Loews Corporation (L) Q2 2012 Earnings Report, Transcript and Summary

Good morning, my name is Jackie, and I will be your conference operator today. At this time, I would like to welcome everyone to the Loews Second Quarter 2012 Earnings Conference Call. [Operator Instructions] I would now like to turn the call over to Mary Skafidas, Vice President of Investor and Public Relations. Please go ahead.

Thank you, Jackie. Good morning, everyone. I'd like to welcome you to Loews Corporation Second Quarter 2012 Earnings Conference Call. A copy of our earnings release 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, Peter Keegan. Following their 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.

Thank you, Mary. Good morning, and thank you for joining us today to discuss Loews' second quarter results. As you know by now, we reported earnings of $56 million for the quarter, as compared to $250 million of Loews earned in the second quarter of 2011. Net income for the quarter includes after-tax, noncash fueling test impairment charges of $142 million at HighMount, related to the carrying value of its natural gas properties. These charges were the results of declines in natural gas and natural gas liquids pricing. Loews ended the second quarter with $3.7 billion in cash and investments at the holding company level. This quarter, we spent approximately $51 million buying back about 1.3 million shares of Loews' stock. During the second quarter, Moody's Investors Service upgraded by 1 notch the senior unsecured ratings of Loews, CNA Financial and Diamond Offshore. According to Moody's, Loews' upgrade to A2 reflects the strengthening credit profile of our primary operating subsidiaries and our standalone financial strength and conservative financial policies. Moody's also affirmed the CNA insurance company's financial strength ratings and revised the outlook on these ratings to positive from stable. So now, both Moody's and S&P have CNA's financial strength on positive outlook, which is a real credit to the progress that's being made by the management team at CNA. In addition to the good news from the rating agencies, CNA had a solid quarter, which was favorably impacted by lower catastrophe losses and improved non-catastrophe current accident year underwriting results. Lower net investment income from CNA's limited partnership investments created a drag on an otherwise strong improvement in net operating income. ELP investment produced a second quarter pretax loss of $35 million in 2012 as compared to pretax income of $11 million in 2011. The combined ratio for the P&C operations, excluding catastrophe losses in prior year development, improved by nearly 3 points versus last year's second quarter. Also, the reported combined ratio improved by 4.3 points to 101.7 during the second quarter. CNA continues to close the underwriting performance gap with its best-in-class competitors. There's more work to be done, and we look forward to CNA continuing its steady progress towards becoming a top-tier industry performer. In July, CNA closed its acquisition of Hardy Underwriting, a specialized Lloyd's underwriter with a solid market reputation and a long history of disciplined underwriting. This acquisition will provide CNA with a key platform for international growth. Hardy's results would be included in CNA's and Loews' third quarter results. Turning to Diamond Offshore and the offshore drilling market. Diamond had a solid quarter despite its net income being down by about $60 million versus last year's second quarter. The biggest driver of the decline was that Diamond had 5 rigs in the shipyard this quarter for the 5-year special surveys compared to none during the same period last year. It's worth mentioning that despite the drop in oil prices, the offshore drilling market continues to show real strength. We believe that Diamond is well positioned to take advantage of these market conditions, given its rig availability over the coming 2 to 3 years. Recent contracts signed by Diamond and other drillers for mid-water, deepwater and ultra-deepwater rigs indicate that demand is strong. Diamond continues to focus on modernizing its fleet. As a reminder, Diamond has 4 ultra-deepwater drillships under construction in Korea. Earlier in '09, Diamond purchased 2 ultra-deep waters semisubmersibles in bankruptcy options. And most recently, Diamond is reconstructing an older semisubmersible into a high spec drilling unit to be named the Ocean Onyx. The rig was recently awarded a 1-year contract at a rate of $490,000 per day to work in the U.S. Gulf of Mexico upon delivery from the shipyard in the third quarter of 2013. Diamond is actively considering another project similar to the Ocean Onyx that should provide the company with very attractive returns. The cost of this fleet renewal since '09 announced to -- amounts to almost $4 billion. Now let's turn to Boardwalk. While Boardwalk had a good quarter, the market fundamentals of its base business remain challenging. Sustaining low natural gas prices, compressed basis spreads and now with seasonal spreads are making it difficult for Boardwalk to grow its base business. In light of this, Boardwalk has prudently decided to hold distribution steady in this quarter rather than raise the payout. This action will help Boardwalk strengthen its balance sheet as it continues to focus on long-term growth prospects. We remain bullish on Boardwalk over the long term. Stan Horton and his team are not standing still. They have a number of projects in the works that should enhance the company's prospects. At HighMount E&P, low natural gas prices continue to impact the company's results and produce -- primarily a producer of natural gas. Given the difficult environment for natural gas, HighMount is scaling up its efforts to produce more oil. In the Permian Basin, HighMount has put dry gas development activity on hiatus and is focusing on drilling Wolfcamp Shale wells that have high oil potential. Additionally, HighMount is now starting to drill for oil on the land it acquired last year in the Mississippian line in Oklahoma. And we are hopeful about seeing significant oil production from this property. Overall, we are encouraged by HighMount's efforts to pursue projects that have the potential to diversify its product mix and generate high returns in the current environment. As you know, for the second quarter, HighMount recorded a noncash ceiling test impairment charge. As I said last quarter, by it bears repeating, ceiling test impairment charges are mandated by Generally Accepted Accounting Principles, and not because the gas is no longer in the ground. I continue to be a firm believer that we will see a continuing increase in gas consumption in the U.S., and we remain optimistic about natural gas usage and pricing over the long term. Finally, turning to Loews Hotels and resorts. Paul Whetsell continues to make progress on this growth program. Let me point the 3 recent examples: number one, during the second quarter, Loews Hotels acquired Loews Hollywood in Los Angeles, which has 632 guestrooms and 48,000 square feet of meeting space. This should be a great property for Loews Hotels and its customers; number two, Loews Hotels announced earlier this month that the Regency hotel in New York will undergo an extensive renovation during 2013. The renovation is designed to ensure that the Regency will continue to offer unmatched contemporary comfort while maintaining its renowned standard of hospitality and service; and number three, Loews Hotels and Universal announced the Cabanna Bay Beach Resort, a newer hotel development at Universal Orlando with 1,800 rooms offering both modern and value-priced accommodations. This resort will be operated by Loews Hotels and is scheduled to open in 2014. At the holding company level, Loews' investment income declined in the second quarter as compared to the same period in 2011. This decrease was due to lower performance of limited partnerships and equity investments for the 3 and 6 months ended June 30, 2012. Finally, before I turn the call over to Pete, while you haven't seen us make any acquisitions at the holding company level recently, you may have noticed that there's been no shortage of activity at our subsidiaries, whether it's Diamond Offshore seizing an opportunity to upgrade its fleet or Loews Hotels adding and upgrading assets in profitable Florida, California and New York City markets or CNA expanding its global footprint with its acquisition of Hardy, Loews' subsidiaries have been making attractive, strategic acquisitions. And we, at the holding company level, have been helping to facilitate some of these transactions. We continue to be pleased with, and involved in, each of our subsidiaries future prospects and will continue to focus on creating value over the long term for all Loews' shareholders. Now let me turn the call over to Pete.

