Sothebys Coverage Initiated With ‘Outperform’: Cowen

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Sothebys (NYSE:BID) could see continued revenue growth as it moves beyond the long-running legal battle it has had with activist investor Dan Loeb. Cowen and Company analysts like the unique way the auction firm exposes itself to high net worth buyers and the luxury market.

Additionally, they see plenty of extra cash for shareholders going forward as the company improves its cost management.

Sotheby’s sees intense competition

In their report dated Dec. 16, 2014, analysts Oliver Chen, Steven Zaccone and Courtney Wilson noted that competition for the best auction consignments is certainly fierce. They note that not only are there strong competitors for Sothebys, but there are also other ways to bring pricey pieces of art to market, like through private sales, dealers, direct sales or even online.

Because of the intense competition, they say Sothebys commission margins have continued to be pressured at around 16% to 17%. That’s compared to the average of 20% between 2009 and 2010. In spite of the difficult commission margins, however, they say the firm’s agency model brings “attractive” operating margins of about 26% with a five-year average of 30%.

The result is between $150 million and $200 million in annual cash flow generation with a 5% to 7% yield.

Sotheby’s improves cost management

The Cowen team said they’re “impressed” with the auction firm’s new capital plans, which involve using special dividends. They particularly like how Sothebys is dividing its leverage on its agency business at 3.5 to 4 times EBITDA. Additionally, they like the dedicated revolving credit facility on the firm’s finance segment and its cost structure review program.

The firm also announced in July that it was restructuring its headcount. Currently Sothebys is also seeking its next CEO, as William Ruprecht said last month that he will step down.

Where Sothebys can grow

The analysts said in the long term, they think the auction firm will be able to increase its share of private art sales, which will reduce the cyclical nature of its revenue glow. They also expect Sothebys to leverage its brand into new business opportunities and new sales channels like online.

The main areas they believe the firm can leverage for growth include its analytical and global specialist teams, its 100 years of expertise in valuing art pieces, its logistical capabilities, like handling import and tax regulations, and its relationships with all ten of the top billionaires.

Sothebys rated as Outperform

The Cowen team initiated coverage of the auction firm with an Outperform rating and $45 per share price target. They like how Sothebys is exposed to “the ultra-high net worth individuals” because they believe it “partly insulates the company from austerity measures in China and negative traffic trends from Hong Kong protests.” They note that China represents 18% of Sotheby’s business mix.

In general, they suggest that retail investors focus their portfolios on companies with high exposure to wealthy households, including Sothebys and Tiffany & Co. (NYSE:TIF).

Shares of Sothebys edged upward less than 1% during regular trading today.

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