Ferrari: The Long-Term Opportunity at this Former Spin-Off

Summary:

  • Sadly, Ferrari’s excellent CEO Sergio Marchionne has been replaced due to health issues.
  • Despite Marchionne leaving, the company remains a case study in effective brand management with their low volume strategy while fostering a culture of enthusiasm, yet exclusiveness.
  • If management can execute their ambitious strategy, then this unique business has the opportunity to double profits over the next few years.

The New CEO

Ferrari’s new CEO is Louis Camilleri, the former Chairman and CEO of Phillip Morris International and current Ferrari board member where he was the Chairman of the Compensation Committee. Camilleri is an interesting choice to become CEO. He has never worked in the automotive or luxury goods industry and spent his entire career at Altria/Phillip Morris where he held a number of roles since joining in 1978.

His lack of experience within the automotive and luxury goods industries is clearly a negative and could represent a risk to achieving the previously communicated long-term financial targets that Sergio Marchionne (who engineered the carve-out from Fiat Chrysler was set on achieving. However, Camilleri makes up for his lack of experience in these areas with his deep expertise in running complex global organizations.

This recent development clouds the short-term view of the business and raises many questions. While the long-term opportunity remains bright (which we analyze below), the current valuation is pricing in significant revenue growth and margin expansion, which will take years to come to fruition.

Nevertheless, Ferrari is a crown jewel, orphan spin-off meaning that there are few if any, comparable companies like it in the world and accordingly it deserves a premium valuation. However, too many factors need to go right for Ferrari to justify today’s valuation and we prefer to build out our knowledge on the company now so that we can be opportunistic later.

The Long-Term Investment Opportunity

The performance over the past couple of years has been outstanding and the business will continue to benefit from a handful of company-specific and macro drivers over the coming years, regardless of the CEO.

Company-Specific Drivers

The first is pricing power. Price is no object to Ferrari customers. They don’t shop around and play one dealer off another because after all, a Ferrari is a Ferrari. For example, to celebrate the 60th year of selling cars in America, Ferrari made a special model, the F60 America. The reported cost of the car was around $2.5 million or nearly 8x the price of the Ferrari F12 Berlinetta, the car upon which the F60 America was based. That’s quite a premium for just redesigned doors and nose.

How did the car’s sales do? Ferrari only produced 10 cars and they were sold out before the car was even announced. There are examples like this all over Ferrari’s model line-up. Ferrari can continue to increase prices over time due to their low volume strategy that always ensures demand outstrips volume. There are very few brands in the world that have this dynamic and will ever have the opportunities created by Ferrari’s extreme exclusivity.

Secondly, there is a large opportunity to increase the bottom line. Management is targeting adjusted EBITDA of €2 billion and industrial free cash flow of €1.2 billion by 2022. If they hit these targets, they will roughly double the business’s profits over the next four years off 2017 levels. Importantly, they plan to achieve these targets by not doubling volume, but by improving the sales mix and operating efficiencies to drive best-in-class margins.

The profitability of any individual car depends on engine size, exclusivity of the offering, the content on the car, and geographic region sold. As Ferrari shifts their mix towards cars that are more profitable, the financial results will undoubtedly follow. If this strategy works out, it will result in EBITDA margins improving to above 36% from ~30% in 2017 and an upper teens bottom line growth rate.

Macro Driver

Global economic growth continues to make the world wealthier and wealthier. This is particularly evident in emerging markets where the greatest gains are currently being made and will continue to be made in the coming years. To get a sense for the magnitude of the opportunity for the growth in per capita income, we can look at the very strong relationship between per capita income and internet access. Only around 35% of Africa and 48% of Asia have access to the internet.

Over the coming decade that penetration rate will continue to increase, which is a massive driver of global wealth creation because those two continents make up around 70% of the world’s population. As per capita income increase, basic needs are met, and significant wealth is created, those geographies will drive demand for high-performance luxury Ferraris for decades to come.

