Sothebys - Buy Them When They're Down and Out
How many times have you heard traders say, "I am a contrarian and I buy when everybody else is selling and there is blood in the streets." Then, you ask them what they last bought, and it is the latest hot social media stock or green energy play that is at 52-week highs and trading at 200x earnings (if there are any earnings).
There's absolutely nothing wrong with running with the herd like that. However, money also can be made by truly being a contrarian and picking over the stocks that have been left for dead by the side of the road despite their underlying quality.
Sothebys Holdings Inc. (NYSE:BID), the venerable auction house, reported second quarter earnings that were not very well received by the market.
Source: TheStreet via Yahoo
After such a big miss, the stock slid 8% and currently is resting around its 52-week lows. In fact, the stock - currently trading well under 38 - has been sliding since it hit a high of 54 last November. On the bright side - it is on sale for the patient, discriminating buyer. This is precisely the situation that a true contrarian looks for, a good company on sale, so let's pick over the damaged goods and see what we can find.
Sothebys definitely had a difficult quarter. Their miss of revenues was not too bad, but the earnings miss was substantial. Higher expenses and a higher tax rate were big problems during the quarter.
As reported during the earnings call, salaries and related costs increased $16.6 million or 20% in the second quarter of 2014, hitting $205.4 million, and increased $21.6 million or 15% in the first half. There were after-tax special charges of $10.2 million, and margins were stagnant.
Another problem was that the company's tax rate for the first half of 2014 increased to 39% versus 23% in 2013, and management estimates the full-year 2014 tax rate at 38%. They blamed this on their decision to repatriate funds from their overseas operations.
Regarding the tax issue, that appears to be something that isn't going away. However, now that it is factored into the equation, the silver lining is that it likely won't be getting worse, either. Repatriating overseas funds is an issue a lot of global companies are going to have to face, and it is better that this is now out on the table for those considering Sothebys. A lot of that money earned overseas will be brought back home and domestic taxes paid on it, simple as that. The analysts couldn't know about that decision - or at least its effects - in advance.
The gross increase in salaries, though, can be addressed. In terms of cutting expenses, the company has realized for some time that this is an issue. As Chairman/CEO Bill Ruprecht noted during the call, "Last month we announced a restructuring plan which will further address costs as we reallocate our resources towards those areas affording us the greatest opportunities for growth. The headcount reductions will be implemented by year end."
The company targeted $22 million in cost reductions for general expenses such as marketing and administrative costs. In addition, the company is actively reducing headcount to bring costs down over and above the $22 million. What will result is a leaner and meaner Sothebys. There will be charges for this taken during the third quarter, but the programme should begin to bear fruit by the end of the year, and certainly by some point in 2015.
Dan Loeb, the activist investor, saw this expense issue coming a long time ago. He now has two seats on the board of directors after waging a rough nine-month public battle to force the company to take the sorts of steps it finally is taking to cut costs. He argued that Sothebys was "an old master painting in desperate need of restoration." It is easy to imagine that his influence is beginning to pay off with the current plan to cut costs. However, fighting him itself cost the company $24.3 million in the first half of 2014, with the fight only ending in May, midway through the second quarter. Now that the fight with Loeb is over and he has input on the agenda, the company can move forward and focus more on its core business.
The important takeaway is that the company recognizes the problem with expenses and is taking big steps to correct them. It needs a little time for that show up on the bottom line.
Reasons for Optimism About Sothebys
When a stock is trading at its 52-week lows, it generally is there for a reason. No argument there. Sothebys reported disappointing earnings and people like Loeb have been calling it out for being antiquated, and that can't be denied. However, there are reasons for optimism about the company looking forward despite high expenses and the other problems affecting it in 2014.
1. Hot Global Art Market
The global art market is sizzling. According to Artprice, a French company that tracks the global art market, global art sales rose 17% in the first half of 2014, to a record $7.15 billion. This was up from $6.11 billion in the first half of 2014.
It isn't just the volume of sales that is important, but the makeup of today's customers. There are now nearly 70 million art lovers and collectors in the world, a huge expansion during the post-war period from a base of only 500,000. It is more than just private collectors sitting in their castles sipping Chablis: there is a new demand for museums and art centers in general. People are more educated and sophisticated than ever around the world, and more and more appreciate high-priced art.
The United States is leading the surge in demand, perhaps fueled by the rising stock market. In the first half of 2014, US collectors bought a third of all global artwork on sale, a 28% increase from the first half of 2013, to $2.38 billion. As discussed below, the top 1% in the U.S. hold a huge fraction of the nation's wealth, higher than pretty much anywhere else, and that is translating into a lust for art.
The Chinese market also is still strong, but slipped to number two after four years on top due to economic issues. Even China, however, had an increase of 6.9% over the previous year, so they increasingly are appreciating art as well.
