance. The company appears to be receiving a significant amount of demand from China and the United States:

Source: Q3 Quarterly Presentation

In Q3 2021, the total number of shipments increased by 18.9% q/q. Business divisions in Mainland China, Hong Kong, and Taiwan reported 109.2% increase in shipments. I believe that the good numbers will continue in the near future.

Source: Q3 Quarterly Presentation

If RACE Continues To Monitor The Number Of Cars And Generates A Community Of Collectors, The Fair Price Could Go To Up To $349

RACE’s financial performance is strongly influenced by the recognition of the company’s brand. Under this case scenario, I expect that management will successfully offer superior design, quality, and performance than other competitors. Besides, I expect that marketing professionals inside the organization will continue to organize promotional activities that will contribute to the company’s image of exclusivity. Under these assumptions, from 2021 to 2025, I expect revenue growth to stand at around 9%-22%:

Revenue Growth

Source: Author's calculations

It will be also be very critical for revenue generation that management creates a connection between the brand and its clients. I mean that RACE’s brand will be strong if there is a strong community of automotive collectors and fans. Management successfully generated a community in the past, so I don’t see why they wouldn’t do it in the future. In this regard, let’s note that RACE studies very carefully the number of cars produced and the number of collectors in the secondary market. The brand will remain exclusive only if the number of cars out there is not that elevated:

The increase in the number of cars we produce relative to the number of automotive collectors and purchasers in the secondary market may adversely affect our cars’ value as collectible items and in the secondary market more broadly. Source: 20-F

Notice that my numbers are not far from the guidance given by RACE in its last quarterly earnings presentation. For the year 2021, the company expects revenue to be close to $4.3 billion, which would mean 2021 sales growth of around 22%. The company’s 2021 adjusted EBITDA margin would also remain close to 24%, which is approximately the figure that I used in my DCF model:

Source: Quarterly Presentation

Revenue Growth

Source: Author's calculations

D&A/Sales

Source: Author's calculations

My assumptions include 2025 sales of $6.46 billion, 2025 EBITDA of approximately $2.46 billion, and D&A of $591 million. The changes in accounts receivables, inventories, and accounts payables are not very different from those reported by the RACE in the past. Finally, if we assume capital expenditures of $586-$898 million, the free cash flow would increase from $401 million in 2021 to $825 million in 2025:

Source: Author's calculations

RACE currently trades at more than 90x FCF, but the company used to trade at close to 500x FCF in the past. Competitors like Ford (F), Li (LI), Honda (HMC), and Toyota (TM) trade at a lower valuation. In my opinion, RACE’s brand is quite valuable, which may justify the current multiple. As shown in the image below, the peer group trades at -50x and 421x FCF. With all these numbers in mind, I decided to be very conservative, and used a multiple of 79x FCF:

Source: YCharts

If we assume a beta of 0.8-0.9x, cost of equity close to 8%-9.5%, and cost of debt around 3.3%, the implied WACC is equal to 6.3%-9%:

Source: WACC for Ferrari N.V. (RACE) | Finbox.com

As of September 30, 2021, with debt around $2.5 billion and cash worth $1.27 billion, the net debt stands at $1.31 billion. I am assuming 2022 FCF of $542 million, so I am not worried about the current amount of debt:

Source: Quarterly Presentation

Finally, with a WACC of 6.34%, an exit multiple of 79x, and a DCF model until 2025, the net present value would be equal to $1.462 billion. If we also assume 183 million shares outstanding, the fair price would be equal to $349:

Source: Author

With traders currently buying shares at $251-$271, under this case scenario, I would be expecting an upside potential of close to 31%:

Source: YCharts

RACE’s New Electric Engine Technology And New Models Could Be A Driver For Revenue

I completely agree with the words of Carlos Ghosn about the new electric cars. I also believe that Ferrari’s management would agree too:

Electric cars are not going to take the market by storm, but it’s going to be a gradual improvement. Carlos Ghosn

With the previous words in mind, I am quite optimistic about the new hybrid engines included in the new SF90 Stradale and SF90 Spider. Besides, the new electric engine technology that RACE is preparing could dramatically change the driving experience.

