Ferrari Races to Record Results

We think the market has not fully appreciated

The Formula One racer and provider of high-end performance vehicles to the world’s wealthy reported second-quarter earnings per share before special items of EUR 0.55, compared with consensus of EUR 0.44 and the prior year’s EUR 0.41. Revenue and profits set record highs and, as a result of the quarter’s strong performance, management tweaked full-year guidance slightly higher for the second time this year.

The revised full-year outlook includes a slight increase in shipments and modestly higher revenue, with confirmation of EBITDA margin and net industrial debt targets. Management’s new forecast for shipments is “roughly” 8,000 versus prior guidance of “greater than” 7,900 units. Revenue guidance improved to “greater than” EUR 3.0 billion from the previous forecast of “roughly” EUR 3.0 billion. Adjusted EBITDA is expected to be “equal to or greater than” EUR 800 million while net industrial debt is “equal to or less than” EUR 730 million.

Second-quarter revenue rose 6% on a nearly 8% increase in vehicle shipments. Revenue growth was lower than volume mainly because of product cycles, as the LaFerrari and 458 Italia are at the end of their respective runs. Launches of the 488 GTB, 488 Spider, and F12tdf began to hit their strides during the quarter. LaFerrari, the flagship exotic sports car of the company with a base price of $1.3 million, reached the end of its product life cycle during the previous quarter. Pricing of the 488 GTB, 488 Spider, and F12tdf ranges between $240,000 and $500,000. Regionally, Europe, the Middle East and Africa contributed the largest year-over-year increase, with volume and revenue catapulting 24% and 28%, respectively, owing to the 488 and the F12 introductions.

Profitability expanded during the quarter, with the EBIT margin reaching 19.3%, a whopping 310 basis points higher than the second quarter of 2015. Excluding the negative effect of currency hedging, the margin would have been 21.5%. We estimate earnings per share would have been better than EUR 0.60 excluding currency hedging. The company attributed the expanded profitability (the 10-year historical median EBIT margin is 15.4%) to higher volume along with an improved contribution from the sponsorship, commercial, and brand segment.

Revenue and Economic Returns Are Stable Ferrari's heritage originates from the engineering, manufacturing, and fielding of race cars since Enzo Ferrari first 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 annually averaged 9% 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 expect the high-net-worth individual population to grow 9% annually in the next five years.

While the information is not pro forma and comes from the segment reporting sections of Fiat SpA and Fiat Chrysler Automobile NV 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 16.2%.

Strong Brand Digs Wide Moat 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 that are commensurate with luxury goods companies and that support Ferrari's wide moat rating.

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, with only 39 produced, but also rare in the sense that 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. The track-only FXX K has a price tag of roughly $3.0 million, and the 40 copies made sold out before the model was introduced to the public in December 2014 and 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 the world of Formula One racing, the Ferrari name is synonymous with technologically advanced powertrains, a nearly insurmountable winning record, and a rich heritage that predates the inaugural Formula One World Drivers’ Championship 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. These 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 its 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 continually 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 pricing power and Ferrari's economic moat.

R&D Required to Stay in Front 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, the strength of the brand and hence substantial pricing power would be at risk if the company were to overproduce to the extent that the aura of exclusivity was lost.

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 F1 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 F1 racing team.