Ferrari and the Fiat Stub — RACE

Warning: Automobile sector definitely does not fall into our circle of competence.

  • Ferrari listed in NYSE and finished on 23rd Oct with a market cap of $10.7B
  • Absolute top class luxury brand with an earnings of ~$300M in 2014
  • Works out to an earnings yield of 3% and a PE of almost 35
  • We feel that Mr. Market is valuing the brand of Ferrari very highly. In our opinion, this is counted twice as the earnings already has the pricing power of the brand factored into it
  • Even if the company increased the production from 6K pcs to 9K pcs, the earnings yield will still be hovering around the 5% mark.
  • It is a low return on capital and low asset turnover business
  • Two positives abound the stock; supply is constrained and revenue and earnings stability will last longer than a normal automobile company
  • It looks as though Mr. Market is pricing RACE much ahead of its earnings potential

On the other hand, Fiat is trading with a market cap of $19.9B and if Mr. Market is pricing Ferrari at $10.7B and is right about it and Fiat owns 80% of Ferrari, then the rest of Fiat must be ~$11B. The last ten years average profit margins of Fiat is 1.7% which would result in a normalized earnings of $1.7B (excluding $300M of Ferrari earnings) valuing Fiat at 6.5 times earnings or an earnings yield of 15%. If one wants the Fiat stub ex-Ferrari, one can go long Fiat and short Ferrari to get exposure to only the Fiat piece of the stock.

We will be watching and learning in this case and not investing / speculating as this does not fall into our circle of competence but to our limited knowledge RACE looks overvalued and since we are not familiar with the cycles of the auto industry, we have no real comment on the cheapness of the Fiat stub.

Note: We are not comfortable with the interest coverage of FIAT for the debt it holds at the consolidated level. It makes us feel that the low margins are levered returns and the underlying returns could be far worse.

what are we reading?

What are we reading?

  • Valeant — A detailed look into a dangerous story well told — Part I, II, III (az)
  • Valeant — A detailed look into a dangerous story well told — Part IV (az)
  • Valeant Pharma — some comments (BronteCapital)
  • Project Owl Documents — Ferrari (SEC)
  • Fait Chrysler profits look good but Bernstein Research worries about debt (Forbes)
  • Marchionne talks of industry mergers called signs of Panic (Bloomberg)
  • Fiat Chrysler CEO spar over consolidation on call (WSJ)

Performance and Management

I have been reading through some annual reports of a company over this weekend. Seen below is the performance of the company (blue line) compared to S&P 500 (yellow line) and DOW (orange / red line). The company has massively under performed the index and even more compared to their stronger peers.

Indus

  • The market cap of the company was 22% higher 5 years ago than now
  • The company has retained ~4B of earnings to lose  close to $10B of market cap over the time period (think about the WEB retained earnings test)
  • The company has repurchased close to 50M shares at an average close to 50% above the current price today costing the shareholders another billion $
  • The company has taken write down or pretty much thrown in the towel on some of the bigger acquisitions over the last decade

Amazingly…. the same management continues to run the show and the market is watching them do another re-org of the company. Just Wow!!!! Are shareholders asleep at the wheel?

Market volatility and circle of competence

The markets have been roiled these last few days to put it mildly. Dow Jones has been down 8.5% in the last four days. Indian Sensex is down 7.8%. Lots of individual stocks are down a lot more. There are a lot of investors wondering what’s in store next. Will the market fall another 10%? 20%? We have a very profound answer. We don’t know. And we don’t try to act or predict on something we don’t know.

However, whenever there is a sale, we are usually in the background looking around trying to see if something catches our eyes. When market goes down, assets get cheaper. It is akin to a shopping sale for us. If the market goes really, really down, it is a garage sale.

We believe what we do have is what Buffett calls a circle of competence. Limited number of companies where we think we have a good understanding of the fundamentals and what the companies might be worth 10 years from now. The intrinsic value of some of these companies is getting very interesting. We do not know what Mr Market will value these companies one year from now and even two years from now. However, we will still be okay if these companies go down 10-20-30% down after we buy it as we think the probabilities are high that the companies that we are investing in will be bigger, better, stronger ten years from now and that knowledge is our competitive advantage that enables us to deploy capital now when there is uncertainty and volatility around in the market. Once the capital is deployed, the key is to be patient and wait for the market to move from a voting machine to a weighing machine.

We are deploying some capital and watching to see if further bargains open up. Our war chest is ready. If none do, we just go back to whatever we were doing before and wait for more shopping festival seasons. If some bargains do further open up, we will be there buying things we understand.