Ensemble Capital Client Call Transcript: Ferrari, First American, and Schwab Updates
We recently hosted our quarterly client conference call. You can read a full transcript HERE.
Below is an excerpt from the call discussing our investments in Ferrari, First American, and Schwab and why we expect them to survive and thrive on the other side of COVID-related economic and business impacts.
We’ll talk about Ferrari next. Obviously being located in one of the hardest hit countries, Italy, has had a major impact on Ferrari’s ability to operate its production operations normally. This hits right at the heart of its ability to supply customers with its highly coveted products.
Given Ferrari’s high average selling price and margins, we believe the company is resilient enough to see through a multi-month period without severe cashflow issues while we expect demand to be fairly inelastic given its long 12-24 month waiting lists across 6 recently launched and limited supply models, all supported by the wealth of its clientele.
So, while supply will be even more constrained at both Ferrari’s and its suppliers’ productions facilities this year, we believe demand will be generally resilient. As a datapoint, even during the depths of the Great Recession in 2009, unit sales only declined 4%. Coming out of the current disruption, we expect a reasonably quick ramp in production to fulfill that pent up demand.
To understand why that might be, lets revisit the core value proposition of Ferrari. Though Ferrari builds and sells cars, the cars are conduits to deliver a great experience to the world’s wealthiest and most elite clientele. Buying and driving a Ferrari is an experience that combines many characteristics including automotive driving and racing passion, status, and an appreciation of design and engineering craftsmanship. Buying a Ferrari also buys membership into an elite global network of peers who share the passionate and thrilling desire for driving and racing. Being a part of this club and being invited to Ferrari’s events provides a lot of value to clients, while working their way up the loyalty ranks earns them the privilege to buy exclusive, limited series models. These limited series models are the most coveted and most restricted in supply. Some of these become collectibles over time and can see strong appreciation in value upon delivery.
Because of the general supply/demand imbalance Ferrari usually favors to maintain product exclusivity, a practice inherited from its founder Enzo Ferrari, those who cancel their order while on the waiting list, do so only reluctantly since there is likely to be someone else nipping at the chance to take their place. And this could also impact their opportunity to buy the next exclusive model creating a strong motivator to follow through on delivery of their orders.
First American Financial, along with their competitor Fidelity National Title, control most of the title insurance market in the United States. When you buy a home with a mortgage, the lender requires title insurance to make sure that the seller actually has full and clear title to the property. While it is just one small piece of the overall home buying transaction, when you sit down to sign the final closing paperwork to buy a house you will generally find yourself sitting in the office of First American or Fidelity National as title companies provide the escrow services to allow the buyer and seller to transfer cash and title to escrow before each is released to the other side.
Of course, the number of home sales is going to drop dramatically during this spring selling season. It is not legal in many parts of the country to host or attend an open house. But the fact is Americans are still going to want to buy and sell homes in the future. Indeed, while home prices have increased a lot in recent years, the number of home transactions, the primary driver of First American’s business, have run at historically low levels. The rate of growth in January and February was actually heating up and growing at the fastest rate since prior to the housing bust over a decade ago. So while home buyers may spend shelter in place browsing Zillow and Redfin in search of their next home, when economic activity returns, we expect First American to benefit greatly from the pent up demand that will be even stronger given even lower rates on mortgages.
While there has been little in the way of new competition to title companies, we expect that many of the small digital first startups that are interested in competing will not be able to survive. Instead, industry participants will be far more focused on staying loyal to First American knowing that in a crisis as well as when trying to emerge from a crisis, if you are engaging in multimillion dollar complicated transactions such as buying and selling homes, you want to work with a trusted leader. As an aside, it is worth noting that title services along with many of the functions involved in home transactions have been deemed essential services and thus are allowed to continue during shelter in place.
With $4 trillion in custodied assets, Schwab is one of the largest financial institutions in the US and among the fastest growing. It has two main lines of businesses that generate substantially all of its revenue, its asset management and advisory business, which collects revenue from a fee charged as a percent of assets under management, and its bank business, which collects a spread between the interest it pays clients for their cash balances and the rate it collects from investing that pool of cash in predominantly low risk bonds issued or backed by the US government.
Schwab has a long history dating back to the 1970’s and has lived through many recessions and shocks. Consistent along its history has been the ability to adapt and grow by winning for its clients and itself by delivering valuable services more cost effectively as it has leveraged its growing asset and operational scale.
We believe its business model is built for both growth and resilience. The combination of the AUM based asset management business and the spread based bank can create a balancing dynamic, though with the fed funds rate cut this year at 150 basis points, both businesses will be pressured but with some offset as clients raise cash due to uncertainty and market volatility.
Net-net, we expect to see Schwab’s revenue decline relative to 2019 in one of the most severe economic periods in history, while operating margins are expected to remain robust even after declining materially.
On the other hand, we believe many of the FinTech startups competing in this space will see a much harsher impact in their ability to continue serving customers and investing in their businesses during this period of tighter capital availability and their subscale, developing business models. This will earn Schwab even greater competitive advantage exiting this period.
You can read the full transcript here.
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