Ferrari's Premium Valuation Explained

In this article, I will try to explain why Ferrari N.V. (NYSE:RACE) has a very rich valuation and why long-term investors should not fear it.

The Company's Expensiveness Explained

Founded in 1947 and headquartered in Maranello, Italy, Ferrari N.V. is a $59-billion market cap company that specializes in the design, engineering, production, and sale of luxury performance sports cars worldwide. They offer a variety of car models, including range, special series, Icona, and supercars, as well as limited edition and one-off cars.

Additionally, they provide racing cars, spare parts, engines, and various after-sales services such as repairs, maintenance, and restoration. The Ferrari brand is also licensed to other luxury and lifestyle goods producers and retailers. The company operates museums, restaurants, and theme parks related to the Ferrari brand. They offer finance and leasing services, manage racetracks, develop and sell apparel and accessories, and operate both franchised and owned Ferrari stores. The company distributes its products through authorized dealerships and its website.

Despite seemingly hard macro conditions, Ferrari announced excellent results for Q1 FY23, with double-digit growth and record-breaking levels in some main financial indicators. They saw a 9.7% YoY increase in total shipments, reaching 3,567 units compared to the same period in FY2021. Net revenues rose by 20.5%, totaling €1,429 million. Ferrari's adjusted EBITDA increased by 27% to €537 million, resulting in an impressive EBITDA margin of 37.32%. Adjusted EBIT showed a growth of 25.3%, reaching €385 million, with an adj. EBIT margin of 26.75%. Net profit amounted to €287 million [NI margin = 24.26%], and diluted adj. EPS stood at €1.62 [+25.58% YoY].

As far as I can tell, Ferrari is actively building up lost sales in Europe by increasing deliveries in high-growth markets - especially Asia and North America, where demand for Ferrari's hybrid cars is soaring:

The Ferrari brand is proving to be more resilient than ever in the current period of deteriorating macroeconomic conditions in the world. Seemingly the management team is targeting affluent customers who have a more stable purchasing power enabling RACE to sustain sales even during a recession. Generally, luxury products offer a perceived value of exceptional quality and craftsmanship, providing a sense of longevity and durability that consumers seek in uncertain times - perhaps this is the explanation for the margin strength of RACE's business despite macro headwinds.

Ferrari's management is doing a great job in employing various strategies to leverage the increasing customer demand. First off, as it follows from the Q1 FY23 press release, they introduced a new organizational structure focused on nurturing the brand's exclusivity, enhancing product excellence, and aiming for carbon neutrality by 2030. This should allow the company to keep up with the general EV trend and maintain its reputation in developed countries (and not only).

So the first reason for the very high valuation of the company is the maintenance of high margins compared to other car manufacturers against the background of a general decline in the industry:

If you visit the company's official IR website, you will find a wealth of reports on how and in what quantity the firm buys back its shares on the open market. This is the second reason for the widening of the multiple, which helps the stock to rise despite the already high valuation metrics.

Ultimately, I think investors assess RACE's current margins and compare them to the rapidly declining industry averages. Based on this analysis, they conclude that the RACE stock warrants a significant premium over the industry because its margins expand, not contract. Additionally, the management's commitment to maintaining a favorable return policy for shareholders further strengthens this perspective.

Aside from the fact that RACE's margin appears to be the most stable in the industry, its forwarding growth rates also promise excellent expansion (especially given the size of the firm). Looking at how the Asia and Americas regions have saved Ferrari in recent months, I am willing to believe that these forecast values may actually be a bit understated as the European customers will be willing to come back at some point in time.

So What's Next For RACE?

I recently came across forecasts from Morgan Stanley analysts [proprietary source] regarding RACE's EPS figures for FY2023 and FY2024 - both of them are higher than the consensus.

However, according to Seeking Alpha Premium, the consensus numbers are a bit higher today - time is passing quickly, and it looks like the most recent EPS revisions have lifted consensus a bit in the last month.

The market is forecasting a multiple contraction - and that is very good. It would be strange if we saw anything else. However, as history shows, it is not wise for investors to worry too much about the stock's momentum. Take, for example, the period when the multiple was declining - from 2H 2018 to 2H 2020 it fell by 6.26%. In the same period, the share rose by over 10%:

Of course, at some point when multiples fell >25%, the stock also corrected sharply. But during the recovery, the stock price rose faster - the company continued to buy shares from the market, and given the company's relative unpopularity in the auto market - compared to Tesla (TSLA) or even Ford (F) - the supply dried up quickly and the stock grew higher and higher on that imbalance.

Right now, the FY 2023 P/E multiple [46.12x] is holding at its local high - I assume it will stay at about the same level a year from now given the unstoppable share buybacks. If RACE earns $8.22 per share under this assumption (the current consensus estimate), then the stock should trade at $379 per share. This calculation gives an upside potential of ~15.3%.

The Bottom Line

RACE is a strong stock because of its momentum, but beyond that, the unidirectional bull move is supported by strong margins and rapid business expansion. All this is happening against the backdrop of a general downward trend in the industry, which can only please Ferrari shareholders.

However, the upside potential I calculated [~15%] seems quite low given the numerous risks surrounding the stock.

First, even if we get why the premium in valuation exists, we should note that the main growth in the stock has been in recent years. Before that, there were clearly long periods of consolidation that lasted several months. Therefore, from a historical perspective, we cannot say that RACE's price is currently protected from a downside.

Second, the automotive market is very competitive. Ferrari has a strong brand and actively uses it - a kind of LVMH Moët Hennessy (OTCPK:LVMHF) among car makers. But demand for such goods is not always sustainable - who knows how high-income customers will react when the current central banks' tightening cycle starts to have a really negative impact on companies' earnings.

Given these risks and against the background of a relatively low upside potential of only 15%, I am issuing a hold recommendation for RACE stock this time.

Thanks for reading!