Ferrari (RACE +0.05%) has crafted a story of prestige, wealth, and exclusivity around its iconic brand. As most consumers know, Ferraris are expensive-with an estimated average selling price of just over $324,000 in 2019, the cars certainly aren't cheap. But Ferrari isn't your typical car company, and it's built its business model for success in any market conditions.
The Ferrari Tributo F8. Image source: Ferrari.
The Ferrari Club
Even someone with enough money to buy a new Ferrari likely wouldn't be able to. Becoming a new Ferrari owner is difficult and almost always requires proof of prior ownership. In order to buy a new Ferrari, customers must demonstrate that they have owned at least one used Ferrari in the past. This makes the cars' collectability quite appealing -- and their secondary markets considerably lucrative.
Once a customer has demonstrated the right to buy a new Ferrari, he or she becomes part of a very exclusive club. This isn't just a Facebook group formed by Ferrari owners -- i's an actual club. Members get invited to extravagant multiday events around the world as Ferrari unveils their newest models. These events offer incredible networking opportunities for any customer lucky enough to be invited. Wealthy people from all over the globe flock to Ferrari's headquarters in Maranello in hopes that they will get to hand over their money in exchange for a new vehicle.
Limited supply, lots of demand
Ever since Enzo Ferrari's early years as a driver for Alfa Romeo, he's been obsessed with racing. He formed his own gentleman's racing team called Scuderia Ferrari, which still exists today. Eventually, Enzo's time on the track ended, but his obsession with racing never wavered. He began building his own Ferrari-badged cars and winning gentleman's tournaments all across Europe.
Ferrari's early success and attention to detail created a lot of buzz. The public was clamoring to get their hands on one of Ferrari's cars. Anyone who could afford one wanted one. Yet, Enzo was still focused on building winning race cars, and his production capacity was limited. So Ferrari was only able to make a small number of cars available to the public each year. This made Ferrari cars even more exclusive to own, leaving potential customers waiting in line for their opportunity to buy one.
This initial inadvertent model of under supplying cars cultivated a remarkable strategy that is core to the business today. During Ferrari's first-quarter conference call earlier this year, Ferrari CEO Louis Camilleri stated that its order book extends "well beyond 12 months." Customers are waiting more than a year for the opportunity to buy. If that opportunity presents itself and the customer decides not to purchase, Ferrari can send them to the back of the line -- or worse, kick them out of the club altogether.
What does this mean for shareholders?
Ferrari trades at 65 times trailing-12-month net income. On the surface, that's a pretty daunting valuation to most investors, especially for a car company. But Ferrari is unique for one big reason: its remarkable pricing power.
Over the last seven years, Ferrari's gross margins steadily increased from 47% to 52%. To expand margins, an auto manufacturer can either lower the cost of production per unit or increase the price customers pay per unit. In Ferrari's case, the average cost of production per car -- cost of sales divided by unit shipments -- rose just 1% from 2013 to 2019, even as the number of vehicles Ferrari shipped annually rose nearly 45% over the same period. This should demonstrate to investors that Ferrari owes its margin expansion to the underlying pricing power of its business model.
In fact, not only are customers willing to pay more, but some analysts believe that in many cases, customers also prefer to pay more. In the customer's eyes, a higher price equals a higher collectible value. Since production costs have stayed relatively flat, this pricing power has trickled right down to the bottom line. From 2013 to 2019, EBIT margins grew from 15.6% to 24.4%, and net income margins from 10.3% to 18.5%.
What can go wrong?
Ferrari's main objective is making sure demand steadily outpaces supply. In order to do that, its brand is of utmost importance. The most realistic way for Ferrari to tarnish their brand would be by a reduction of the collectable value. If the world transitions to electric vehicles, and Ferrari can't keep up, that might harm the company's brand.
The best indicator of brand value is Ferrari's customer backlog. CEO Louis Camilleri mentions this metric on every conference call, and for the last few years, the backlog has stayed consistent at longer than 12 months. If that backlog decreases significantly, investors should start worrying. On the flip side, as long as Ferrari maintains a strong backlog and no sign of brand erosion, the company should continue to increase profits at a sustainable rate.
