Loews Corp (L) — Q1 2015 Earnings Call Transcript

Thank you, Lori, and good morning, everyone. Welcome to the Loews Corporation's first quarter 2015 earnings conference call. A copy of our earnings press release, our earnings PowerPoint snapshot 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. 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 projections made in any forward-looking statements. Forward-looking statements reflect circumstances at the time they are made, and the company expressly disclaims any obligation to update or revise any forward-looking statements. This disclaimer is only a brief summary 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 for reconciliation to the most comparable GAAP measures. I will now turn the call over to Loews' Chief Executive Officer, Jim Tisch. Jim?

Thank you, Mary. Good morning, and thank you for joining us on our call today. I hope that you all had a chance to look at our press release, which was distributed earlier this morning. Loews reported income from continuing operations for the first quarter of $109 million compared to $265 million in the first quarter of 2014. The quarter's results were significantly impacted by an impairment charge at Diamond Offshore of $158 million after-tax related to the carrying value of eight of its older drilling rigs. David Edelson, our CFO, will provide more details on the charge and key earnings drivers later in the call. I want to start today by looking at Loews $5.5 billion of cash and investments. Obviously, this is a lot of cash, but that's nothing out of the ordinary for Loews. Over the years, maintaining a sizable liquidity position has given us the freedom to deploy our capital opportunistically in order to create value for our shareholders over the long term. We've done this by using our cash to invest in our subsidiaries, to add new businesses, and to repurchase our shares. Let's briefly examine each of these levers. Two subsidiaries we've provided funding for over the last few years have been Boardwalk and Loews Hotels. At Boardwalk, when attractive capital markets funding has not been available or inflexible forms of financing are required, Loews has stepped in and provided bridge financing. We work closely with Boardwalk's management team to hone the financing plans, and our cash position enables us to utilize parent company capital on projects with attractive risk-adjusted returns for both Loews and Boardwalk. At Loews Hotels, over the past six months, the parent company has invested approximately $300 million to finance hotel acquisitions. Some of these investments have been in the form of equity bridge financing which we anticipate will be returned as Loews Hotels brings in outside equity partners. We like this model, and we intend to use it going forward to acquire additional hotels. In addition to enabling us to invest in our subsidiaries, a high level of liquidity allows us to move quickly and decisively when considering an acquisition at the holding company level. We are actively seeking to diversify our portfolio of businesses, but we don't want to rush into a deal simply because we have the funds available. Current valuations for companies and assets don't lend themselves to the kind of equity returns we want. We are looking for the right deal at the right price, either a company with good cash-on-cash returns and strong secular growth trends or distressed undervalued assets at an advantageous entry point in the cycle. And finally, let's not forget about share repurchases which remain an important way that Loews creates value for shareholders. On our call last November, I discussed in detail the various metrics we use when considering share repurchase decisions including the sum of the parts calculation. Over the last year, Loews spent almost $700 million of its cash buying back almost $16 million shares. As we have said before, money doesn't burn a hole in our pockets. While we acknowledge that cash can be a drag on Loews' short-term