Loews Corp (L) — Q2 2015 Earnings Call Transcript

Thank you, Laurie. Good morning, everyone, and welcome to Loews Corporation's second quarter earnings conference call. A copy of our earnings release, earnings 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 securities filings for a reconciliation to the most comparable GAAP measures. I will now turn the call over to Loews' Chief Executive Officer, Jim Tisch.

Thank you, Mary. Good morning and thank you for joining us on our call today. I hope you've had a chance to look at our press release, which was distributed earlier this morning. David Edelson, our CFO will provide details on our second quarter earnings later in this call. What you would have noticed without the help of our release, however, and what I want to acknowledge upfront, is the significant decline in the share prices of Diamond Offshore and Boardwalk Pipeline Partners. Since last quarter's remarks, Diamond's share price has declined by nearly 35% and Boardwalk's by about 20%. While we're certainly not happy with these declines as shareholders and as capital allocators, our job is to look ahead and assess future opportunities for Diamond and Boardwalk. Yes, the equity markets are currently punishing their stocks and those of their peers. But as we look to the future, we're positive about Diamond and its customers' needs to pursue offshore drilling programs. And we believe the changing gas laws in the U.S. combined with the renaissance of U.S. manufacturing and the transition from coal to gas-powered generation bode well for Boardwalk. Both Diamond and Boardwalk are focusing on taking strategic actions in order to better position themselves for future growth. And both companies certainly have the financial strength to undertake these actions. I suspect you're wondering if Loews intends to buy Diamond and Boardwalk shares at these depressed prices. As those of you who've been listening to our calls for any amount of time know, with regard to share purchases, we let our actions speak for themselves and we will do so again today. What I can tell you is that, since April 1, we have repurchased 9.1 million shares of Loews common stock for $360 million; and that, year-to-date, we have repurchased 10.9 million shares for $432 million. While we don't publicly announce our share repurchase plans, we have talked about how we think about buybacks. And that thinking hasn't changed. We've always believed that repurchasing our shares at prices below intrinsic value enhances the long-term value of Loews' common stock. And from the 'put your money where your mouth is' department, our recent actions certainly show that we believe our shares are a good value. Now, let's take a look at each of our businesses. CNA's earnings comparisons during the second quarter were affected by a number of one-time items, which David will explain shortly. Operationally, however, CNA continues to make progress in improving its underwriting results. Year-to-date through the second quarter, the company's loss ratio, excluding catastrophe losses and prior-year development, was 61.7% compared to 62.8% for the full-year 2014 and 63.8% for the full-year 2013, a 2-percentage point improvement over two years. A key driver of CNA's improved underwriting performance is its focus on deepening its industry-specific technical expertise. CNA's targeted growth efforts in specific consumer-focused segments such as technology, professional services, and financial institutions allow CNA to more accurately assess and price risk. Additionally, CNA continues to manage risk and volatility across the company and maintains a very strong capital position. Although there's more work to be done, we believe CNA has made great strides and is positioned well for better and more consistent underwriting profitability. Turning to Diamond Offshore. Despite stiff headwinds, the company had a good quarter, primarily due to the expense controls that were put in place last year. Even as the competitive environment for the offshore drilling industry continues to be adversely affected by the trifecta of a steep drop in oil prices, a reduction in exploration and production budgets, and a wave of new rig deliveries, Diamond's marketing efforts have paid off. The company recently signed an agreement with Woodside Petroleum for its newly rebuilt Ocean Apex to drill in Australia. This is an 18-month contract beginning in the first half of 2016 at a rate of $285,000 per day. Additionally, Diamond has taken delivery of the Ocean BlackLion, the last of its new drillships. The Ocean BlackLion will be mobilized to the Gulf of Mexico and should begin working for Hess before the end of this year. Diamond's ultra deepwater harsh environment semi-submersible, the Ocean GreatWhite, is scheduled to join the fleet in 2016 and has an initial three-year contract with BP in South Australia. As a reminder, all four of Diamond's sixth generation drillships and the Ocean GreatWhite are contracted into 2019 and 2020. We have no doubt that Diamond will withstand this tough cyclical downturn. We hope and expect that the company will find opportunities to take advantage of these market conditions to profitably grow its fleet. Moving on to Boardwalk, the U.S. shale revolution has been a transformative force in Boardwalk's business. Increased shale production has disrupted natural gas flows and created re-contracting challenges for Boardwalk and for the rest of the industry. More recently, however, the shale revolution has opened the door to a number of organic growth opportunities. In fact, Boardwalk has been able to secure an impressive $1.6 billion in organic growth projects since 2014. Over the past few years, the growth of low-cost gas production in the U.S. has unleashed an abundant supply of natural gas liquids, precipitating a rapid expansion of petrochemical manufacturing along the Gulf Coast; and Boardwalk Louisiana Midstream, our natural gas liquids transportation and storage company, is benefiting from this industrial expansion. The increased demand from Louisiana's industrial corridor has also been a boon for Boardwalk's Gulf South natural gas pipeline. The natural gas that Gulf South transports to Louisiana's petrochemical plants not only powers them but also serves as a building block for the products they produce. With the company's recent agreement to service Sasol's new ethane cracker and with the addition of the Evangeline Pipeline late last year, Boardwalk continues to focus on growing its natural gas liquids and dry gas service offerings to capitalize on burgeoning petrochemical demand in Louisiana. And last, but certainly not least, let's turn to Loews Hotels. Loews Hotels posted another good quarter. Over the past few years, our hotel company has successfully focused on profitable growth and operational excellence. From 2012 to 2015, Loews Hotels added eight hotels across the country. These additions to the hotel network have contributed positively to adjusted EBITDA. The company currently has one hotel under construction, the Loews Sapphire Falls Resort, its fifth hotel in Orlando which is scheduled to open in 2016. When it opens, the 1,000-room hotel will result in our having 5,200 rooms in Orlando. Not to tempt fate, but our hotel investments in Orlando over the past 15 years rank very high in the pantheon of outstanding worldwide hotel investments. Before I turn the call over to David, I want to add that we have great confidence in the long-term prospect for each of our businesses. We recognize that diversification may mean that not all of our subsidiaries will be moving in the same direction at the same time. However, we have found that disciplined capital management, coupled with a diverse portfolio of businesses, is an exceptional way to create value over time. And now, over to you David.

