Loews Corporation (L) Q3 2011 Earnings Report, Transcript and Summary

Good morning. My name is Melissa, and I will be your conference operator today. At this time, I would like to welcome everyone to the Loews Third Quarter 2011 Earnings Conference Call. [Operator Instructions] I will now turn the conference over to Darren Daugherty, Director of Investor Relations. Please go ahead.

Thank you, Melissa. Good morning, everyone. Welcome to Loews Corporation's Third Quarter 2011 Earnings Conference Call. A copy of the earnings release may be found on our website, loews.com. On the call this morning are Chief Executive Officer Jim Tisch and Chief Financial Officer Peter Keegan. 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 reconciliations to the most comparable GAAP measures. I will now turn the call over to Loews' Chief Executive Officer, Jim Tisch.

Thank you, Darren, and good morning, and thanks for joining us on our call today. Loews reported net income of $162 million for this year's third quarter compared to $36 million for the third quarter of 2010. Results for the prior year quarter included a $328 million after-tax charge related to CNA's agreement to cede its legacy asbestos and pollution liabilities to a subsidiary of Berkshire Hathaway. Excluding that charge, net income for the quarter decreased by $202 million versus the prior year quarter, primarily from 3 factors: one, decreased limited partnership investment results at CNA; two, lower performance of equity-based investment in the Loews holding company portfolio; and three, higher natural catastrophe losses at CNA. Setting aside these factors, our subsidiaries delivered solid performance in their operations. At CNA, the growth strategies that has been put in place are resulting in continued improvement in the fundamental of its core property and casualty operation. Increased net written premium has marked the third consecutive quarter of topline growth, which was driven by strong new business and high retention. Along with this growth trend, CNA continues to achieve rate improvement, particularly in its commercial segment. Third quarter combined ratios before catastrophes and development improved for both specialty and commercial, while the property and casualty business segment benefited from its 19th consecutive quarter of favorable loss reserve development. CNA remains confident in the overall adequacy of its reserve and will continue to maintain its disciplined reserving practices. Despite the good operating performance in its property and casualty operation, CNA's results were negatively impacted by the performance of its limited partnership investment. LP losses were driven by negative equity market return during the quarter, combined with widening credit spreads and overall capital market volatility. Although CNA's portfolio of limited partnership investment can create earnings volatility, it continues to be an attractive investment strategy for CNA. These holdings have yielded equity-like returns over the years with less volatility and higher absolute returns than in equity portfolio. Given the LP results for the quarter, it might be helpful to review how these LP investments have performed over a longer timeframe by repeating some performance figures that CNA disclosed on its call earlier today. CNA's LP portfolio produced a third quarter return of negative 3.7%, while the S&P 500 total return was negative 13.9%. Over the last 10 years, CNA's LP investments produced an annualized return of approximately 8% compared to a 3% total return for the S&P 500. So as you can see, over the longer term, the hedge fund portfolio has provided good return, especially in light of the prevailing low yield in other asset classes. Turning now to Boardwalk. With Stan Horton on board as CEO for about 2 quarters now, Boardwalk is in full growth mode. Last quarter, Boardwalk enumerated a growth strategy that included expanding its existing pipeline assets to connect to new supplies and markets. Two weeks ago, Boardwalk announced that it has won a joint venture with an affiliate of its general partner, which is owned by Loews. The new JV has entered into a definitive agreement to acquire Petal Gas Storage and Hattiesburg Gas Storage from Enterprise Products Partners for $550 million. Petal and Hattiesburg operate 7 high-deliverability salt dome natural gas storage caverns located in Mississippi. These assets are a great addition to Boardwalk's pipeline footprint. The facilities are anchored by a long-term fund agreement, with approximately 80% of the existing customer base being either electric or natural gas utilities. The location and types of storage assets are very desirable, and when combined with existing assets, Boardwalk expects numerous opportunities for synergy and growth. Loews will contribute $280 million of the joint venture's equity for an 80% ownership interest, and Boardwalk will contribute $70 million for 20% ownership. An additional $200 million will be raised by the JV through a 5-year bank loan. At a later date, if it makes economic sense, Loews' 80% ownership interest can be dropped down to Boardwalk in one or more transactions. Within its field services business, Boardwalk has also announced a new gathering pipeline in the Marcellus shale. This new project is expected to cost approximately $90 million and will be built out over several years. It is anchored by a 15-year fee-based contract with Southwestern Energy. Marcellus is likely to become a very significant supply basin for the United States, and Boardwalk hopes to identify and execute on additional opportunities in the Marcellus area in the future. Additionally, Boardwalk has received regulatory approval to turn some of its assets in South Texas into a rich gas system in order to transport liquids-rich natural gas out of the Eagle Ford region. The project is expected to be completed by year end, and while Boardwalk has not announced any firm commitment, it is seeing interest from the producer community. Boardwalk's goal over the next several years is to strengthen its position of pipeline business while diversifying its products and services. Boardwalk is working hard to identify organic growth opportunities and other acquisition opportunities that are accretive and do not significantly increase its overall risk profile. Turning now to HighMount. I'd like to give an update on its most recent acquisition. As of today, HighMount has completed the purchase of working interest in oil and gas properties located on approximately 70,000 net acres in Oklahoma. These properties are mostly undeveloped, and HighMount believes that they contain primarily oil and liquids reserves that can be produced through horizontal drilling. The purchase price of $106 million was funded with a capital contribution from Loews. There are a few key points to the investment rationale: First, we believe there is a large upside potential in this oil resource play. HighMount will be able to drill nearly 600 wells which should have favorable single-well economics. Second, the resource opportunity will focus on the Mississippian line and Woodford Shale. The Mississippian line has been reasonably de-risked by development on and surrounding the properties. Third, while we remain bullish on natural gas over the longer term, these properties should help to diversify HighMount's reserves, which consists almost entirely of natural gas and liquids. And fourth, HighMount will control operations over 82% of the leasehold, and the continuous makeup of the acreage creates operational efficiencies. The resource opportunity fits well with HighMount's core technical competencies. While this acquisition is not a game-changer in terms of its magnitude, it is a significant step in HighMount's overall growth strategy. HighMount will continue to look for other value-creating opportunities. And with that, I'll now turn the call over to Pete Keegan, our Chief Financial Officer. Pete?

