Recently, I took a couple of hours to re-watch the modern classic film Ford v Ferrari starring Matt Damon as Carroll Shelby, the bold Le Mans racing champion turned automotive engineer who took on the perennial powerhouse of Ferrari at Le Mans in the mid-60s. In the film, Enzo Ferrari is approached by Ford for a buyout and refuses the deal after it’s revealed Ford wanted full control of the racing budget. What follows is the development of the Ford GT40 supercar that eventually defeats the Ferrari 330 P3 at the 1966 Le Mans, the ultimate endurance test for both driver and automobile.
Ferrari may have lost that race, but regarding the power of branding and the long-term capital return advantages good branding brings, Ferrari has lapped Ford many times over. To illustrate the impact on shareholder returns, let’s look at the respective total returns since Ferrari’s spinoff from Fiat Chrysler in late 2015.1
Clearly, there must be differentiating factors between the two automotive manufacturers to justify such a divergence in performance. Ford stock was only positive in total return roughly five years later if you had bought and held the stock. As of this writing, Ford stock barely averages a 1% return per annum.
The primary difference is that Ferrari is an ultimate luxury brand and can charge commensurate prices, whereas Ford vehicles exhibit more commodity-like pricing. The chart below with other economy vehicle competitors Honda, Toyota and General Motors further illustrates this point.2
Again, this divergence is no accident. Ferrari can price cars as it wishes due to a rabid fanbase and the power of its branding. Some Ferrari models aren’t even available for purchase to the general public. For example, when the 2014 LaFerrari model priced at roughly $1.4 million was set for sale, one had to simultaneously own five other Ferraris to even be granted the privilege of being allowed to purchase one of the 210 models. That’s a degree of unmatched customer loyalty. Interestingly, the model is so sought after that the duPont Registry listed a 2014 LaFerrari for $3,595,000 at the time of this writing. So much for depreciating in value once driven off the lot!
The relative power of branding sounds great, but how does that translate into financials? It turns out the extra margin of operational safety provided by higher margins flows into historical financial statements as well. Here’s a quick snapshot:
Ferrari (RACE) Liquidity & Solvency Ratios3
Ford (F) Liquidity & Solvency Ratios4
I believe a company’s greater operational flexibility given through higher margins is an undervalued hidden asset. The option to choose the method of financing to use, along with the ability to easily return cash to shareholders at any given time and rate, has inherent value.
Ferrari has a high current ratio of 3.4 (current assets/current liabilities) and an interest coverage ratio of 35 (earnings before interest and taxes/interest expense) vs. Ford’s corresponding metrics of 1.17 and 2.61. On a relative basis, Ferrari has a greater ability to adjust to market conditions, return cash to shareholders, and progress towards its long-term strategic goals.
Inherent Inflation Hedge
The effects of inflation on gross profit margins also helps explain how powerful brands can weather the impacts of inflation. Gross profit margins are effectively revenue minus COGS (cost of goods sold). Common-size income statements represent all line items as a percent of revenue to help better see trends and aberrations on an ongoing basis. Below are common-size financials for Ferrari’s and Ford’s gross profit margins.
Ferrari (RACE) Gross Profit Margins5
Ford (F) Gross Profit Margins5
No surprise, Ferrari has higher gross profit margins than Ford – but how does this translate into a relatively superior defense against inflation? Let’s presume inflation hits the auto industry at an aggressive rate of 10%.
Ferrari’s COGS of roughly 50% would increase by 10% to 55% of sales, assuming no costs can be passed to the customer. This lowers gross margins to 45% and flows down to net margins. Ferrari’s net margins of roughly 20% would fall to 15% – still comfortably profitable in adverse times.
How does Ford compare? Ford’s COGS of roughly 85% would rise by 10% to 93.5% and eliminate their net profit entirely! See the respective net profit margins below:
Ferrari (RACE) Net Profit Margins6
Ford (F) Net Profit Margins6
Notice in this example that I assume inflation is entirely borne by the producers, Ferrari and Ford. In reality, inflation will be passed on to the consumer to some degree. However, Ferrari will have a much easier time conveying the cost to their customers than Ford will, further protecting profits and enhancing the relative benefit of the brand to the business.
When discussing the power of brands and long-term effects on their companies’ share price and operations, Ferrari is an example of a luxury brand that stands out in the automotive industry, a sector of the market where it’s harder to generate high returns on capital due to the high ongoing capital requirements. Ford could outperform Ferrari over certain periods due to their higher leverage, volatility of the shares, and other factors under the right circumstances. However, the continued focus on the higher compounding capital returns good brands provide could have you sitting in the driver’s seat of your own Ferrari!
Dean Schwefel, CFA®
Senior Investment Analyst
1. YCharts. RACE & F Total Returns 10/21/2015 - 5/20/2022
2. YCharts. Total Return Levels of RACE, F, HMC, TM & GM 10/21/2015 - 5/20/2022
3. YCharts. Ferrari Liquidity & Solvency Ratios - 5/23/2022
4. YCharts. Ford Liquidity & Solvency Ratios - 5/23/2022
5. YCharts. RACE & F Common Size Income Statements - 5/23/2022
6. YCharts. RACE & F Net Profit Margins - 5/23/2022
Ferrari Image Photo Credit - AA+W - stock.adobe.com - 6/14/2013
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