Overall, investors have the opportunity to purchase one of the most unique businesses in the world. Ferrari generates a spectacular economic profile with best in class margins and returns on invested capital along with the opportunity to grow profits at a high teens rate over the next three to four years. While it is difficult to think of many companies that have the same unique characteristics and investors should pay a premium price for this business, the current valuation is simply too rich. However, investors should build up and continue to expand their knowledge base on the company in order to be ready when an attractive opportunity arises.

Business Analysis

Nearly everyone is familiar with Ferrari, the premier luxury high-performance car manufacturer that was a 2015 spin-off from Fiat Chrysler. However, what makes Ferrari very interesting is their approach to managing the brand and business. To understand where Ferrari is today and where it might go in the future, it is important to understand the history.

Ferrari was founded by an Alfa Romeo driver named Enzo Ferrari in the late 1930s when he left to set up his own company. Eventually, that company evolved into Ferrari and they produced their first racing car in 1947. Ferrari carries this racing legacy with it today as they continue to have one of the most successful Formula 1 racing teams. They utilize this racing heritage and know-how developed through designing F1 cars to design best-in-class luxury performance vehicles that continually push the barriers and foster a community of loyal customers and enthusiasts.

A Luxury Goods Company

While Ferrari is one of the most recognized car brands in the market, they operate the business more like a luxury goods company than an automotive car manufacturer. The management team focuses on performance, aesthetics, quality, and brand. However, a major difference between Ferrari and other luxury goods companies is that Ferrari has a low volume strategy and drives demand for their products through new product launches.

This creates a sense of excitement and exclusivity unlike any other mass-market car manufacturer or luxury goods company and can help drive consistent performance through economic cycles. This results in the attractive financial profile you see below.

Brand Management Case Study

Ferrari is the perfect case study on effective brand management. They maintain low volume relative to demand, which results in waiting lists for their cars. This allows Ferrari to maintain a reputation for exclusivity and client service while allowing for significant pricing power.

Their product introductions and model retirements are very structured. At any given time, they offer around eight different models. Currently, they have six range models, one special series, and one limited edition model. The range models typically have a lifecycle of four to five years, while the special series, supercars and limited-edition cars typically have shorter lifecycles. You can see in the chart below their models in any given year back to 2004.

For 2017, they shipped a total of roughly 8,400 cars of which about 70% fit into the Sports segment and 30% fit in the GT segment.

Very few companies can manage the business this way. It takes decades to build this type of brand and Ferrari has a handful of programs to continue to foster brand loyalty and enthusiasm. These programs are working as evidenced by more than 65% of new cars sales for 2017 to existing Ferrari owners. By buying a Ferrari, you become part of a select global community. Ferrari organizes events at their facilities in Maranello, Italy and around the world.

These events range from factory visits where you can customize your car to invitations to model launch events. Also, Ferrari hosts a variety of driving events that allow customers to experience driving a Ferrari on some of the most famous tracks around the world. All these different programs build the brand value through making Ferrari owners feel like they are part of an exclusive club. This enthusiasm for the brand allows demand to continually outstrip shipment volume and gives the company significant pricing power.

Industry Analysis:

Ferrari competes in the luxury performance segment of the auto industry. They have a ~20% share of this overall market, which is comprised of a ~22% market share in the sports car segment and a ~16% market share in the GT segment. Unlike the mass market auto industry, market share isn’t as important as a metric because it moves around based on product launches by the individual brands.

The luxury performance car market is fairly concentrated with a handful of companies making up the majority of the industry. Interestingly, there are only a few companies that exclusively manufacture high performance, luxury vehicles while the remainder of the competition is one-off models from more mass-market car manufacturers. This speaks to the difficulty it takes over decades and decades to build a brand worthy of commanding a vehicle price tag that can run into the millions of dollars.

