Loews Corporation
Q2 2017 Earnings Call Transcript

Published: 31 Jul 2017

[Operator:]

My name is Nicole and I'll be your conference operator this morning. At this time, I'd like to welcome everyone to the Loews' Second Quarter 2017 Earnings Results Conference Call. I would now like to turn the call over to Ms. Mary Skafidas, Vice President of Investor Relations and Corporate Communications. You may begin.

[Mary Skafidas:]

Thank you, Nicole. Good morning, everyone and welcome to the Loews' second quarter earnings conference call. A copy of our earnings release, earnings supplement and company overview may be found on our website, loews.com. On the call this morning, we have our Chief Executive Officer, Jim Tisch; and our Chief Financial Officer, David Edelson. Following our prepared remarks this morning, we will have a question-and-answer session, which will include questions submitted via email by our shareholders. Before we begin, however, I will remind you that this conference call might include statements that are forward-looking in nature. Actual results achieved by the company may differ materially from those made or implied in any forward-looking statements due to a wide range of risks and uncertainties, including those set forth in our SEC filings. Forward-looking statements reflect circumstances at the time they are made. The company expressly disclaims any obligation to update or revise any forward-looking statements. This disclaimer is only a brief statement of the company's statutory forward-looking statements disclaimer, which is included in the company's filings with the SEC. During the call today, we might also discuss non-GAAP financial measures. Please refer to our security filings and earnings supplement for a reconciliation to those most comparable GAAP measures. In a few minutes, our CFO, David Edelson will walk you through the key drivers for the quarter, but before he does Jim Tisch, our CEO, will kick off the call. Jim, over to you.

[James S. Tisch:]

Thank you, Mary, and good morning. Overall, Loews had a great quarter, and operating results were strong across the board. But instead of simply focusing on quarterly results as was once my custom, on today's call, I'd like to continue my recent practice of speaking in detail on a single topic of interest. Specifically, I'd like to talk a bit about the benefits of diversification with regard to our portfolio of businesses using the recent histories of CNA and Diamond Offshore as examples. It has long been our belief that having a diversified portfolio of businesses subject to different market cycles offers the best way to deliver superior returns over the long-term. However, operating in diverse industries does mean that, at any given time, our subsidiaries can face vastly different market environments, some hospitable and others more challenging. CNA and Diamond today illustrate the point. Over the last few years, CNA has been on the upswing while Diamond now operates in an industry facing a protracted down cycle. Let's focus on the positive first and take a look at CNA and the commercial property and casualty insurance market. Over the last year, CNA's total return to shareholders was more than 70%. While CNA was just as strong financially a year ago as it is today, the market seems to have finally caught on. A little less than 20 years ago, CNA was an insurance company that had lost its way trying to be all things to all people with no focused strategy. Today, the company has been transformed into a consistently profitable commercial P&C insurance carrier with strong operating results and an intense focus on underwriting fundamentals. Let me give you a little history. Steve Lilienthal, CNA's CEO from 2001 to 2009 had the arduous task of streamlining the company. He divested certain lines of business that were not core to CNA, such as reinsurance, life insurance and personal lines. It sounds easy in retrospect, but at the time it was grueling and Steve did an excellent job riding the ship. When Steve retired in 2009, Tom Motamed became the CEO and focused CNA on improving its market position in specialty and commercial lines, creating a culture of underwriting discipline and making sure that the company had adequate reserves. This new direction helped modify CNA's balance sheet which remains rock solid to this day. In November of last year, industry veteran Dino Robusto joined CNA, ready, willing, able and chomping at the bit to lead the company through its next phase of growth and profitability. CNA's longstanding goal is to post best-in-class underwriting results and it's getting closer to that achievement every day. CNA's loss ratio is basically in line with, if not better than its top tier competitors. However, its expense ratio tends to be higher than its competition, which management is addressing. The bottom-line is that while CNA has come a long way, we believe there is still ample runway for value creation and we believe that Dino, with his energy, experience and vision is the right individual to get the job done. If you look at CNA's earnings results for this quarter, you'll see he's already been hard at work. The company had a combined ratio of 93.5% primarily due to improved underwriting performance. In stark contrast to CNA's upswing, Diamond Offshore is operating in an industry that continues to face one of the sharpest downturns in its history. Contracts have been cancelled, leading edge day rates are oftentimes at or below operating costs and oil prices remain well below levels of a few years ago. Despite the pain, Diamond's CEO, Mark Edwards, and his team continued to navigate these troubled waters with tireless focus, skill and determination. And while the short to medium term outlook for the offshore drilling market remains bleak, Diamond has maintained its relative strength and all of its newbuild drilling rigs are operating under long-term contracts at an average rate of $450,000 per day. The company has also been exploring new ways to differentiate itself from its competitors and provide better value to its customers. While we don't know exactly when the offshore drilling market will recover, we do not doubt the inevitability of a recovery. Steep declines in existing oilfields will hit the market in the next few years and growth in offshore oil production will be needed to meet demand. Offshore oil is a significant part of the global supply mix that we believe cannot and will not be replaced by conventional offshore drilling or shale production. Today, we're seeing the faintest of green shoots as the offshore drilling industry moves towards product standardization and simplification. So, in conclusion, let's remember that it was only about five years ago that Diamond was Loews' largest subsidiary by market value, supplying the lion's share of our cash flow. Back then, CNA was just beginning its rise, yet today, the roles are reversed. Owning companies in a variety of industries offers the safeguard to shareholders against volatility in any one sector. Looking back at our history, we can clearly see that operating in diverse industries has given Loews a distinct advantage in its quest to create long-term value for its shareholders, a commitment that has defined Loews for more than 50 years. And now over to David.