Thanks, Jim, and good morning, everyone. Loews Corporation reported earnings of $0.40 per share for the third quarter of 2011. Adjusting for the charge associated with CNA's Loss Portfolio Transfer transaction in 2010, earnings for the prior year third quarter would have been $0.87 per share rather than the reported $0.09 per share. This decline in results versus the adjusted number was primarily due to lower results from CNA and lower investment income in the holding company portfolio but was partially offset by higher earnings from Diamond Offshore. CNA's contribution to Loews' net operating income was $84 million in the third quarter. In the prior year quarter, CNA contributed an operating loss of $140 million, or, when adjusted for the Loss Portfolio Transfer, CNA contributed operating income of $169 million in the prior year quarter. Net operating income in CNA's core property and casualty operations declined primarily because of lower net investment income than higher catastrophe losses. Net investment income for the 3 months ended September 20, 2011 decreased by $187 million pretax as compared to the same period in 2010, primarily driven by the previously discussed decrease in limited partnership results as well as lower fixed-maturity security income. In the third quarter, CNA reported catastrophe losses of $29 million after tax and noncontrolling interest as compared to $7 million for the same period in 2010. P&C operations produced a third quarter combined ratio of 99.1% versus 98% in the third quarter of 2010. Excluding the impacts of prior year development and catastrophe losses, combined ratios were 101% and 103.7% for the comparable periods. For the quarter, CNA reported realized investment losses of $15 million after tax and noncontrolling interest versus realized investment gains of $37 million in the prior year quarter. Diamond Offshore's contribution to net income for the quarter increased to $121 million from $93 million in the prior year quarter, primarily as a result of an increase in contract drilling revenues. Results for the third quarter of 2011 reflect the return to service of 3 of Diamond Offshore's high-specification floaters that were idled during the second quarter of 2010 following the Macondo incident in the Gulf of Mexico. Also, the newest addition to Diamond Offshore's floater fleet, the Ocean Valor, began generating revenue in the fourth quarter of 2010 when it commenced operating under contract in Brazil. Contract drilling expense increased by $41 million and included normal operating cost for the Ocean Valor as well as the increased amortized mobilization costs and higher cost associated with rigs operating internationally rather than domestically. Additionally, Diamond Offshore recognized a pretax gain of $31 million in the third quarter of 2010 related to the sale of the Ocean Shield. Also benefiting Diamond's results for the quarter was a lower effective tax rate as compared with the 2010 period. HighMount's operating income for the quarter decreased to $16 million from $19 million in the prior year quarter due to decreased sales volumes stemming from a reduction in HighMount's drilling activity. Average prices realized per Mcfe were $6.22 in the third quarter of 2011 compared to $5.80 in the 2010 period. Operating expenses increased by $2 million in the third quarter of 2011 as compared to the 2010 period, primarily due to increased DD&A expenses related to negative reserve revisions in December 2010 and projected future development cost. HighMount's production volumes and realized prices in the third quarter are as follows: natural gas production was 11.3 billion cubic feet at an average realized price of $5.73 per thousand cubic feet. Natural gas liquids production was 664,000 barrels at an average realized price of $40.57 per barrel. Oil production was 68,000 barrels at an average price of $82.67 per barrel. As of September 30, HighMount had hedges in place that cover approximately 77% and 54% of total estimated 2011 and 2012 natural gas equivalent production at a weighted average price of $6.28 and $5.51 per Mcfe, respectively. Boardwalk Pipeline's contribution to net income for the quarter decreased to $18 million from $21 million in the prior year quarter. The decrease in net income versus the prior year quarter was primarily due to higher interest expense from a loss in the early extinguishment of debt. Additionally, Boardwalk reported higher operation and maintenance expense related to integrity management and reliability spending. These negative impacts were partially offset by higher gas transportation revenues resulting from increased capacities from the completion of several compression projects in 2010 and operating the Fayetteville Lateral at its designed capacity. Loews Hotels reported breakeven results for the third quarter versus the loss of $2 million in the prior year quarter. Revenue per available room increased to $161.76 from the third quarter from $143.89 in the prior year quarter, reflecting improved occupancy and average room rates. Holding company cash investments as of September 30 totaled $4 billion. During the quarter, we repurchased 7.5 million shares of common stock for $275 million. We received $154 million in dividends and interest from our subsidiaries, and we paid $25 million of dividends to our shareholders. In the fourth quarter, we have made a capital contribution to HighMount of $106 million, and we also anticipate making an equity contribution of approximately $280 million for an equity ownership interest in the joint venture discussed in the call today. And now, I'll turn the call back over to Darren.

