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Got Ferrari fever? This could cool your engines
The euphoria over Ferrari's (NYSE: RACE) market debut could soon fade as investors get over the glamour of owning a supercar stock and recognize the issues facing the Italian company.
Ferrari shares closed up at $55 each on its first day of trade this week, giving the company a market capitalization of about $10.4 billion, from an initial public offering price of $52 a share. Overnight, the stock ended more than 3 percent higher at $56.75.
But investors are divided over whether to label the company a carmaker or a luxury brand, a choice that has consequences for Ferrari's financial metrics.
If viewed in the former category, its valuations well exceed rivals. Ferrari is trading around 33 times trailing earnings, versus 9 times for fellow luxury brand BMW (XETRA: BMW-DE), Ford's (NYSE: F) 19 times and General Motors (NYSE: GM)' 14 times.
"At the end of the day, this company makes cars. They've loaned their brand to clothing and luggage, etc, but this is a company the produces automobiles that people can drive. And with that in mind, we have no choice but to look at the profit multiples of other car companies," explained Brian Hamilton, chairman of financial analysis firm Sageworks.
"Even if we placed a brand premium on the company, their valuation still looks rich compared to peers."
That Ferrari stock is fetching a premium to automakers risks putting pressure on the company's top and bottom lines as shareholders demand greater returns in the years to come.
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"That may disturb some of the balance between supply and demand that Ferrari has very nicely maintained till date," noted Mohit Arora, Asia Pacific executive director at J.D. Power and Associates.
Arora reckons that numbers-savvy investors have been dazzled by Ferrari's reputation for providing power, performance and heritage, as well as the attendant social cache. "The IPO's success shows that people are willing to pay a significant premium for a brand that goes well beyond the company's operational realities."
On the other hand, Ferrari's metrics are more in line with luxury giants like Hermes and Brunello Cucinelli, whose price-to-earnings stand at 37 and 32 times respectively.
Experts in this camp point to Ferrari's stark discrepancies with carmakers as justification for its luxury label.
Ferrari only produces 7,000 cars a year and is worth $10 billion, while GM produces 10 million cars per year and is worth about $50 billion, pointed out James Chao, Asia Pacific director at IHS Automotive Consulting, adding that he believes the firm is a luxury performance, lifestyle brand of the highest level that has few peers when measuring brand equity.
"The price of the cars themselves and the exclusivity has made it a luxury goods company, similar to Patek Philippe. We think the economics of Ferrari at a scale production at 10,000 units is going to produce margins of 40-50 percent, which will be instructive of a luxury goods company," noted Adam Wyden, founder of ADW Capital Management.
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Valuations aside, Ferrari faces a number of other obstacles.
The emerging markets of China, Russia, Middle East and Latin America that have driven the brand's growth in recent years are no longer in healthy economic shape, with vulnerabilities likely to worsen once the U.S. Federal Reserve hikes interest rates.
China's slowing economy and a graft crackdown that has cut consumers' appetite for ostentatious displays of wealth are already hurting sales. 450 Ferraris were sold in the mainland last year, slowing from 700 in 2013 and well below the 2,500 sold in the U.S. and Europe this year, flagged Michel Dunne, president of Dunne Automotive. In 2013,
But Dunne believes President Xi Jinping's current anti-graft campaign is unlikely to last long.
"We've seen these campaigns come and go and in China, and the wealthy always emerge even wealthier, so the outlook of future [Ferrari] demand is strong," he said, adding that Chinese consumers remain committed to prestigious brands.
Meanwhile, increasing sensitivity towards the environment and fuel efficiency may leave the Italian racing house struggling to keep step with consumers' tastes while also maintaining its core values of power and performance, warned Arora.
"Keeping the performance of their cars near or above its peers will cost more research and development spend in the coming years, especially as there are increased fuel efficiency and safety regulations," echoed IHS' Chao.
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