Thank you, Jim, and good morning. For this year's second quarter, Loews reported income from continuing operations of $170 million or $0.46 per share, down from $303 million or $0.79 per share in the second quarter of 2014. Lower earnings at CNA Financial drove the decline, as well as reduced earnings from the parent company's investment portfolio, as I will discuss more fully unusual items affected the year-over-year earnings comparison at CNA. Our second quarter net income was up from last year. The second quarter of 2014 included after-tax losses from discontinued operations of $187 million attributable to our disposition of HighMount Exploration & Production. CNA Financial contributed $124 million to Loews' income from continuing operations in this year's second quarter as compared to $235 million in the second quarter of 2014. The year-over-year comparison wasn't nearly as negative as it first appears. Two unusual items accentuated the year-over-year decline. Last year, CNA's earnings contribution to Loews included a $50 million non-recurring benefit from a post-retirement medical plan curtailment. This year, CNA's earnings contribution was reduced by $49 million attributable to a retroactive reinsurance charge related to the loss portfolio transfer entered into by CNA and National Indemnity in 2010. As a reminder, the loss portfolio transfer provides CNA with $4 billion in reinsurance coverage for legacy, asbestos, and environmental pollution liabilities. This quarter's charge resulted in a deferred retroactive reinsurance gain, which will be recognized back into CNA's earnings in future periods as losses are paid by National Indemnity under the loss portfolio transfer. These two unusual items comprise a $99 million year-over-year negative swing in CNA's contribution to Loews' net income. Other factors contributing to the earnings decline from CNA were lower income from the company's Life & Group segment as well as from limited partnership investments. Offsetting positives included favorable net prior-year development this quarter versus adverse development last year and better current accident year underwriting results, which Jim previously mentioned. Diamond Offshore contributed $45 million to income from continuing operations, up slightly when compared to its contribution of $42 million for the same period last year. Diamond's results reflect the cold stacking or sale of 16 rigs since the second quarter of 2014, offset in part by newbuild drillships and other high-spec assets going to work. Contract drilling revenues were down 5%, but Diamond's expense control initiatives enabled it to reduce contract drilling expenses by 13%. Interest expense and depreciation were up versus prior year, however, because of the delivery of the newbuild assets. Bottom line, Diamond itself delivered second quarter 2015 net income essentially flat with prior year. As a reminder, we have increased our percentage ownership of Diamond from 51% to 53% since last year, which explains the higher net income contribution despite flat net income at Diamond. Boardwalk Pipeline contributed $12 million to income from continuing operations in the second quarter as compared to $17 million last year. While Boardwalk's operating revenues were up slightly, this increase was more than offset by higher costs including depreciation and interest expense. Boardwalk's transportation revenues were up because growth projects more than offset contract expirations. In addition, transportation revenues benefited from the ongoing Gulf South rate case and the receipt by Boardwalk of insurance proceeds related to a business interruption claim. Consistent with the first quarter, park and loan and storage revenues were down year-over-year. The timing of maintenance activities drove the increase in operation and maintenance expenses. Also, the prior-year quarter included a one-time benefit from a legal settlement. To date, Boardwalk has not drawn down on its $300 million subordinated loan agreement with Loews. We anticipate the company will draw the full $300 million by the end of 2015. Loews Hotels contributed $8 million to our second quarter income from continuing operations, up from $5 million last year. You will note a large jump in revenues from last year's second quarter. Loews Hotels has added five wholly-owned properties to the chain since the second quarter of 2014, which together with growth at existing wholly-owned hotels, accounts for the sizable revenue increase. Of course, the company's operating expenses, interest expense, and depreciation are also up for the same reason. The year-over-year growth in pre-tax and net income is attributable mainly to the joint venture hotels in Orlando, which continued to perform extremely well. Adjusted EBITDA, which you can find in the earnings snapshot posted on our website, was $55 million during the second quarter versus $32 million in the prior year. The five new wholly-owned properties, as well as Cabana Bay in Orlando, accounted for the preponderance of the increase. Turning to the parent company. After-tax investment income declined from $30 million in 2014 to $7 million in 2015, driven by reduced performance from equities and limited partnership investments. At quarter end, cash and investments totaled $5.1 billion as compared to $5.5 billion at the end of March. During the quarter, parent company cash was used to repurchase shares of Loews common stock and invest in Loews Hotels, which closed on the purchase of its San Francisco property and a 50% joint venture interest in its Atlanta property. We received $83 million in dividends from our subsidiaries in the quarter, which broke down as follows: $61 million from CNA, $9 million from Diamond, and $13 million from Boardwalk. During the first six months of the year, we received a total of $650 million in dividends from our subsidiaries compared to $512 million during the first half of 2014. As for returning capital to our shareholders, during the second quarter, we paid $23 million in cash dividends and spent $233 million buying back 5.8 million shares of our common stock. Subsequent to June 30, we have repurchased an additional 3.3 million shares for $127 million. In total, since January 1, 2015, we have spent $432 million repurchasing almost 3% of our common stock. I will now hand the call back to Mary.