[David B. Edelson:]

Thank you, Jim, and good morning. For the second quarter, Loews reported net income of $231 million or $0.69 per share, up from a loss of $65 million or $0.19 per share in last year's second quarter. Diamond Offshore and CNA Financial accounted for the bulk of the $296 million year-over-year positive earnings swing, while parent company investment income was the main detractor versus the prior year. Lower rig impairments at Diamond contributed to the year-over-year improvement. Rig impairments reduced Loews' net income in Q2 2016 by $267 million whereas in this year's second quarter the impairments' hit dropped to $23 million. Excluding the Diamond impairments, Loews' net income was $254 million in Q2 2017, up from $202 million in Q2 2016. The key drivers for the quarter are set forth on page 12 of our earnings supplement, which has been posted to our investor relations website. CNA had an excellent quarter and was by far the largest contributor to our consolidated net income at $244 million. This represents a $55 million or 29% year-to-year increase. Two factors drove this increase. Stronger P&C underwriting income and higher realized investment gains. Net investment income was in fact down slightly year-over-year, given a modest fall-off in LP results. The improvement in P&C underwriting income came from a meaningfully lower combined ratio. CNA's calendar year combined ratio declined from 97.4% in Q2 2016 to 93.5% in this year's second quarter, a 3.9-point improvement on $1.6 billion of quarterly net earned premiums. Given the catastrophe losses and favorable prior year development essentially offset one another this quarter, I would highlight the improvement in CNA's combined ratio, excluding cats and prior year development, also known as the non-cat accident year combined ratio. Specifically, the company's non-cat accident year combined ratio dropped 3.7 points from 98.3 in Q2 2016 to 94.6 in this year's second quarter. All three of CNA's P&C segments, Specialty, Commercial and International, showed excellent year-over-year improvement. The improvement was particularly notable in the company's Commercial and International segments, as those non-cat accident year combined ratios dropped by 3.2 points and 14.2 points, respectively. This quarter highlights CNA's enhanced underwriting discipline, its ongoing favorable prior year development and its focus on expense control. Dino Robusto and his team are singularly focused on continual improvement across CNA, building on the solid foundation created by Tom Motamed during his tenure as CEO. Turning to Diamond Offshore. While Diamond contributed only $7 million to our net income this quarter, that is over $300 million more than last year's second quarter. The previously mentioned rig impairments accounted for most of the year-over-year swing. That said, even after excluding the impairment charges, Diamond's contribution to our net income increased $57 million year-over-year, driven mainly by higher contract drilling revenues, strong cost controls, reduced depreciation expense owing to last year's rig impairments and a lower effective tax rate. Boardwalk posted excellent results in the quarter after excluding a one-time loss associated with the sale of a gas processing facility, and related gathering assets. The loss decreased Boardwalk's contribution to our net income by $15 million, thus accounting for the year-to-year decline in net income contribution. Absent this loss however, Boardwalk would have contributed $21 million to our Q2 2017 net income versus $17 million last year. And remember that in last year's second quarter, Boardwalk benefited from the legal settlement that increased its net income contribution by $4 million. Loews Hotels also had a good quarter, with net income of $10 million. During last year's second quarter the company wrote down an equity investment in one of its joint venture hotel property. So, while the year-over-year net income comparison was still favorable, it's not as dramatic as it first appears. The Hotel company's adjusted EBITDA, which excludes the write-down in other non-recurring items was $61 million for the quarter, up from $56 million in Q2 2016. The increase was principally driven by Loews Hotel's joint venture properties at the Universal Orlando Resort. Our earnings supplement includes a definition of adjusted EBITDA. Turning to the Parent company, net investment income was weak in Q2 2017 as results from gold related equities were down meaningfully versus the prior year as were results from other equity strategies. While our holdings of gold-related equities can be volatile from one period to another, we have under 3% of Parent company cash and investments devoted to this asset class. And over time, these investments have performed as intended within the context of the overall parent company portfolio. As you know, we closed on the purchase of Consolidated Container Company on May 22. In the segment results on page 5 of our release, CCC's revenues for the period of our ownership are included in investment income and other. CCC's pre-tax net income are included in corporate. CCC essentially broke even during the first six weeks of our ownership as the company's income was negatively affected by deal-related expenses and the impact of purchase accounting entries. Please note that we will be disclosing in our Form 10-Q the purchase price allocation for the acquisition. We expect to show CCC as its own reporting segment beginning with our Form 10-K for the year ending December 31, 2017. Loews continues to maintain an extremely strong and liquid balance sheet. At June 30, post the funding of the CCC acquisition, the Parent company portfolio totaled $5 billion with approximately two thirds in cash and short-term investments and the remainder in fixed maturities, marketable equity securities and a diversified portfolio of limited partnership investments. During the second quarter, we received $74 million in dividends from our subsidiaries, including $61 million from CNA and $13 million from Boardwalk. CNA announced this morning that it had increased its quarterly dividend from $0.25 per share to $0.30 per share, which translates into an incremental $12 million per quarter to Loews. This dividend hike is yet further evidence of CNA's rock solid capital position and its improving operating performance. I will now hand the call back to Jim.

