Shares of Silicon Valley car and energy innovator Tesla (NASDAQ:TSLA) have been on quite a run. Thanks to excitement around the company's upcoming Model 3 sedan, Tesla's shares have risen about 75% over the past year.
Tesla gets a lot of attention from investors, and rightly so. But somewhat under the radar, there's another auto stock that's also been on a tear over the past year or so, and it isn't exactly a futuristic green company: Ferrari N.V. (NYSE:RACE).
It took investors a while to catch on to Ferrari -- and vice versa
It's no surprise that many investors have overlooked Ferrari, given that its history as a public company is quite short. Fiat Chrysler Automobiles (NYSE:FCAU) owned 90% of Ferrari and controlled the supercar maker for decades -- but that changed in October 2015, when FCA began selling its stake through an initial public offering.
Ferrari went public at $52 a share amid excitement around its exceptionally strong brand. But that excitement faded quickly, as investors became concerned that the company had no easy path to growth. Conservative 2016 guidance led to a sell-off that drove prices down to a low of $32.00 on Feb. 11, 2016. But since then, Ferrari's shares have been on quite a run, outpacing even Tesla's over that period:
What changed? More than anything else, what changed was the story: Investors have caught on to how Ferrari plans to generate bottom-line growth over the next few years -- and Ferrari has caught on to how to tell its story to investors.
Ferrari needed to show investors how its profits would grow
What discouraged early Ferrari investors was a simple reality: Ferrari has long limited its annual sales to preserve the exclusivity of its brand. Investors began that Ferrari sell-off in February of last year, after the company's 2016 forecast anticipated a tiny 3.3% year-over-year increase in shipments, to just 7,900 vehicles. With little growth in the forecast, investors lost interest. (That's why investors love Tesla, with its seemingly limitless growth potential.)
Ferrari was still new to this public-company thing, but management quickly caught on. CEO Sergio Marchionne pointed out that limited runs of super-high-priced Ferrari models (think seven figures) could boost profits without boosting overall sales numbers to the point of damaging the brand. And, he hinted, Ferrari could probably gradually boost its annual sales limit by a few thousand cars a year without doing damage to the brand.
As the year went on, investors saw those themes begin to play out. In the third quarter of 2016, Ferrari's net income rose 20% on a tiny 1.5% increase in shipments, thanks in large part to the limited-run (just 200) $2.1 million LaFerrari Aperta model.
Ferrari's full-year 2016 results drove the stock higher still. Ferrari's net income doubled in the fourth quarter, driving a 38% increase to 290 million euros for the full year, on just a 5% increase in vehicles sold. Its guidance for 2017 called for more profit growth: Ferrari expects adjusted EBITDA of more than 950 million euros in 2017, up from 748 million euros in 2016, on sales of about 8,400 Ferraris.
Marchionne thinks Ferrari can nudge that annual sales number up to about 10,000 over the next few years, without significant impact on its pricing -- or, put another way, while keeping supply below the level of demand.
Isn't Ferrari's stock expensive now?
We've seen that Ferrari has a plan to generate significant profit growth over the next several years, as long as demand from the world's wealthy sports-car fans remains strong. But does that make its stock a buy now?
At first glance, Ferrari's stock is far from cheap unless you're comparing it with Tesla. It's trading at a little over 33 times its 2016 earnings. That's a huge valuation for an automaker. But that's not the whole story.
Remember that Ferrari's forecast calls for substantial profit growth this year. Looked at through that lens, Ferrari's shares are trading at 27 times its expected 2017 earnings. That's still very high for an automaker -- but Marchionne has argued that traditional big automakers are the wrong comparison for Ferrari.
Remember also that Ferrari isn't just an automaker; it's also a luxury brand. On top of that, its Formula One racing team is one of the world's most widely followed sports teams. Taken together, there's an argument that Ferrari deserves a valuation more in line with established luxury brands -- despite the high fixed costs of its core automaking business.
What would that look like? Well, French luxury giant LVMH Moet Hennessy currently trades at around 28 times its 2016 earnings, while Tiffany & Company trades at just over 26 times last year's result.
Long story short: If we accept the argument that it should be valued as a luxury brand, Ferrari's current valuation is in the right range.
So is Ferrari stock a buy?
I think Ferrari might be a buy for an investor looking for an intriguing growth story that isn't an all-or-nothing bet. (I don't own it myself, but I might soon.) Ferrari will never have the upside of a moonshot stock like Tesla. But on the other hand, as a solidly profitable company with a top-drawer brand, it doesn't have nearly the risk of Tesla: Even if its growth falls short of our expectations, Ferrari will still be a very valuable company.
What about auto cycles? With the big automakers, we worry about slipping consumer demand now that the new-car cycle is likely to be past its peak. But in Ferrari's stratospheric market segment, that's less of a concern. Unless there's a severe global recession, Ferrari is likely to be able to meet its sales goals with strong pricing -- meaning that the profit growth we anticipate is likely to materialize. And that profit growth should outpace the growth of the overall market.
Ferrari's valuation suggests that the expected growth for 2017 is largely priced in. An investor who buys Ferrari today might need to be a bit patient. But Ferrari's profit-growth plan could make for a fun and profitable ride over the next few years.