It’s been a tough few weeks for the car industry.
The emissions-rigging scandal at VW has cost the company its chief executive, and is likely to end in fines and product recalls costing billions. It might not be the only skeleton in the industry’s closet, and it’s already hitting sales of diesel vehicles.
So car manufacturers might have been cheered by the successful listing of Ferrari – part of Fiat – in New York yesterday. The initial public offering raised nearly $1bn.
So should you pile in and snap up some Ferrari shares too? Or are there better bets out there?
A great car with plenty of demand for it – what’s not to like?
You can see why investors like Ferrari. It has a strong brand name and good profit margins.
Sales have risen by nearly 20% over the past two years. But the management team thinks they could easily jump by another 30%, from 7,000 to 9,000. There are, after all, long waiting lists for new Ferraris.
Much of this demand is expected to come from Asia. In particular, the promise of a new class of rich and super-rich Chinese consumers could see demand for status symbols – like expensive, flashy sports cars – take off even more than it already has.
Sales should also get a bump from the new models Ferrari is releasing. Last month, the 488 GTB and 488 Spider went on sale. They hope that these will repeat the success of the popular 458 Italia.
It’s a persuasive story – you can understand why investors lapped it up. However, we’re sceptical. Here’s why.
Ferrari has a good story – but there are lots of holes in it
Building a Ferrari requires a lot of precision engineering. It takes time and the input of skilled workers. Increasing production significantly will cost time and money, and it will also increase the risk that mistakes will be made which could damage the brand.
This is a real concern. You only need to look at what happened to Tesla this week when a US consumer research group took the shine off its halo by giving it less than stellar reviews.
Perhaps even more importantly, Ferrari also benefits from a certain rarity value. The long waiting list is part of its mystique. Make it too easy to get one, and it becomes just another supercar, and one that is more expensive than much of the competition at that.
Relying on China to deliver a big increase in demand is also risky. Sure, the country looks likely to avoid a “hard landing”, economically speaking. But as my colleague Merryn Somerset Webb has pointed out, the clampdown on the most blatant elements of official corruption has already had a big impact on luxury goods sales.
In any case, rising labour costs suggest that the middle class, not the super-rich, will be the big winners from future growth – good for the country, not so good for Ferrari. Meanwhile, the collapse in energy prices could also hit demand in Russia and emerging Central Asia.
The laws around emissions may represent another barrier. Both the EU and the US are cracking down, and the fallout from the VW scandal means that things can only get tougher.
At the moment, Ferrari has a deal which allows it to get around many US regulations. However, it only holds if global sales are below 10,000, which puts a major crimp in its ambitions.
Even today, Ferrari has been making discreet changes to its models. The latest versions still have extremely powerful engines, but they’ve already had to make concession regarding the noise levels and engine size. In a recent interview, top management said that they expect this trend to continue, with smaller engines and bodies.
The problem is that while this is good for the planet, it undercuts a key part of Ferrari’s appeal, which is based on speed, engine size and the amount of noise generated. So the company is between a rock and a hard place.
Finally, the most convincing argument against Ferrari (NYSE: RACE) is that it is just plain expensive. Right now, it trades on a price/earnings (p/e) ratio of more than 30. Even if it manages to meet its targets for boosting revenue and earnings in the next few years, it will still only fall to 23 times. These are multiples associated with the tech sector, not with car firms.
In contrast, Renault and Ford trade at far more modest p/e ratios of 8.5 and 12. While you can argue that these serve a different segment of the market, even the more upscale BMW trades at a p/e of only ten.
It might make sense to pay crazy amounts of money for a Ferrari sports car, if that’s your hobby. But you never want to overpay for shares, regardless of the brand they represent.
You might be better off with something less… flashy
So are there any opportunities in the car market? Well, you can’t argue that VW (Dax: VOW) is expensive. It’s currently trading on just 5.5 times trailing earnings.
That’s understandable. Earnings are going to take a hit from the emissions scandal – some have put the potential total cost at over $20bn. Still, it trades at a 40% discount to the value of its assets and at just six times 2017 earnings – to me, that makes it a gamble worth taking.
And early signs suggest that the problem may not be quite as bad as initially feared. While VW will have to recall all cars affected, it hopes that in most cases this will just involve removing the “defeat device” – ie changing software – rather than more extensive repairs.
At the same time, the market’s evident appetite for luxury car brands may work in its favour. This is because it could make large sums of money from offloading stakes in subsidiaries such as Bentley, Bugatti or Lamborghini.