In the sports car segment, their main competitors are Lamborghini, McLaren,Ford (GT), Honda (NSX), Porsche, Mercedes (SL 63/65 AMG), Aston Martin, and Audi (R8). In the GT segment, their main competitors are Rolls-Royce, Bentley, Aston Martin, and Mercedes (S Coupe and Convertible 63/65 AMG, AMG ATC Coupe and Spider and AMG GTR).

These players compete mainly on performance, novelty, and brand strength as well as the ability to renew product offerings to stimulate demand. The total cost of ownership is another important factor when assessing the competitive environment. A manufacturer that has cultivated a brand built around exclusivity and excellence will have cars that better retain their value over time. This lowers the total cost of ownership for the customer and encourages repeat purchases.

Spin-Off from Fiat Chrysler:

Fiat had a long history of owning Ferrari. They originally acquired a 50% stake in Ferrari in 1969 and increased their stake to 90% after Enzo Ferrari’s death in 1988. The remaining 10% was owned by Enzo Ferrari’s son, Piero Ferrari, who still owns that 10% today.

Fiat Chrysler’s traditional ownership structure changed when Ferrari was carved-out from Fiat Chrysler on October 21st, 2015 through the IPO of 10% of the business. This was followed by the distribution Fiat Chrysler’s remaining 80% ownership through a pro rata distribution on January 3rd, 2016.

Ferrari was a crown jewel buried within the large automotive conglomerate and has clearly benefited from the separation. The performance over the last couple of years has simply been fantastic. Revenue has compounded at over 9% per year, operating income has grown at 28% per year (margins up over 600 bps), and they have reduced debt by over €450 million.

Risks:

Like any business, Ferrari does carry its share of different risks.

Brand Image And Reputation

Ferrari’s brand, built up over decades from its racing heritage, is the company’s most important asset. As a result, factors that diminish the brand are the biggest risk to the company.

  • Performance of the Scuderia Ferrari Formula 1 racing team. If the team is unable to perform at a high level and consistently have top finishes, then it will hurt the perception of Ferrari’s brand – especially since this is the main form of marketing to the general population.
  • They must keep up with technological advances. If they don’t have top-of-the-line performance vehicles, then the perceived brand value will diminish and customers could question if Ferrari’s best days are behind them and scoff at the price tag.
  • They need to continue to cultivate passion within the automobile collector and enthusiast community. This enthusiasm keeps the waitlist long and residual prices high.
Macro

To some extent, Ferrari’s business is driven by the demand for luxury goods, which is susceptible to economic conditions. However, the Global Personal Luxury Goods Market has historically outpaced Global GDP over the long term.

Furthermore, Ferrari’s core customers are in the super-affluent category, which further insulates them from drastic swings in the business. This is illustrated in the chart below. Ferrari’s volumes dipped during the global financial crisis but were much more stable than the Luxury Performance Car Industry as a whole. This is consistent with Ferrari’s low volume strategy, which creates waitlists and smooths out shipments over time regardless of the economic climate.

Rely On A Small Number Of Car Models

The mass market auto manufacturers have many different models diversified across cars, crossovers, SUVs, trucks, and vans. However, Ferrari depends on around 8 different models at any given time. For instance, their business today relies on the sales of 6 range models, 1 special series, and 1 limited edition supercar. This means that any “miss” with a particular model can have a huge impact on the overall business.

Concentrated Manufacturing Assets

They assemble all their cars at their production facility in Maranello, Italy and manufacture all their car chassis in a nearby facility in Modena, Italy. Not only are their manufacturing assets concentrated in these two nearby towns, but these towns are located in a region known for seismic activity. Any disruption to these assets will cause production delays and non-trivial impacts to the business.

Conclusion:

Ferrari is a crown jewel asset with few if any, comparable companies like it in the world and accordingly deserves a premium valuation. However, Ferrari needs flawless execution in order to justify today’s valuation.

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2018-10-18T12:42:44+00:00