Ferrari NV (NYSE:RACE) is known worldwide for its iconic cars. This strong brand power means demand is consistently very high in a market that is able to pay a premium for its products, leading to very interesting financials, strong growth prospects and high margins.
But this does not come for free. There is a very high premium on Ferrari's stock with price-earnings and price-to-free cash flow multiples well above its peers. So it is necessary to be highly cautious and consider whether this premium is really adequate and can eventually be converted into a return.
Exclusive business model drives demandThere is no doubt Ferrari cars are very premium and focused on a high-income customer base, but exclusivity goes beyond what many people think. There are often certain requirements beyond having the money to buy one of its vehicles. It is possible, for example, that some kind of history of ownership or similar criteria is required for the buyer to be accepted.
This has a direct impact on supply and demand. In addition to demand already being high due to the coveted brand, this restriction on supply makes the relationship much better for the company, increasing exclusivity and being able to charge more for the cars. A car like the Ferrari 296 GTS - which was one of the models that drove second-quarter revenue - can be found for over $600,000. In addition to this price already supporting a decent margin, it is possible to imagine that in future similar launches, the company will be able to pass on the cost and inflation easily, since for its target audience and with the strong demand for its products, an increase of around 10% would still be viable, characterizing it as a product with low elasticity of demand.
This also creates predictability. In its second-quarter earnings, the company mentioned the order book is well into 2026, sustained by the 12Cilindri family order intake. In other words, as there are order books, high demand and few units sold of a series of cars, it is easier to trust that the company will continue to be a compounder in the coming years. Additionally, it is easy to trust the company's guidance. In the second quarter, the guidance for 2024 was revised upwards, from an expected net revenue of 6.40 billion euros ($7.09 billion) to 6.55 billion euros, in addition to an improved adjusted Ebit margin, which was raised from 27% to 27.50%. Justifications for this revision include a better product mix, stronger customizations, racing activities and more.
The e-building project also illustrates how Ferrari is an innovative company with very interesting prospects for the future. This building is focused on technological concepts, with flexible production and the ability to produce internal combustion engine, hybrid and fully electric models, as well as improvements in development. In other words, as well as increasing flexibility and focusing on ESG initiatives (mainly the environment), it is a positive thing as it shows how Ferrari plans to maintain its competitive edge through technology, innovation and remaining relevant in trends such as high-voltage batteries and electric motors.
Exceptional margins reflect financial strengthThese moats and the efficient business model reflect directly on the company's financials. In the second quarter, shipments increased by 2.70% to 3,484 units. Even though the number of shipments seems low, the company managed to achieve net revenue of 1.70 billion euros, up 16.20% year over year given the better mix and better prices in the period. The longer history is also positive, showing us a gradual evolution in net revenue and margin gains (despite seasonal fluctuations).
The company's Ebit margin was 30.20%, compared to a margin of 28.70% in the prior-year period, driven mainly by the better mix and prices mentioned, such as in the sales of the Daytona SP3 and 499P Modificata, as well as a better geographic mix driven by the Americas, greatly offsetting the increases in industrial costs and research and development. Not only is its Ebit margin robust, but so is its net income margin. In fact, the net margin is so high that it ends up being higher than the gross margin of traditional players. While Ford Motor Co.'s (NYSE:NYSE:F) gross margin is around 8% and General Motors Co.'s (NYSE:NYSE:GM) is about 11.70%, Ferrari's net margin reaches 24%. By way of comparison, its gross margin is almost 50%, a very high level for an automotive company.
Other profitability indicators, such as return on equity and return on invested capital, are also high and exceed 20%, giving the company a profitability rank of 10 out of 10.
Ferrari's capital structure is also comfortable. The company has a gross debt of 3.10 billion euros, which drops to 1.79 billion euros after taking into account the 1.33 billion euros in cash and equivalents. As a result, its leverage (net debt/ adj. Ebitda) stands at 0.70, allowing cash generation to be distributed to shareholders in the form of dividends and buybacks.
Despite this, cash conversion is one of the weak points of the financial analysis. The second-quarter adjusted Ebitda was 659 million euros, but after capital expenditures, working capital, interest and taxes, the free cash flow was 121 million euros, but maintaining a high remuneration to the shareholders, divided between 440 million euros in dividends and 148 million euros in buybacks.
Source: Ferrari's second-quarter presentation
Premium valuation limits stock appealWhile Ferrari has one of the widest moats in the automotive industry and is a compelling company because of it, its stock is unattractive due to the size of the premium to justify these competitive advantages. Even with 440 million euros in dividends paid out in the quarter, that gives us a dividend yield of 0.50% based on a market cap of over 79 billion euros.
One factor that clearly illustrates that Ferrari shares are not trading at low levels is the comparison with the rest of the industry. At times, such as in early 2023, the stock was trading at a forward price-earnings ratio above Tesla Inc. (NASDAQ:TSLA), which still has very aggressive prospects and options such as Robotaxi that Ferrari doesn't have. Ferrari's forward price-earnings currently stands at 54, while that of companies such as Toyota Motor Corp. (NYSE:TM), Ford and General Motors are below 10.
Of course, Ferrari deserves to be traded at a level above the traditional players in the sector. But with a multiple of 54 times earnings over the next 12 months, it is hard to justify a scenario where the company would be cheap or even at fair value.
For the company to only be trading close to its fair price (which means there is a low margin of safety) based on a discounted cash flow model, it would be necessary to believe its free cash flow will grow at a rate above 20% for the next two decades. This scenario is even probable, given that Ferrari has the efficiency to continue capturing high demand for its products and very high ROIC and ROE, but it ends up being a level where even if this positive scenario materializes, there is little to be gained year over year with the stock. In other words, Ferrari's valuation appears too stretched for a value investor.
Final thoughtsIt is clear that Ferrari is an incredible company with solid competitive advantages and no comparison with other players in the automotive industry. With its brand power, the company suffers almost nothing from relevant concerns in the sector, such as macroeconomic pressures and competition.
Therefore, it is undeniable the company deserves a premium on its valuation compared to its peers. The debatable point is how much of a premium this should be. In my opinion, the price of the stock is at a point where the margin of safety is so low that it does not justify investing for the time being, and greater caution is also needed in this area. Even so, it is one of the most interesting stocks in this sector to have on your radar.
This content was originally published on Gurufocus.com