returns, we feel that having the flexibility to be opportunistic and not rely on financing markets has served our shareholders very well over the long term. Now let's look at some highlights from our subsidiaries. Let's start with Diamond Offshore. Loews has been in the offshore drilling business for more than 25 years. In that time, we have learned one thing with absolute certainty: offshore drilling is a cyclical business, and therefore, Diamond is managed accordingly. Nine years ago, when others were paying top dollars for new drilling rigs, Diamond began returning capital to shareholders by paying special dividends. Since January of '06, Diamond has paid over $41 per share in regular and special dividends, returning more than $5.7 billion to shareholders over that time. As this current cyclical downturn accelerated, however, Diamond decided not to pay a special dividend. Instead, the company elected to retain cash in order to maintain Diamond's financial strength and to position the company to be ready to act if rig acquisition opportunities presented themselves. While Diamond has been able to secure long-term contracts for its newest deepwater rigs, prospects have been far more challenging for its mid-water fleet. Diamond expects newer rigs to continue to compete aggressively against lower spec units. As a result of the increased competition and dramatically reduced rig chartering opportunities for mid-water rigs, this quarter Diamond decided to cold stack or scrap eight of those rigs that have no foreseeable employment prospects. We have no doubt that Diamond will withstand the cyclical downturn, and we hope and expect that the company will emerge having found opportunities to acquire good assets at attractive prices. But as of today, we are not aware of any distressed assets available for sale at prices even close to a price we would be willing to pay. Hopefully that situation will change in the next several quarters, and when it does, Diamond will be ready. Now let's turn to CNA. The company had a good quarter producing an 18% year-over-year jump in net operating income. The results were helped by lower catastrophe losses and strong investment income from limited partnerships. More importantly, management continues to focus on margin improvement in its core P&C business. While there is more to be done, we’re pleased with CNA's steady progress. For the coming year, CNA will be operating in a market where rate increases are likely to be relatively modest, and investment income will be constrained by the low-interest rate environment. CNA will remain focused on improving its underwriting capabilities in its commercial segment, maintaining its leadership position in its specialty segment, and prudently managing its long-term care book of business. At Boardwalk, over the last 15 months, the company has secured an extraordinary $1.6 billion in organic capital projects. These projects are backed by long-term agreements that are expected to generate double-digit unlevered returns once completed in the next two to four years. Since the projects will not come online immediately, Boardwalk raised $116 million in equity to help fund its capital expenditures this year and to manage its leverage. Maintaining its credit quality will be a key focus for Boardwalk during the build-out phase of these projects. Last but not least, let's turn to Loews Hotels. The hits just keep on coming for our hotel companies. Since the beginning of the year, the company opened the Loews Chicago Hotel, and it completed the acquisition of the 155-room Mandarin Oriental in San Francisco, which has been proudly renamed to Loews Regency, San Francisco. New additions to the hotel company continue to be well received, especially our newest hotel in Orlando, The Cabana Bay Beach Resort, which has been growing significantly since it opened a year ago in March. If you haven’t visited one of the hotels in Orlando, you should. And now, I’d like to turn the call over to David.