Thank you, Pete. Operator, at this time, we'll open it up for questions.

[Operator Instructions] Your first question comes from Bob Glasspiegel of Langen McAlenney.

And I want to wish Darren good luck. You're leaving big shoes to fill. I'm glad to know that you're going to be staying in the family. On the Boardwalk transaction, we won't be able to figure out what Loews' earnings are from what Boardwalk's earnings, given that we're going to have this sort of side venture working through the numbers. What sort of transparency are you expecting to provide? And any sense of what the sort of core running earnings rate of what this business might be?

Well, we haven't decided whether we'll split any of that out. As you indicated, it will be included in our overall Boardwalk results unless we disclose it separately, Bob.

Any sense for just the rough earnings run rate of what this business is? Is it a GAAP earnings contributor? Is it a cash flow business where the GAAP earnings don't have any correlation to, necessarily, to operations?

Our internal projections show it has both. It has a reasonably good cash flow for the joint venture or whoever the ultimate owner is. And as well, it should have reasonably similar GAAP results. The other thing that it does is that it provides a very strong anchor for one end of our system -- one end of the Boardwalk system, where electric and gas utilities will find it very advantageous to use that storage, which is high-release storage, so that they can get the gas that they need for -- in the case of utilities, hot days, and in the case of -- electric utilities, hot days, and in the case of gas utilities, very cold days.

Just the fact that you're letting your cash position work after a long period of sort of letting it build suggest that you're feeling better about the world. Or is this just sort of one-off transactions that popped up?

Over the years, we've said that we would support our subsidiaries. And right now, what we're finding is that we're able to support them with -- by helping them to finance transactions that should be very accretive to shareholder value not only with the subsidiaries, but also at Loews. So we're very pleased with the Petal and Hattiesburg acquisitions at Boardwalk, and likewise, we're very pleased with the $106 million land acquisition that HighMount is making just today in Oklahoma.

Okay. So it really doesn't have any change in your macro view of the world, then, it sounds like.

No, but I think what's happening, though, is that we're finding that we're able to do these transactions. We're finding that there may be somewhat less competition, and we're finding that the prices are more reasonable. So that's why we're willing to step in.

Your next question comes from David Adelman of Morgan Stanley.

Jim, how much of a consideration was it on the Boardwalk transaction that because of where Boardwalk's unit price is that they had to, in effect, rely on Loews? And how might that color your interest going forward in doing subsequent transactions with Boardwalk? Is that a major consideration? Is it irrelevant to you? Is it a concern of yours?