Good morning, Loews. I'm curious on the hotels. What would your thought process be on the pros and cons of bringing the hotel operation public given the nice growth in EBITDA? It seems like there's a pretty good story that might have interest with investors.

Yeah. Bob, there's a good story, but we got to figure if that's good for Loews Corp. and also for Loews Hotels. And right now, I think it just seems to us it doesn't make sense. So Loews Hotels is 100% owned and for the foreseeable future will stay that way.

Why doesn't it make sense?

Because Loews finances and provides a lot of finance for Loews Hotels, which is much easier when it's 100% owned. Combined with the fact that, I don't know that there is a really great business purpose to take Loews Hotels public. Being public is a lot different than being owned privately. And at this point in time, the management of Loews Hotels is focused on growing their business and not on dealing with shareholders who are looking for growth or, Lord knows, what else.

Okay. On the Diamond side, is there anything – you bought some shares, I think, in the $30s, if I'm not mistaken, and have been sort of inactive as the stock has drifted down. Your thought process – are you at sort of where you want to be in that for now, or could you be bigger if you wanted to be?

I love quoting myself. And as I said in my comments, we just don't comment on share purchases or repurchases.

That's okay, Bob. I'm going to give it a try, too. How are you all doing?

So far so good.

So can you tell me a little bit about the difference in mentality between buying a Loews share versus buying a Boardwalk or a Diamond share?

There really isn't that much difference.

So would it just be which one is cheapest at the time that you make the decision, or – how do you – how would you negotiate that situation? Do you really want to increase ownership in something when you could just reduce your own share count? What are the types of discussions you have in that regard?

We discuss all those issues as well as lots of other issues. The overriding theme of all the issues though is what is in the best interest of Loews shareholders. So we factor a lot of different things in, and I don't really want to go into any detail about what those issues are, but like I said, the overriding question is what makes the most sense for our shareholders.

Okay. And in terms of – no, I'm just going to let it be, I'll take it Jim. Do you have any thoughts on Puerto Rico and whether there's any risk to you guys?

We do not have significant exposures to Puerto Rico. With respect to Puerto Rico, man, it seems to me that they could really use some action in Washington to allow them to make use of the bankruptcy code. Otherwise, I think it's going to be a real massive mess, because holdouts can just hold out, and I don't fully understand just yet how things will settle out.