The British art market also was strong, with a rise of 25%. Together, the top three art markets accounted for 86% of the global art market.
Sothebys is taking advantage of the growing art market. They noted during the call that 26% of their buyers during the first half were first-time clients, and "we're engaging with the new generation of collectors and that's very exciting for us."
The luxury goods sector is thriving in general. According to Claudia D'Arpizio, a Bain & Co. partner who specializes in the luxury-markets field, ""The global market is maturing, stabilizing and consolidating." Things have changed in the field, as it has become less cyclical: "It is becoming more resilient to economic crises, more responsive to a demanding and highly mobile global consumer base, and less reliant on market booms for growth," she said.
Analyst Taposh Bari at Goldman Sachs has been following Sothebys closely and has maintained his Neutral rating with a positive bias. He has a price target of $44.
While analysts clearly expected more, Sothebys did have very good revenue growth over the previous year. They had a net increase in auction sales during the first half of 2014 of 24%. And, despite everything - they still made a nice chunk of change in profit. It's not as if they lost money. So, they are doing all right despite the earnings miss.
2. Growing Customer Demand
There are plenty of customers for high-priced art, and that pool of customers is growing by leaps and bounds. Concentration of wealth may be a hot political topic, but it tends to work to the advantage of those selling luxury goods such as fancy art. The top 1% have lots of money to bid against each other to get the best paintings and sculptures which are perceived to appreciate steadily in value (exactly how good an investment art turns out to be on average is open to debate). Even if outpaced by other asset classes, art provides some useful diversification of assets and a private storehouse of value.
One of the simple realities of the upper reaches of the art market is that it represents demand for a good investment by the very rich. Wealth is heavily concentrated in society these days, as the graphic below shows, so the "very rich" are quite rich indeed.
Recent studies show that the top .1% - those who have at least $20 million in net wealth - held 23.5% of all U.S. wealth in 2012. Much of that wealth is hidden away in overseas bank accounts and the like - artwork in vaults, for instance - so there is more there than meets the eye. The Europeans, according to the studies, may be hiding even more of their wealth in secret, 10% of their wealth versus about 4% for Americans. One place where the wealthy like to secrete their assets is artwork - which is one reason the global art market is booming. Overall, the top 1% apparently held 35-37% of U.S. wealth in 2010, and anecdotal evidence suggests that figure has only increased recently.
This is not the place to bemoan the inequality of life. Rather, it is to appreciate that Sothebys is not going to be hurting for well-heeled customers in coming years. People are accumulating piles of cash and need somewhere to put it. Artwork is a handy place, and that is a reason why the U.S. art market in particular is booming.
Even so, Sothebys is not standing pat. It is engaging with eBay (NASDAQ:EBAY) to broaden its market with online sales. As CEO Ruprecht said during the call:
"[W]hat we're doing is distributing the events that Sotheby is current[ly] conduct[ing] to a much, much, much broader audience than has had of the opportunity to participate in those sales. So once again when you have even at our most expansive sales 1200 or 1500 people in a room and couple of 100 people on the phone, you have through the distribution of these events and the ability to participate in these events for as much as a 100 million plus people. You completely change the inclusiveness and the opportunity to participate in what we're currently doing."
The effort with eBay is a bit of an experiment, and it is easy to pooh-pooh it for any number of reasons. Sothebys, though, has a host of reasons why they think it is a good idea, such as the fact that eBay already sells many high-priced objects (over $5000) every day.
A study published in Europe earlier this year found that online art sales generated 2.5 billion euros in 2013 and could grow at 25% per annum. So, there is a lot of potential in online sales, and Sothebys is making an effort to grab its share.
Simply giving more people exposure to Sothebys via eBay is a good thing. As Ruprecht said during the call, it's a "chunky and unpredictable business," but one that holds a lot of potential.
Sothebys has an ugly chart, and some will stay away from it for that reason. However, I chose the weekly to show that the $35 level has been significant for it over time. While the stock has been falling and the old saw is to "not catch a falling knife," in the absence of any more bad news, 35 could serve as long-term support. The p/e ration is about 18, which is average in this market, so the recent sell-off was useful in wringing the excess out of the stock price. It is worthy of being on a watch list, at least.
The company announced a quarterly dividend for shareholders of record on Tuesday, September 2nd (ex-dividend Thursday, August 28). They will be paid a dividend of $0.10 per share which is scheduled for Monday, September 15th. This represents a $0.40 annualized dividend and a dividend yield of 1.07%. Certainly not a high yielder, but every little bit helps as you wait for the stock price to recover.
Sothebys had a difficult quarter and sold off. That provides a striking opportunity for those who are comfortable with the prospects for the global art market in general and Sothebys, the premier name in art auctions, in particular. Sothebys is working hard to decrease its costs and beat expectations in the future and that should bear fruit in the stock price down the road.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.