[James S. Tisch:]

Thank you, David. Man, oh man, I lost my pages, here we go. Thank you, David. Before we turn the call over to Mary, I want to bring up a question that I think is top of mind for most of you; namely, why hasn't Loews bought back more shares considering that the sum of the parts discount is the highest it's been in a number of years. As I'm sure you know, we are well aware of Loews' sum of the parts valuation. In fact, it's something that I track constantly. Judging by the increase in our stock price over the past nine months, it certainly seems that we should have been more active repurchasing our stock. What's held us back is that while Loews almost only seems relatively cheap and even more so now, given the widening discount, the market still seems very high to us. We've been nervous about the equity market for a while and we've been struggling to reconcile our view of the market's absolute level with the relative value of Loews' stock. As you know we take a long-term view on share repurchases. We look for opportunities to repurchase Loews' stock when both its relative and absolute values are attractive. We know that if the stock market declines, our share price will likely move in the same direction. So, given our nervousness about the stock market, we've been waiting for a time to repurchase shares at a more advantageous price. Some of you may think we may be too cautious. You may be right, only time will tell. Historically, though, we have shown that once we are comfortable buying back shares, we buy back a lot of them. In the last two years, our buybacks may have seemed anemic, but over just the last five years we've bought back 14% of our outstanding shares at a cost of approximately $2.5 billion. Clearly, repurchasing our shares remains an important way that we allocate capital to create shareholder value. And now, I'd like to hand the call back to Mary.

[Mary Skafidas:]

Thank you, Jim, for answering that important question from shareholders. At this time, Nicole, we'd like to hand the call back over to you for questions.

[Operator:]

Our first question comes from Bob Glasspiegel from Janney.

[Robert Glasspiegel:]

I'd like to pursue a little bit a few questions on CCC. I think, you said you think it's a 10% cash-on-cash return. But it sounds like purchase accounting might offset some of that. Now that you've had it in your hands for longer, any sense on the conviction on that 10% cash return and what sort of goodwill offsets might there be to that?

[James S. Tisch:]

So, we've owned it now for approximately two months, and it's performing basically exactly the way we had expected it to. When I talked about the potential for double-digit cash-on-cash returns on our investment, that is just what it says. Cash-on-cash, so it doesn't include any factoring in of goodwill, nor of depreciation. And, as I said, in our first two months of ownership we have nothing to disabuse us of our notion that it's going to be a good cash generator for Loews.

[David B. Edelson:]

Bob, I'd also note that the purchase accounting and certain of the purchase accounting entries in the six weeks of the second quarter really related only to the six weeks of the second quarter. There will, of course, be ongoing purchase accounting given the accounting, but these were sort of one-time setup sort of purchase accounting entries.

[Robert Glasspiegel:]

I was using $600 million for the equity investment or is there further disclosure somewhere?