Is there an opportunity for you in Puerto Rico or is it doing anything in the municipal market to give you an opportunity to do something else?

Right now, the municipal market is priced pretty well from an issuer's perspective. I could see a situation where if municipal investors get concerned about Puerto Rico, and then you add on top of that, they get concerned about certain state and municipality pension liabilities and you could see the retail investors start to move away from the municipal market; and if that happens, you could see possibly forced selling on behalf of mutual funds. And if that's the case, oftentimes they sell the good solid names because the gamier names often don't have a bid. And so you could see a real decline in the municipal market as a result.

And have you seen any contagion with the full Puerto Rico thing? Has there been any rippling through to anything that you hold that's completely unrelated?

No, not at all.

Thank you. So maybe this is impossible to answer, but where do you see oil prices, petroleum prices, going in the next five years? And in the long term, are we looking at different fuel sources?

So I'm glad you asked about five years instead of six months or one year, because five years, I think I might actually be able to give you a thoughtful answer. I would see that five years from now, oil prices will be at least 50% higher than they currently are. That in order to find a barrel of oil today, it probably costs a minimum of $70 a barrel to get that marginal barrel of oil that's needed. My guess is, five years from now, it will be a bit higher than that. And I think what has to happen is, the world has to supply the 1 million barrels of growth, plus approximately 5 million barrels to replace the depletion from the world's productive capacity. So that 6 million barrels a day has to be found every year for the next five years, or about 30 million barrels of new production. In order for the world to be able to produce that, even with Iran coming back onto the market in the not too distant future, I think it will take significantly higher oil prices. And five years from now, I think it's certainly reasonable to think that the price will be $70, $75, or $80 a barrel. That doesn't account for another wild card, which is political instability. A lot of oil comes from the Middle East and we have – while we have political instability in the Middle East in certain places, we don't currently have that having a significant effect on oil production. But in the future, as we all know, anything can happen.

So it sounds like your assumptions are that we are going to need to replace the oil and doesn't suggest that maybe other things are replacing oil from gas to shale to non-petroleum-based products?

Well, first of all, I think shale can continue its growth, but I don't know that it's going to be the panacea for oil production over the next five years. But right now, it looks like shale production in the United States has flattened out. And I think what we're seeing is that it will take higher prices to get shale production moving again. I think that offshore oil will be a big beneficiary because in the future, 20% to 25% of our oil – of world oil production will have to come from offshore. And so that actually makes me very positive when I think about Diamond Offshore.

How much comes from offshore now?

About 20%.

Okay. Moving on, in five years, how much contribution or percent contribution to earnings will come from hotels?

The good news is we don't make forecasts and I try not to make forward-looking statements about our businesses in any detail, so I'm not going to answer that.

So let me ask it in a non-detailed way, will it be greater than 10%?

I don't know. You're going to have to run your own numbers.

Yes. Good morning. Can you hear me?

Good morning, Michael.

Just a follow-up question, the rig count or the supply, especially in the U.S., at least according to Baker Hughes, both of the horizontal rigs as well as gas rigs is down between 50% on the horizontal rigs, and I believe gas is down about 40-plus percent. How much more supply shrinkage do you think is necessary for the production to begin to really decline?

Supply shrinkage of – or utilization of drilling rigs?

Yes.

I don't know, because what we've seen over the years is tremendous improvement in efficiency of these drilling rigs. I don't have the numbers at my fingertips, but gas rigs, for example, are down dramatically from five years ago, yet gas production is up significantly. So I don't quite know what those numbers look like, or what the numbers are in answer to your question. I'd suggest you try asking the people at Baker Hughes or Halliburton who would have a much better idea of what that is.

Thank you. What do you think is the probability of the law changing where the United States will allow the export of oil?

Look, I'm not much of a political analyst. For me, it's a great amateur sport. But I would say, my guess is, there is a pretty good chance that they're going to get the proverbial ball over the goal line this year and allow for the exportation of oil from the United States. From my perspective, it certainly makes a lot of sense. Right now, we have a system that favors the refiners by making available to them oil at very cheap prices because it can't be exported. And instead, the refiners are exporting 3 million barrels to 4 million barrels a day of refined products. So all we're doing with our current system is subsidizing refineries and penalizing oil producers.

One last one from me. What was the cash – the corporate cash at the end of the quarter on the balance sheet?

About $5.1 billion.

Thank you so much and good luck with the rest of the year.

Thank you.

Thank you, David. Laurie, at this time, we would like to open up the call for questions. Could you please give instructions for asking questions to caller participants?