Thank you, Jim, and good morning. Loews reported income from continuing operations of $109 million, or $0.29 per share, for this year's first quarter, down from $265 million or $0.68 per share in the first quarter of 2014. Diamond Offshore reported sharply lower earnings this year, only partially offset by earnings improvements at CNA and Boardwalk. As I will discuss more fully, unusual items affected earnings comparisons at both Diamond Offshore and Boardwalk. Loews' net income, which reflects the impact of a $206 million loss from discontinued operations in last year's first quarter, was up year-over-year. As a reminder, last year’s loss from discontinued operations related primarily to the sale by CNA financial of its life insurance subsidiary. CNA contributed $202 million to Loews' income from continuing operations in this year’s first quarter, compared to $176 million in the first quarter of 2014. These amounts exclude after-tax realized gains of $8 million this year versus $24 million last year. The increase in CNA's net operating income was attributable to two main factors: number one, higher net investment income driven by limited partnership investments, and two, higher P&C underwriting income driven by lower catastrophe losses and improved non-cat accident year results. During the first quarter, CNA paid a $2 per share special dividend and a $0.25 per share regular quarterly dividend. At quarter end, after the payment by CNA of over $600 million of shareholder dividends, the company's capital and liquidity positions remain rock solid. Diamond Offshore contributed a loss of $126 million to our first quarter net income, down from an earnings contribution of $69 million last year. Diamond's first quarter results include an after-tax impairment charge of $319 million, of which $158 million flows through our net income. The charge resulted from Diamond's decision to impair eight of its lower spec rates, seven mid-water semi-submersibles and an older drill ship. Diamond announced that it plans to scrap three of the seven mid-water units being impaired. Additionally, Diamond booked a restructuring charge in this year's first quarter that reduced Loews' net income by $2.3 million. Absent the impairment and restructuring charges, Diamond's contribution to our net income declined from $69 million last year to $34 million this year. Lower rig utilization negatively affected rig operating income. In addition, depreciation expense was up from last year because of new rigs having been placed into service. Boardwalk pipeline contributed $25 million to Loews' net income during Q1 2015, up from a loss of $18 million last year. The loss last year included a $55 million after-tax charge related to the write-off of all capitalized costs associated with the former Bluegrass project. Absent this charge, Boardwalk's contribution to our earnings decreased primarily due to lower EBITDA and higher depreciation. The EBITDA decline stemmed from lower revenue from transportation, park and loan, and storage, attributable in large part to warmer winter weather this year versus last in Boardwalk's market areas. During the first quarter and into early April, Boardwalk sold $7 million common units under its equity distribution program. Net proceeds to Boardwalk were $116 million including the general partner contribution. Boardwalk sold the equity to manage its capital ratios during a period when it is spending capital on projects that are not yet in service and thus not producing EBITDA. In keeping with its focus on capital management, we anticipate that Boardwalk will draw down its $300 million subordinated debt facility from Loews later this year. Loews Hotels generated net income of $5 million during the first quarter, up from $3 million last year. Adjusted EBITDA, which you can find in the earnings snapshot posted on our website, was $35 million during the first quarter versus $24 million in the prior year. The increase in adjusted EBITDA was driven by Loews Hotels property at Universal Orlando, including The Cabana Bay Beach Resort, as well as improved performance at various other properties. As Jim mentioned, during the first four months of 2015, we invested over $300 million in Loews Hotels to finance the all-equity acquisitions of the Loews Chicago and Loews Regency, San Francisco hotels. Over time, those hotels will likely put leverage on these properties and may, if appropriate, bring in equity partners. Turning to the parent company. After-tax investment income declined from $34 million in 2014 to $19 million in 2015, driven by reduced performance from equities, partially offset by higher returns from the parent company's limited partnership portfolio. At quarter end, cash and investments totaled $5.5 billion, compared to $5.1 billion at the end of December. Over $4 billion of our cash and investments were in treasury bills and notes and other short-term instruments which, given the current interest rate environment, earn us very little but provide strong liquidity. We received $567 million in dividends from our subsidiaries in the quarter, which broke down as follows; $545 million in regular and special dividends from CNA, $9 million from Diamond, and $13 million from Boardwalk. As for returning capital to our shareholders, during the first quarter we paid $23 million in cash dividends and spent $71 million buying back $1.8 million shares of our common stock. We also spent $24 million during the quarter buying just over 900,000 shares of Diamond stock, taking our ownership to 53.1%. I will now hand the call back to Jim.

