Is Sotheby's Facing a Bear Market in Art?

Image source: Sotheby's.

Longtime auction house Sotheby's (BID +0.00%) has developed a strong reputation for serving the high-end market for art and other collectibles, and its auctions draw plenty of media attention when customers choose to put famous and valuable paintings and other works of art up for sale. Yet high-end jewelry retailer Tiffany (NYSE: TIF) and other companies that rely on the jet set to spend have been under pressure lately, and Sotheby's has also seen its stock fall in anticipation of slower global economic growth.

In Friday's fourth-quarter financial report, Sotheby's investors are expecting relatively flat performance on the earnings front, but lower sales expectations show the nervousness about the business. Let's take a closer look at what we're likely to hear from Sotheby's and whether it will build up some momentum for 2016.

Stats on Sotheby's

Data source: Yahoo! Finance.

Can Sotheby's earnings keep climbing?
In recent months, investors have had mixed views about Sotheby's earnings, raising their fourth-quarter projections by almost 20%, but cutting their 2016 estimates by almost $0.30 per share. The stock has also struggled, falling 17% since mid-November.

Sotheby's third-quarter report in November reflected the usual troubles that the auction house faces in its slow season, although calendar impacts helped produce some encouraging results. Revenue jumped 46%, largely because of the move of its London evening sale of contemporary art into July, and Sotheby's posted an adjusted net loss of $17.9 million. Yet both figures were better than investors had expected to see, and positive results from auctions early in the fourth quarter gave Sotheby's hope that it would be able to keep up its growth rate to finish 2015.

Yet subsequent events have led to more concerns about Sotheby's. In January, the company said that it would post a net loss for the fourth quarter on a GAAP basis, resulting in adjusted earnings of $1.11 to $1.17 per share. Sotheby's said that the sale of the Taubman Collection during the quarter was subject to an auction guarantee, and a shortfall will force Sotheby's not to recognize any net auction revenue from the sale.

Even after the quarter ended, Sotheby's kept seeing signs of a slow art market. The company's Contemporary Evening Sale saw sales drop more than 40% from year-earlier levels. Reports that a major collector is divesting artwork at fire-sale prices was also problematic in light of assertions that the artwork in question was pledged to Sotheby's financing unit as collateral. All in all, many are calling for a correction in the art market, and that could put Sotheby's in difficulty if it continues.

Similar trends are showing up elsewhere in the luxury market. Tiffany reported that its holiday sales fell 6%, with comparable-store sales down 5%. With expectations for full-year earnings to fall by double-digit percentages, Tiffany is looking at potentially laying off part of its workforce, showing the depth of the downturn in demand for luxury items. Although some ultra-high net worth individuals will remain strong regardless, the absence of the marginal affluent auction participant could hurt Sotheby's badly.

In the Sotheby's report, investors need to learn how CEO Tad Smith and his team will respond to slowing conditions. Only by making sure that the auction house is protected against major losses can investors in Sotheby's feel confident about its ability to weather the storm, and emerge stronger from the effort.