The Investment Case for Ferrari: Importance of Pricing Power

A case study of how Ferrari is able to leverage pricing power into business success

I recently listened to a fascinating episode of the Millennial Investing podcast with Arif Karim, a senior investment analyst at Ensemble Capital where they took a look at the investment case for Ferrari Stock. Ferrari trades under the ticker symbol $RACE on the New York Stock exchange. At the time of writing, Ferrari has a market capitalisation of $35.42 billion.

My key takeaway from the podcast was the level of pricing power Ferrari has and how the investment thesis is essentially built around this premise. Pricing power is an economic term that describes the effect of a change in a firm's product price on the quantity demanded of that product. This is linked to the price elasticity of demand. Price elasticity of demand is a measurement of the change in consumption of a product in relation to a change in its price. A good is elastic if a price change causes a substantial change in demand or supply. On the other hand, a good is inelastic if a price change does not cause demand or supply to change significantly.

In laymans terms, what this means is that a company with a degree of pricing power will not see a big change in the demand for their product if they increase the price of the product. Whereas a company with a low degree of pricing power will see a sharp drop-off in demand if the company decides to increase the price of the product. Consider for example a company that sells milk. If they decided to increase the price of their product by say R5 they will see a sharp drop in demand as customers will rather purchase milk from another brand at a lower price. Pricing power, therefore, is largely dependent on the availability of substitute products as well as how easy it is for a consumer to switch from one brand to another. 

Ferrari has been around for over 70 years and has a strong heritage of Formula 1 racing. Since the early days of Ferrari very few cars were built for sale and as a result, the demand of buyers wanting to purchase a Ferrari would always exceed the available supply of cars for sale. Given the high demand, owner and founder, Enzo Ferrari would personally select who was able to purchase a car in the early years. This created a level of exclusivity surrounding the brand. Just because you wanted a Ferrari and had the means to purchase one didnt mean you would be guaranteed to be able to get one. These were expensive cars that you had to get into the good graces of Enzo Ferrari to be offered the opportunity to buy one.

That ethos and legacy of the relationship between the car and the customers still exist today in the sense that Ferrari doesnt build enough cars to meet the demand for those cars. A Ferrari is more than just a car that gets you from point A to point B. It is a showpiece and certain models can even be considered investments given the appreciation in price. 

Another interesting nuance of the Ferrari business model is that their limited-edition cars are only available to existing Ferrari owners. As much as two-thirds of new Ferrari sales are to existing Ferrari owners. A new Ferrari can range anywhere from $250 000 to upwards of $1 000 000. What this essentially tells us is that most Ferrari sales are going to uber-wealthy individuals who arent even looking at the price tag. This is a true testament to the pricing power Ferrari have and the high demand they have been able to build around the release of their cars.

The success of the Ferrari business model has been built around the exclusivity and the scarcity of cars. Typically, Ferrari will only manufacture around 12 000 vehicles a year compared to big automakers that manufacture millions of vehicles. Porsche in comparison manufactures around 300 000 vehicles, roughly 25 times more cars than Ferrari. The number of wealthy individuals in the world that can afford a Ferrari far exceeds the limited supply of 12 000 vehicles are year. This creates an interesting dynamic where the number of people trying to get their hands on the latest model far exceeds the supply. Most models have long waiting lists and certain limited edition models can only be purchased through invite. Ferrari are price setters not price takers in the market. Their customers are not sensitive to price changes, and the demand is so high that Ferrari could easily bump up prices and not see a notable decline in demand.

This strong brand image and cult-like following have allowed Ferrari to trade at a strong premium to the market. Ferrari ($RACE) currently trades a price-to-earnings ratio of 35, slightly below the 5-year average of 38. This is a significant premium to the market given that the S&P 500 currently trades at a PE ratio of around 24. Ferrari stock has been incredibly resilient through all market conditions since listing on the NYSE and the share price has fared well. The stock is currently up over 240% since its listing in 2015. Year-to-date the stock however is down around 6%.

The investment thesis for Ferrari is fairly simple. Will the uber-wealthy car fanatics and collectors still want the latest Ferrari in years to come or will they go out of fashion? If you think that the legacy and ethos around the cars will continue to be valued by customers in years to come, then the business is likely to continue to thrive in years to come.