Thank you, Jim, and good morning, everyone. Loews Corporation today reported net income of $56 million or $0.14 per share for the second quarter of 2012 as compared to $250 million or $0.61 per share in the second quarter of 2011. As Jim mentioned, net income for the quarter includes a noncash, ceiling test impairment charge of $142 million after-tax at HighMount Exploration & Production, as a result of declines in natural gas and natural gas liquid prices. Excluding the ceiling test impairment charge, Loews' net income for 2012 would have been $198 million as compared to $250 million in the second quarter of 2011. The change is due primarily to lower earnings of Diamond Offshore Drilling and decreased performance of equity and limited partnership investments at the parent company. These decreases were partially offset by higher earnings of CNA Financial and Boardwalk Pipeline partners. CNA's contribution to Loews' net income for the second quarter was $138 million as compared to $101 million in 2012 -- in 2011. Period-over-period comparisons were favorable due to lower catastrophe losses, improved underwriting results and premium rate increases in CNA's core P&C operations, as well as lower losses in its run-off businesses. Results were partially offset by lower net investment income due to decreased limited partnership results. CNA continues to sustain positive rate momentum across its P&C portfolio. A 6% rate increase in the quarter, which was up 2 points from the 4% CNA reported in the first quarter and up 5 points from the second quarter last year. Diamond Offshore's contribution to net income for the second quarter of 2012 was $94 million compared to $125 million in the prior year's quarter. Diamond Offshore's earnings decrease resulted primarily from lower rig utilization as more rigs were undergoing special surveys, the decrease in average day rate and an increase in contract drilling expenses, reflecting the costs of the special surveys. These decreases were partially offset by a $23 million gain after-tax and noncontrolling interests from the sale of 5 jacked up rigs in the second quarter of 2012. Boardwalk Pipeline's contribution to net income for the second quarter increased to $25 million from $5 million in the prior year quarter. The increase in net income was due to the absence of a $28 million materials and supplies impairment charge from the 2011 period, as well as higher transportation and storage-related revenues and the contribution of HP Storage operating results, which was acquired in just December 2011. HighMount recorded a net loss of $139 million for the second quarter of 2012 compared to net income of $15 million in the second quarter of 2011. The lower results were due to the noncash cost centers ceiling test impairment charge of $142 million after-tax related to the carrying value of its natural gas and oil properties, as well as decreased sales volumes stemming from the reduction in drilling activity and declines in natural gas and NGL prices. Excluding the ceiling test impairment charge, net income for the quarter would have been $3 million. For the 3 and 6 months ended June 30, 2012, HighMount reported noncash ceiling test impairment charges of $142 million and $170 million after-tax. The ceiling test calculation was based on average 12-month prices of $3.15 per MMBTU for natural gas and $51.59 per barrel of natural gas liquids and $95.67 per barrel of oil. The price and reserve levels remain unchanged through 2012. It is likely that HighMount will incur noncash and after-tax ceiling test impairments ranging from approximately $230 million to $280 million for the remainder of 2012, amounting to $400 million to $450 million for the full year of 2012. HighMount's second quarter production volumes and realized prices, which include the benefit of hedges, are as follows: natural gas production was 10.1 billion cubic feet at an average realized price of $3.89 per 1,000 cubic feet; natural gas liquid production was 582,000 barrels at an average realized price of $38.38 per barrel; and oil production was 101,000 barrels at an average realized price of $89.01 per barrel. HighMount has hedges in place as of June 30, 2012, that cover approximately 66% of the remaining projected equivalent 2012 production at $5.49 per Mcfe. At Loews Hotels, net incomes remain flat at $6 million for the second quarter of 2012 compared to the same quarter the previous year. Revenue per available room increased $6.49 to $182.08 for the second quarter of 2012 as compared to the 2011 period. The increase in revenue per available room reflects improving occupancy and average room rates. Holding company cash investments as of June 30, 2012, totaled $3.7 billion, the same amount held at March 31, 2012. We received $173 million in interest and dividends from our subsidiaries, and paid $25 million in cash dividends to our shareholders during the second quarter of 2012. We also provided $43 million to Loews Hotels for the acquisition of its Hollywood property and bought back 1.3 million shares of Loews' common stock for $51 million. And now, I'll turn the call back over to Mary.