Thank you, David. Before we open up the call to questions, let me summarize how we think about each one of our businesses. As I said six months ago, trouble is opportunity when it comes to the offshore drilling market. The market is certainly challenged, but Diamond is positioned to withstand this downturn and hopefully sees opportunities as they arise. CNA is improving its underwriting performance and maintaining a stellar balance sheet. Diamond is repositioning its operations to align with the evolution of the U.S. natural gas marketplace, and Loews Hotels is adding to its presence in key markets with exciting potential. We continue our commitment to pursuing a value-oriented investment strategy and to creating a diverse portfolio of solid businesses. As always, Loews is focused on managing capital to achieve the best long-term return for our shareholders. We found that disciplined capital management, coupled with a diverse portfolio of businesses, is an exceptional way to create value over time. Now I'd like to turn the call back to Mary.

Thank you, Jim. Lori, we're ready to start the Q&A portion of the call.

Good morning, Loews. What's behind the thought process of using the Regency brand name for San Francisco, and are there other hotels that you might want to consider rebranding to, I assume that's a preferred segment?

So we have the Loews Regency in New York, which is a hotel that is of a higher quality than the Loews hotel brands. And when we had the opportunity to acquire the former Mandarin Oriental in San Francisco, we decided that that would be a good place to extend the Loews Regency brand. So voila, you see that we now have two Loews Regency Hotels. If we have the opportunity going forward to create more Loews Regency Hotels, we certainly would like to do that.

But there are no other candidates from your installed base of hotels that compare with these two in your mind?

No, there are no plans to upgrade any of our hotels to the Loews Regency brand.

Okay. You've been prescient in one respect of saying troubles ahead in the offshore drilling marketplace for a couple of years, and I was thinking the opportunities would be nearer for Diamond than I think you just suggested in the call today. What sort of macro variables should we be looking at to see that it would be a time that Diamond would become more active to benefit from the carnage?

I think right now the conditions are bad enough for rig valuations to go down. The problem is they haven't been bad enough for long enough. There are people who either have rigs chartered, so they are not feeling any pressure. There are people who may have lost charters or who have rigs that are unchartered now, that are feeling a lot of pressure. But interest rates are low, and at least for the next few months, they are able to get by. People that have rigs that are scheduled to come out of the shipyard - many of them have delayed the arrival of those ships. But there is no doubt in my mind that as the charter market remains a vast desert for these fifth- and sixth-generation rigs, that the carrying cost of the rigs— which includes both the interest that they have to pay on their debt and additionally the staffing cost for these rigs, which can be as much as $2 million to $3 million a month—will start to weigh on the owners. And at that point, in the next two, three, or four quarters, I think we could see some fifth- and sixth-generation rig assets become available for sale.

So it sounds like we're a couple of years away from seeing—

Or at least the number of quarters.

Right. How many shares of Diamond do you now own?

We own about 53% of Diamond.

I got that. But do you have the absolute number of shares?

Yes, we will get it for you. It's probably $73 million - $73.9 million - $72.9 million, yes.

Thank you.

Thank you.

Yes, good morning, everyone. So I think maybe a year or two ago in a question about making acquisitions during what has been a variable market, you said that while back five, six, seven years ago public equities were very cheap, it didn't necessarily feel that way for private equities. And Loews, and if I'm incorrectly stating anything, please correct me. You like to take a controlling stake or a complete ownership, so private equity is really the avenue you'd like to pursue. I'm wondering if you can update, given the amount of cash you have on the balance sheet, your view on what opportunities there are out there private versus public and how you feel broadly about the next Loews acquisition?

So, I don't recall the comments that I made; I’m sure that I made it. Let me just talk about where I think the market is right now. I think that after all these years of low-interest rates and quantitative easing, what we have is markets—both fixed income and equity markets—that are priced for perfection. Stocks are almost at new highs. The NASDAQ reached new highs last week, and the S&P is within a shot of it. Today, as we speak, the market multiple is, I don’t know, 16, 17, 18 times earnings. When you look at companies that are auctioned in the private equity world, what I would say is that 10 is the new 6, and what that means is, in the old days, when companies would trade at an EBITDA multiple of six times, today that number is 10 times. And yes, interest rates are low, but still it seems to me that even though you can finance at low rates, there just isn't enough room for return for the equity holder at these kinds of valuations. So, my guess is that for the time being businesses look like they're priced too high for us. Now, one of the things that I always remember is that the world is cyclical. And it's easy to lose sight of that because we're now firmly in year six of an upcycle for equity prices. But at some point in time, something will happen. People will lose all the confidence that they have, and my guess is that opportunities will present themselves. Like I said, for offshore drilling, it could be a while, and offshore drilling, it’s in the next several quarters. In the market for businesses, it could be in the next several years. But I’d rather be patient and get a good business at an attractive price rather than lose patience and buy a business at too high a price.

