Ferrari's Pricing Power Is in Overdrive

We think

Ferrari's heritage is in the engineering, manufacturing, and fielding of race cars since Enzo Ferrari founded Scuderia Ferrari in 1929 under Alfa Romeo ownership. Substantial pricing power, enabled by the brand and strategic scarcity, supports the ultra-exclusivity of Ferrari street cars. Pricing power also bolsters the company's ability to generate stable streams of revenue and economic returns through the business cycle.

During the past 10 years, revenue growth has averaged 9% annually while volume growth has averaged 4%, demonstrating pricing power. Management's objective is to gradually increase shipments to 9,000 units per year in 2019. If Ferrari reaches this target, annualized growth in the next five years will be 4%, the same as it was for the past 10 years. Boston Consulting Group expects annual high-net-worth individual population growth in the next five years to be 9%.

While the information is not pro forma and comes from the segment reporting sections of Fiat and Fiat Chrysler Automobile financial documents, we calculate that Ferrari's median EBITDA margin during the past 10 years is 25.8%. The only other automotive company that had matching profitability in the same time frame was Porsche at 26.3%. The next closest, BMW, was roughly 10 percentage points lower at a 16.2% EBITDA margin.

High Power, High Profits Ferrari has a wide economic moat, the source of which flows from intangible assets that include brand strength and intellectual property. The evidence of Ferrari's economic moat stems from stable growth throughout economic cycles, substantial pricing power, consistent high profitability, and a brand that captures the imagination of many around the world, but a price that only high-net-worth individuals can afford. Gross margins exceeding 50%, EBITDA margins in excess of 25%, and returns on invested capital in the upper teens to low 20s are all metrics commensurate with luxury goods companies and support our wide moat rating.

Among car enthusiasts, the mere mention of the name Ferrari conjures images of incredibly fast, highly exclusive, strikingly beautiful vehicular art. According to Motor Authority, in 2014, a 1962 Ferrari 250 GTO set the record for most expensive car ever sold at auction through the traditional bidding process. The winning bid was $34.7 million ($38.1 million including the buyer's premium). The previous record was $30.0 million paid for a 1954 Mercedes-Benz W196R race car. Also according to Motor Authority, a 1963 Ferrari 250 GTO holds the record for the most expensive car ever sold, carrying a $52.0 million price tag in a private transaction. The 250 GTO series is rare because only 39 copies were produced, but also rare because the model was made to be both a road car and a race car.

Ferrari maintains this tradition today, with the latest addition to the stable being the FXX K, a race car based on the street-legal LaFerrari. While the street-legal version sells for near $1.1 million, the track-only FXX K has a price tag of roughly $3.0 million. The only 40 copies made of the FXX K sold out before the first vehicle was even produced. Those 40 copies were offered by invitation only to existing Ferrari owners. Approximately 70% of Ferrari's 7,000 units in annual production are purchased by individuals who already own a Ferrari.

In Formula One racing, the Ferrari name is synonymous with technologically advanced powertrains, a nearly insurmountable winning record, and a rich heritage that goes back to before the inaugural F1 World Championship for Drivers in 1950. Ferrari is the only F1 racing team that actually receives payment from the league just to participate. Ferrari has won 16 constructors' titles since the prize was initiated in 1958. Constructors' titles are awarded to the maker of the chassis and the engine that scored the most points during the F1 season. Points are awarded to the drivers and the vehicles that finish up to 90% of the race distance and place 10th or higher. The next closest to Ferrari are the Williams team with nine constructors' titles and McLaren with eight.

The Formula One racing team's notoriety and technological innovation spur demand for the sale of on-road Ferrari cars. The exclusivity of the on-road exotic sports cars remains a strategic imperative for the brand image of the company. In 2014, there were 7,255 Ferraris produced to meet worldwide demand, but according to various media reports, wait times for certain models were still as long as one year and have been as long as two. With such lengthy wait times on vehicles with lofty price tags, absolutely no discounts are available, and pricing power is substantial.

Management strives to balance exclusivity with the rising demand from a growing global pool of high-net-worth individuals and with customer satisfaction. Ferrari believes that it can reasonably increase volume 4% per year through 2019 to 9,000 units while maintaining this balancing act. Restricting capacity to a level that upholds pricing power and preserves exclusivity while sustaining customer satisfaction is evidence of Ferrari's economic moat.

R&D Important for Continued Success Ferrari's success is highly dependent on the strength of the brand image and Formula One-inspired advanced powertrain technology. While we see a low probability of occurrence, if the company were to overproduce to the extent that the aura of exclusivity was lost, the strength of the brand and hence substantial pricing power would be at risk. In the past three years, Ferrari has spent roughly 15% of revenue on research and development, more than twice as much as other automotive companies. The high level of expense is directly related to the Formula One racing team and to the renewal of Ferrari's product portfolio.

While R&D will expand and contract as product cycles run their course, we expect the company to continually spend a far greater percentage of revenue on R&D than other car companies to maintain a prestigious position as a Formula One racing powertrain innovator. Ferrari's clientele perceives the racing team as a demonstration of powertrain technology, especially for Ferrari's GT road cars. Ferrari's healthy profits and economic returns would be at risk if its R&D budget were for some reason drastically cut. The same risk would arise if clientele began to perceive that powertrain technology failed to reflect that used by Ferrari's Formula One racing team.

Our fair value estimate is $50 per share and assumes a U.S. dollar/euro conversion ratio of 1.0744, annualized 6% revenue growth, margin expansion until our midcycle assumptions in the final year of five-year forecast, and an 8.7% weighted average cost of capital. Since Ferrari's financials are in euros while the stock trades in U.S. dollars on the NYSE, currency translation affects our fair value relatively significantly. For every $0.05 increase or decrease in the exchange rate, our fair value estimate rises or declines by roughly $2.30. If the euro strengthened relative to the dollar to a conversion ratio of $1.30, commensurate with historical levels, our fair value estimate would be $60.