Thank you, Peter. Jackie, at this time, I would like to open up for questions.

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

You guys have spoiled me over the years with a very good long-term record and how your partnerships have generated excess returns. So I'm not questioning that. But just looking at the year-to-date -- your investment income at the parent is negative $6 million. And that's in a stock market that's up 8% through the first 6 months and a bond market that was very strong. Is it fair to say that maybe your position for rates to go higher or was there something else that generated the subpar returns year-to-date?

I would just say, it was more about not being in the strong sectors of the stock market. We didn't really have any significant bets in fixed income. And part of the problem is that cash earned were pretty close to 0, so you don't get any benefit from -- to your income statement for having cash. So this was all about just being in the wrong sectors in the stock market.

I think you've made some public comments about the relative lack of attractiveness of bonds, and bonds have rallied. So I'm just surmising that maybe you have more of a negative bet towards fixed income than you traditionally had? Or is that not factored into the partnership or parent income at all?

We are -- first of all, we are not short in the bond market, but the partnerships that we've invested in the quarter, as you saw at CNA, were down. And the market for -- even though -- first of all, I think as of June, the market was not up very much -- at the end of June, as of July 1. And I think that the problem is the market is pretty directionless. And so it's been difficult, I think, for all participants in the equity markets to generate returns.

Okay. And any -- it seems like the subsidiaries are doing a lot which suggests that you're not so bearish about the macro environment in total. But the parent is not doing much either on your own stock or elsewhere. So where are you on the global economy? Things are fine or are you concerned?