And is there any way that you can use expensive dollars to buy something overseas as opposed to being here in the states or where your appetite is ultimately?

No, we’re happy to buy businesses here that have foreign operations. I think it's a much bigger leap to buy a business based in a foreign country. First of all, we keep scoring dollars; secondly, the foreign markets are markets that don't scare us. By the same token, we’re not fully familiar with the rules, regulations, customs, and taxation. And so our hunting ground is primarily in the United States.

That's perfect. Thank you, Jim. I look forward to a press release, but I can't imagine when it will come. Take care.

Thank you.

Thank you. So continuing on the same theme on the macro, what price does crude have to get to or oil have to get to before I guess the blood rushing in the industry?

WTI is currently at about $59 a barrel. Brent is $66 a barrel. I think here at the price where investment starts to make sense for offshore and onshore drilling. But there is something else I think that has to happen in order for investment to pick up, and that is that I think people have gone want to see how volatile prices are. So will prices be at $59 a month from now? Will they be at $49? If they are $49, then there is still a lot of volatility in the marketplace; then I think you are not going to see a confident comeback to the market. On the other hand, if $59 on WTI and $66 on Brent is the new normal and we will see that over the coming few months, then I think you will start to see some glimmers of drilling. But there are a lot of headwinds for the market. Number one, we have thousands of wells in the United States that have been drilled that have not yet been tracked. Number two, we have very high levels of oil in storage in the United States beyond the normal levels, and so I think that there is a distinct possibility that those headwinds can be a real hindrance to prices moving up more from here.

Moving up much more from here in the next year, the next decade?

Six months or so.

And how do you -

One other thing, and that is there is a real distinction between drilling for oil in shale formations and drilling for it offshore. When you drill for oil in shale, it can be as little as two months between the time that you make the investment decision until the time that you start production. And so, it's relatively—and you also have a very good sense of exactly how much oil you are going to be able to produce from that shale well. So with prices at $59 a barrel, you are able to pretty effectively hedge your first several years of production, which makes all the difference in terms of the economics of your well. So there is, remember, I am sure shale production is two months from the time you decide to drill until the time you’re producing. For offshore drilling, it’s two to five years from the time you decide to drill until the time that you can be producing. So, the offshore guys are much less concerned about the spot price for oil and much more concerned about what the trend is going to be. They don't know nearly as well how much oil they are going to be able to produce from that well that they may drill in the next year, and they have got to complete all manner of completion, so they don't know exactly when the oil is going to be produced. So it's much more difficult for them to hedge their production than it is for the onshore shale people.

How much shale oil is available or put another way why would offshore drill unless they thought that the oil shale was going to be there out?

So, offshore production is about $20 million barrels a day, and it is a very important part of total worldwide oil production. Shale production is probably under $5 million barrels a day. So, shale production just cannot make up for the production that takes place offshore, that’s number one. Number two, when you look at breakeven rates, you see that offshore oil drilling, in many theatres, is very competitive with the economics of shale production. So there is no doubt in my mind that moving forward we will continue to see shale drilling and shale production, and we will continue to see offshore drilling and offshore production.

To switch a little bit, I know it's very helpful, on hotels can you envision the hotel business generating anything near what your oil-related businesses generate?

I don't know. All I know is that the business has been growing very rapidly. Recently we have added hotel, we have added two hotels in Chicago, Minneapolis, Washington DC, Boston, Orlando, Hollywood, San Francisco, and there is one more on the boards for Orlando. We've seen a significant increase in EBITDA, and hopefully earnings will soon follow. So I think you’re seeing a rejuvenation of the Loews Hotels brand name, and we’ll just see how we are able to do going forward.

Do you envision the hotels generating 10% of total revenue and if so, when?

You're talking about far in the future, and I just don’t know.

Okay. Thank you. I appreciate it.

Thanks everyone. I just wanted to remind you the replay of this call will be available on our website in approximately two hours. That concludes today's call.