[David B. Edelson:]

Yes.

[James S. Tisch:]

That's correct.

[Robert Glasspiegel:]

Are you going to disclose it in the Q.

[James S. Tisch:]

No, no, I'm sorry, it's correct that our equity investment was approximately $600 million.

[Robert Glasspiegel:]

Yes.

[David B. Edelson:]

Yes, that will be disclosed.

[Robert Glasspiegel:]

In the Q, okay.

[David B. Edelson:]

Yes.

[Robert Glasspiegel:]

And now that you don't do the sort of parent rollup, I have to bother you with a couple other questions. Hotel carrying value?

[David B. Edelson:]

I'm going to have to get back to you on that.

[Robert Glasspiegel:]

Okay.

[David B. Edelson:]

You're talking about net book value?

[Robert Glasspiegel:]

Yes, equity. Yes, carrying value, yes. So it'd be great if you could like somehow put that in the supplement or in some other source now that it's no longer in the 10-Qs, your divisional carrying values.

[David B. Edelson:]

Okay.

[Robert Glasspiegel:]

And what was the gold losses either absolute or year-over-year?

[James S. Tisch:]

Yes, in the context of the portfolio, it wasn't big, but there were some losses in the quarter. Gold prices went down during the quarter. But let's keep it all in perspective. Gold is not a big factor in our portfolio. And what we have is a portfolio. So, we have a number of hedge funds, we have a few hundred million dollars in equities, and it just so happened that for the quarter, the hedge fund didn't perform particularly well. Gold was down and the equities that we had didn't perform particularly well.

[Robert Glasspiegel:]

I was just curious, I'm trying to get to what the run rate for corporate is, recognizing there's volatility in investment returns prospectively, but...

[James S. Tisch:]

The run rate is that we've got I think about $1 billion of hedge funds, we have like $150 million of gold-related securities, and we have a few hundred million dollars of equities.

[David B. Edelson:]

The real change in the quarter, Bob, was just the fact that in the second quarter of last year, gold had extraordinary returns, and in this year's second quarter, as Jim described, gold declined in the quarter. So it was really the year-over-year change that's more remarkable than the absolute return.

[Robert Glasspiegel:]

Okay. You gave me enough information that I can be a little bit dangerous in my modeling. Thank you.

[David B. Edelson:]

Yeah.

[Operator:]

And our next question comes from Michael Millman from Millman Research.

[Michael Millman:]

Thank you. So as I guess recent publicity about some huge number of uncompleted wells in the U.S., as one article indicated, there is huge underground storage. With that kind of news, is that accelerating any dumping of drilling equipment? You've always said the time to be optimistic is when you start to see equipment being dumped. And then I have another question.

[James S. Tisch:]

So drilled but uncompleted wells, otherwise known as DUCs, I am not exactly sure what's been happening to that number. I haven't followed it recently. What we do know is that shale oil production is up rather significantly in the past year. And the general forecast is that U.S. shale oil production can increase by about 1 million barrels per day every year. The question is for how many years will U.S. shale production be able to increase at that rate. And the other question is, what's going to happen to worldwide oil consumption. And most importantly, in my mind, what's going to happen to worldwide oil depletion. Our guess is that the underinvestment in oil exploration and production over the past three years is going to start to take its toll as projects that were completed before that period start to come online and start to deplete. And it's our view that in the coming years there will be a significant need for the offshore oil that has provided up to 30% of the worldwide oil supply. So I would say that we feel that right now, even though you didn't ask about it, we feel that right now we're bouncing along at the bottom with respect to offshore oil drilling. But we believe that there are, as I said, a few greenshoots, and we think that in the coming months and years, there will be more.

[Michael Millman:]

So are you suggesting that we shouldn't expect to see this historic – what has been historic kind of dumping at the bottom – dumping of equipment at the bottom?

[James S. Tisch:]

I'm not exactly sure what you mean by dumping of equipment. Are you talking about offshore drilling equipment?

[Michael Millman:]

Yes.

[James S. Tisch:]

So, yes, there has been significant scrapping of certain offshore drilling equipment. That's equipment that's generally third- and fourth-generation rigs where there has been an assessment by the individual owners that those rigs it is not worthwhile for them to store those rigs with a hope and expectation that in a number of years they will be able to come back into the market. There is general agreement that there are more than enough fifth- and sixth-generation rigs in order to satisfy the future demand for drilling assets over the coming five years. So I think that it's very possible that some of that scrapping will continue. But I think the important thing to look at is not the scrapping but rather what percent of the fleet is operating and how much of the fifth- and sixth-generation fleets are stacked, and what would be the cost to be able to bring those rigs out of the stack mode when, as, and if the demand increases.