I'm very concerned. And in fact, I find it actually quite extraordinary that we find ourselves with attractive investment opportunities at the subsidiary level in view of just how poorly, I think, the U.S. economy and the global economy is doing. I think that's driven by the fact that each one of our individual businesses has been able to find attractive bolt-on acquisitions that we hope will generate very attractive returns for us. But in the United States, we've got 1.5% economic growth. The Eurozone is not growing. The emerging markets are not emerging as fast as they had been before. And nobody -- you don't see anybody really expressing optimism about what's going on in the economy either here in the United States or overseas. So for a whole host of reasons, I don't see growth picking up any time soon. But having said that, I'm very pleased with the opportunities that we're seeing in our individual businesses.

Your next question comes from the line of David Adelman with Morgan Stanley.

A couple of things. First, do you think that the moderate pace of parent company share repurchases over the last several quarters played a part in, or contributed to, the credit rating upgrade of Loews?

No, I don't think so. I think this is a long time coming. They have rated us A2. Just for a little perspective, we have $700 million of debt and we have $3.7 billion of cash and investments. So our cash and investments covers our debt by a factor of 5x. I do not know what we need to do to get an upgrade from here. But it just seems that the metrics for an upgrade on Loews debt is crazy, and this one was long overdue. But again, I think of Loews as a AA-rated company.

Okay. Secondly, can you give us a sense of the status of the drilling program on the newly acquired HighMount properties? How much -- how long has it been going on? What are the early learnings? And how did they -- how are they relative to the expectations by this point?

So we've just started in the past several months, in the Mississippian lime. It took some time because permitting work and disposal well drilling that we had to do. And I'm hopeful that in the next quarter, we'll be able to report some preliminary results that we're seeing there, as well as possibly report on how we're doing in the Wolfcamp zone, so we're drilling in the Permian Basin in our Sonora properties.

Okay. And then just a quick question on the hotels, maybe for Pete. Were there large or material one-off costs associated with the acquisition during the quarter? Because I'm just curious, revenue's up $5 million, operating income is basically flat.

No. There were not material costs related to that. There were some, but they weren't material.

So why isn't -- and again, it's obviously not your biggest business, but why isn't that division, overall, demonstrating operating leverage?

Well, they are showing some improvement, but the rounding, you lose it at the moment. But going forward, I hope to see some more improvement.

[Operator Instructions] Your next question comes from the line of Andrew Baker with Barclays.

Jim, just a question. You mentioned earlier, again talking about your confidence in the rebound of natural gas prices over time, as you go to increased utilization there. Obviously, the forward curve always -- just had been consistently wrong in the short term, obviously. In the long term, things have yet to play out. I'm just wondering, are there ways you can position yourself or investments you can make now based on valuations in the market with gas down where it is, such that you'd be positioned not just to, sort of, have HighMount to return to the levels that we're looking at when it was first acquired, but also to benefit from getting it at the low levels as well.

So first of all, gas is actually been staging a pretty significant rally. The 12-month strip in the past 4 or 5 months is up about, I think, $0.90 -- hold on 1 second. The strip is up to $3.56, whereas in April, it was about $1 lower. So there has been a significant rally in gas prices already. Spike gas prices, last I looked, about just under $3.20 an Mcf. Just as a reminder, that's the equivalent to about $19 a barrel of oil. So even though gas has had a significant rally, it is still very, very cheap relative to oil. And at the $3.20 level, it's still at a price where, for most people drilling for natural gas -- for dry gas, it is generally uneconomic to drill at these prices. So we've seen the rig count -- the natural gas rig count in the past year or so virtually cut in half as people are laying down natural gas rigs. I think that the rally in natural gas has already started, but it still has a ways to go. And I think, as I've said before on these calls, I think that the steady state equilibrium price for natural gas in the United States is probably somewhere between $4 and $4.50 an Mcf. We have, at HighMount, we've been looking to diversify our portfolio. We have plenty of gas in the ground that can be produced at higher natural gas prices. And so we've been -- we have acquired, last year, properties that we think are rich in oil. And our drilling programs have been focused on drilling for oil and natural gas liquids. And so we are moving to diversify HighMount away from just being focused on natural gas.

Thank you. That was our final question. And I would now like to turn the floor back over to Mary for any closing remarks.

Great. Thank you, Jackie, and thank you, all, for your continued interest. A replay will be available in our website, loews.com, in approximately 2 hours. And that concludes today's call.

Thank you. This concludes today's conference call. You may now disconnect.