It was a significant consideration. Based on the price of Boardwalk's shares when we agreed to the acquisition, the deal did not make a lot of economic sense for Boardwalk, and Loews was willing to bridge that acquisition and wait for the Boardwalk price to go higher, which, in fact, has occurred. And I think the market is now starting to understand that there are very significant things that are taking place at Boardwalk under Stan Horton. There's the recent gathering system that we announced that we're refinancing in the Marcellus shale. There's Petal and Hattiesburg acquisition, and likewise, there's the permission that we got from regulatory authorities to convert some of our pipelines near the Eagle Ford shale into wet gas pipelines from dry gas pipelines. So there's a lot of activity, and my sense is that at some point in time, the market is going to understand that Boardwalk's price has been very cheap relative to what its prospects were.

And the debt that the JV takes on. I assume that that's going to be nonrecourse to Loews, the holding company?

That is correct. And ideally, what will happen is -- drop-downs are very common in the MLP space. We would hope and expect that over the coming years, as Boardwalk is able to finance it, we will -- Loews or the JV will sell interest in Petal and Hattiesburg to Boardwalk so that the ultimate goal is that this will be 100% owned by Boardwalk.

Okay. And then on the HighMount acquisition that was announced today, Jim, can you help us understand sort of the return profile and the general sense that you find attractive in looking at these kinds of properties? What's sort of the base case? How much variability is there around that when you bid?

We foresee very attractive, very, very attractive double-digit IRRs from investments in this property. This property cost us $106 million. We think there could be more than 600 drilling sites, and that would mean drilling expenditures over the life of the properties in excess of $1.5 billion. And we see very attractive IRRs on that drilling investment.

Okay. And then lastly, it's not a large operation, but the hotel business. You had good increases in average daily rates. The business more or less appears to be operating at a breakeven level. What needs to occur for that operation in aggregate to become materially more profitable than it is today? Does it need more scale? Do you need more properties? Is it simply a function of average daily rate continuing to go up? Or is there something else?

I think it's all of the above. We need to fill out our portfolio in a number of key gateway cities, and we are looking at that. We're looking to do that both through owned properties, through joint venture properties and also through management deals. So we are and have been for the past few quarters and will be for the next several quarters reevaluating our growth strategy and then actually implementing it.

[Operator Instructions] Your next question comes from Sam Yake of BGB Securities.

I just had 2 today. One was, I listened to the CNA conference call and read the results. It seems like, like you said, they're really improving their performance. And I'm just wondering, it must be frustrating for you to have owned 90% of it, and you have this 10% amount trading in the public market at what looks to me like an extraordinary discount. And yet, when I had tried to value Loews, everybody seems to value Loews off the public price of CNA. Is there anything you can do to close that gap between the publicly quoted value and what the true value is? I mean, I know there's not many levers you can pull, but what are your thoughts on that?

I've tried to, in these calls -- check the transcripts over the past several years, I have tried to talk about how CNA is doing, the strategies that they've been putting in place. And now, I think we're seeing after the past 3 quarters that those strategies are actually starting to gain traction. Beyond that, I'm not going to stand out in front of the office with a sandwich board saying, "Buy CNA stock." Instead, as you can see, Loews has been buying its own stock, and the stock -- the price of Loews stock, I think, reflects the low valuation that CNA is receiving. So that's one of the reasons that gives us so much confidence buying in our own shares.

Okay. And one other question. When I look at the value of Loews, it seems to me that the tax issue's a pretty important one. And I'm just wondering, I don't think -- you've kind of disclosed your tax basis and your major assets in kind of a general way. But do you disclose anywhere like the specific numbers? And if you don't, is there a reason why you don't do that?

We don't do that, and historically, we don't do that. Tax basis is a very simple item when it comes to your own portfolio. When it comes to subsidiaries and other corporate assets, it is phenomenally complicated and takes an enormous amount of effort, and we do not typically adjust the basis. We do not calculate the basis on either a quarterly nor annual basis. And I would say, likewise, I don't think there are any S&P 500 companies that actually do that.

At this time, there are no further questions. I'll turn the call back to Mr. Daugherty for closing remarks.

Let me just say something before Darren gets on. Bob Glasspiegel referred to it at the beginning of the call. We think this is Darren's last call on the Loews call. Darren has been here for a number of years and done admirable service. And so as a reward for all the fine work that he's done, he's moving to Houston and has become the Head of IR for Diamond Offshore, where there are a lot more callers in to the quarterly calls. There are a lot more analysts that follow the company, and he's staying dramatically more busy than he's been here at Loews. Take it away, Darren. You'll be among the missed here.

Thank you, Jim. It's been a wonderful opportunity to be at Loews. And thank you all for joining us on the call today. That concludes today's call.

Thank you for participating in today's conference call. You may now disconnect.