If the engineers successfully develop electric cars that can compete with the new models from the United States and China, sales will most likely spike. Take into account that the global electric vehicle market size is expected to grow at a CAGR of 24.3% from 2021 to 2028. Many drivers are willing to buy an electric car:

Global Electric Vehicle Market Size is Anticipated to Grow USD 1,318.22 Billion at a CAGR of 24.3%. Source: Global Electric Vehicle Market Size [2021-2028] (globenewswire.com)

That’s not all. From 2019 to 2022, the company is introducing a significant number of new models, which will most likely push sales up:

At our Capital Markets Day in September 2018, we announced our plan to introduce 15 new models in the 2019-2022 period (which is unprecedented for Ferrari over a similar time period), including the Icona limited editions, a concept that takes inspiration from our iconic cars of the past and interprets them in a modern way with innovative technology and materials. Source: 20-F

Source: Quarterly Presentation

Under the previous assumptions, I would be expecting revenue to grow from $4.33 billion in 2021 to close to $7.5 billion in 2025. We would be talking about 2025 EBITDA of $3.2. Finally, with capital expenditures of around $1.05 billion, the FCF would be close to $1.100 billion:

Source: Author's calculations

If we assume that RACE will be able to finance its operations a bit cheaper, the WACC may be lower than that in the previous case scenario. I used a WACC of 5.75%, which implied discounted FCF between $35 million and $890 million. Finally, the implied price would be close to $500. Yes, under this particular case scenario, the company looks quite cheap at its current valuation:

Source: Author's calculations

I am a bit more optimistic than most analysts out there. In my view, they don’t seem to be including the revenue generation that may be created thanks to the new electric vehicles. With that, they all seem to obtain, in their best-case scenario, a fair price that is a bit higher than the current price mark:

Source: FERRARI N.V. : Target Price Consensus and Analysts Recommendations | RACE | NL0011585146 | MarketScreener

RACE Is Producing More Cars, Which May Be Wrong

I believe that management may be playing with fire. In the last annual report, the company announced that it expects to increase its target market by offering a larger product range :

On the other hand, our current growth strategy contemplates a measured but significant increase in car sales above current levels as we target a larger customer base and modes of use, we increase our focus on GT cars, and our product portfolio evolves with a broader product range. We sold 9,119 cars in 2020 despite the effects of the COVID-19 pandemic, compared to 7,255 cars in 2014, and sales are expected to continue to increase gradually. Source: 20-F

With more cars in the market, customers may not perceive the brand as exclusive. As a result, they may not be willing to acquire that many cars, and they may not be willing to pay high prices. In this case scenario, I would be expecting revenue growth to be less significant than expected.

Under this detrimental case scenario, 2025 sales would only stand at $6.95 billion with EBITDA being close to $2 billion. Finally, the FCF would not even reach $500 million by 2025:

Source: Author's calculations

With less revenue growth than expected, both cost of debt and cost of equity would increase, which may lead to a higher WACC. With this in mind, I used a WACC of 7.5%. With a lower EV/FCF and exit multiple of 78.5x, the implied fair price would equal $175:

Source: Author's calculations

Conclusion

With RACE launching many new models from 2022 in addition to designing more electric vehicles, I would expect revenue growth to increase. If management also successfully grows a community of collectors and fans, the exclusivity of the brand will not disappear. Yes, there are some risks coming from the fact that RACE expects to produce more cars. With that, I believe that the upside potential is not significant than the downside risk. I will be buying shares at the current price mark.

Analyst’s Disclosure: I/we have a beneficial long position in the shares of RACE either through stock ownership, options, or other derivatives. 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.