[Michael Millman:]

Okay. And then just kind of a follow up on your share repurchase. As analyst talking to investors and trying to convince them to buy Loews, it's difficult to do that when the company is saying, gee, it's not a good time, because we think it's possible the stock is going to go down with the market. So maybe you could sort of help us out on how do we approach this?

[James S. Tisch:]

So let me just mention a few things. Number one, we think about absolute value versus relative value. I don't think that Loews in any way is overpriced versus the stock market. But the stock market trading at 17x, 18x, or 19x earnings, the fact that interest rates are still as low as they are when we're seeing economic growth of 2.5%. The fact that there's a lot of complacency in all markets, not just the equity markets, leads me, and I'm pleased to say a significant number of other market commentators, to the view that this complacency that we're seeing in the markets can lead to a decline in equity values. When most investors buy Loews' shares, if they change their mind, if they get nervous about the market, they can turn around and sell those shares. When the company buys in the shares, we buy them forever. And so what we are trying to do when we buy our shares is to buy them at the cheapest price we can purchase them at. I understand there are a lot of companies that repurchase their shares, they do it according to a program, and they know every quarter they've budgeted so and so many dollars to buy in their shares. That's not the way we roll. I will stand firmly behind, and I am proud of, our repurchase record that goes back to the 1970s, that we've bought shares at attractive prices over that time period, and in that time period, have probably retired in excess of 75% of our then outstanding shares. So, yes, it is possible that I'm being a bit stubborn that the market is going to go up from here, but we've got to do what we think is right for all the shareholders. And our guess, at this point in time is, as it has been, not to spend our corporate cash on share repurchases. That can change at any point in time without any notice to shareholders, but it's how we come out after assessing all the factors that we consider.

[Michael Millman:]

Okay. Thank you.

[Operator:]

And our next question comes from Josh Shanker from Deutsche Bank.

[Josh D. Shanker:]

Hi. Thank you. I hate to keep hitting this horse, but maybe you can explain a few things to us. So you spoke about...

[James S. Tisch:]

The horse is already dead.

[Josh D. Shanker:]

Yes. Well, thank goodness Loews isn't. So that's what we're talking about here. And if we think about the idea of a 10% cash-on-cash return at Consolidated Container versus repurchasing your own shares, those are two different kinds of investment decisions. But as a good investment manager, you're supposed to be able to explain why one makes more sense than the other. Is a 10% cash-on-cash return better than you can do by buying your own shares and would you do that to kind of trade over and over again? And if that's the case, why buy any shares of those back? Why not be doing bolt-ons for CCC?

[James S. Tisch:]

Listen, first of all, buying CCC did not in any way hinder our ability to repurchase shares. Even after the CCC acquisitions, we had $5 billion in cash and investments. With respect to bolt-on acquisitions, CCC is ready, willing, and able to do it. They're looking around, they're waiting for the right deal at the right price, and doing bolt-ons is not like buying shares of stock. It's not there is something to do every day. You have to wait for the right opportunity and then seize it. And I promise you that CCC is looking for those opportunities. We discussed it with management, and we have complete confidence in management's ability to over time find the right bolt-on acquisitions for CCC.

[Josh D. Shanker:]

And with Loews's loan CCC the money to do bolt-ons or would it purchase those bolt-ons on their behalf?

[James S. Tisch:]

We haven't fully thought about it. It depends how big the acquisition might be. If it's not too big, certainly CCC can afford it itself. So there are a lot of different factors that will go into it.

[David B. Edelson:]

The way we've structured CCC post the acquisition is they have balance sheet capacity to do bolt-on acquisitions up to a point, of course, but a number of them.

[Josh D. Shanker:]

All right. And then I mean, we don't know. This is all hypothetical, but should we assume that a bolt-on for CCC has a higher cash-on-cash return than CCC itself because of your ability to leverage economies of scale and take out costs?

[James S. Tisch:]

Yeah. That's generally the case.

[Josh D. Shanker:]

Okay. Thank you very much.

[James S. Tisch:]

Thank you.

[Operator:]

This will conclude our question-and-answer session for today's program. I will now hand it back over to Mary for any additional remarks.

[Mary Skafidas:]

Thanks, Nichole. As always, we want to thank all of you for your continued interest. A replay will be available on our website, loews.com, in approximately two hours. That concludes the Loews's call.

[Operator:]

And that does conclude today's conference call. We thank you for your participation and ask that you please disconnect your lines.