Three Quarter ago we published our bullish thesis on Ferrari stock. At that time, the stock was trading at $87 per share, now it’s 40% higher and trading at the $122 level. Three weeks ago, UBS increased its price target on the stock from $129 to $160 per share, citing a possibility of a higher production volume and improved EBITDA margins.

We do not recommend investors to get into RACE stock at current levels. We rate the stock as a “hold” and believe that the stock is priced for perfection at these levels. 

First, we would like to cite a flaw in UBS analysis. The analysts working on the report placed the whole weight of their valuation on the EV/EBITDA  multiple. We believe that’s not the right way to value a luxury automobile manufacturer as a huge percentage of the EBITDA is deployed back into the business (in Ferrari’s case, 37% of the EBITDA is re-deployed to maintain/grow the company’s production). Excluding depreciation, which is 25% of Ferrari’s EBITDA, is one of the biggest mistakes an analyst would make when valuing a company in a capital-intensive industry. 

The other flaw in UBS’ research is comparing Ferrari to Hermes, the Paris-based high-end retailer, UBS analysts cited: “Ferrari trades at a 19% discount to Hermes on EV/Sales, 11% discount on EV/EBITDA and 11% discount on P/E. Despite this, Ferrari is due to grow earnings at a 14% EBITDA CAGR to 2022e versus Hermes long-term growth expected at 7%-8%”. UBS analysts would have a point if Hermes is in the same market, or at least have a similar capital-intensive model as Ferrari. Hermes makes wearable products with equipment (assets)/resources that have long durable life, which is not the case for Ferrari. This difference between two business models is evident in the companies’ financial statements. For instance, Ferrari spends 11.5% of its sales on Capex while that rate is only 5% for Hermes. 

UBS analysts were reached for comment but did not offer any. 

We believe that Ferrari stock has limited upside from current levels. The company is production constraint so the long-term growth rate can’t be high enough to justify the current stock price. Our model takes into account the best-realistic cases possible for Ferrari stock, yet we arrived at a valuation that is nearly 5% below current levels. Our assumptions are; 13,500 annual production rate by 2022 compared to a current rate of ~8,400, EBITDA margins rising from a current rate of 30.3% to 42.5% in 2022 which is better than UBS’ base-case estimates, a FCF to EBITDA margin of 52% taking the 3-year average, a 7% WACC, and a 20x multiple on 2022 FCF which is 3 to 5 times the current average multiple of automotive OEMs. We calculated the present value of 2022 using the 7% WACC and arrived at a valuation of 17.8 billion euros, or around $117 per share in dollar terms, a ~5% downside from current levels. 

We believe that Ferrari should be valued at the FCF front, not the inflated EBITDA which doesn’t take into account the true nature of the business. UBS was one of the main underwriters of Ferrari’s IPO and as other banks, does and seeks to do business with the company so the report may be biased and the price target which implies a 33% upside should not be taken for granted. 

We are not bearish on Ferrari stock, but we are not bullish either. We recommend our readers to stay on the sidelines and wait for a better entry point to own this stock.