Loews Corporation (L) Q2 2019 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by and welcome to the Loews Corporation Q2 2019 Earnings Conference Call. [Operator Instructions] Thank you. I will now turn the conference over to Mary Skafidas, Vice President of Investor Relations and Corporate Communications. Please go ahead.

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

Thank you, Mary, and good morning. Loews had another good quarter with strong results from our largest subsidiary CNA. In the quarter, CNA's domestic property and casualty net written premium was up by 8% and rate was up by about 4%. The sizable increase over last year and last quarter reflect significant new business development, as well as sustained improvement in pricing across a number of business lines. Since our CFO, David Edelson will do a deeper dive into CNA's numbers, I want to focus my remarks today, primarily on CNA's strategic direction over the mid to long term, our confidence in their strategy and the state of the P&C industry. Reflecting our confidence in CNA through last Friday, Loews spent nearly $0.5 billion on share repurchases and CNA currently accounts for more than 70% of the value of each Loews share. Now that I've told you how much we believe in their strategy, let me walk you through some of the reasoning for this confidence. CNA's management team has done the work to enhance profitability by establishing a highly disciplined expert underwriting culture. Additionally, the company has strengthened its talent pool and built mechanisms to share expertise across the organization through critical investments in technology and analytics. At the same time, CNA has embedded a disciplined awareness of expense management throughout the company. The CNA team has worked diligently and successfully to deliver improved growth and profitability with the goal of remaining a consistent top quartile underwriter. CNA's underlying loss ratio continues to be in line with the loss ratios of the company's peers. In terms of the expense ratio, there is still a few points of improvement to be had and the CNA team has plans to achieve that improvement. Adding to my confidence in CNA and without diminishing the company's achievements and what is still a competitive marketplace, in my 40 years of experience in the insurance industry, I have never known it to be more financially disciplined than it has been for the past five years. Since CNA and its peer companies are allocating almost all of the earnings to dividends and share buybacks, there is less appetite to underwrite unprofitable risk. With the continual return of capital to shareholders over that five-year period, management's are loath to disappoint their investors with strategies to increase volume at the expense of profitability. Turning to Diamond Offshore. The company continues to be affected by a longer than expected downturn in the offshore drilling market. As I mentioned last quarter, while Diamond may add a lot of noise to Loews' quarterly results, our downside is limited to the value of our equity stake, which comes to less than $2 per Loews share. And although we offshore drilling market continues to be challenging, there is a positive side to the ledger, since 2015, diamond has restructured its fleet to focus on its most competitive assets and has selectively invested in several assets that operate in attractive niche markets. Furthermore, Diamond has differentiated itself from the competition through value-added innovations that enhanced drilling efficiency and save customers time and money. Diamond has accomplished all of this while maintaining its focus on operational excellence and continuous improvements in safety. We believe that these actions coupled with prudent financial management have positioned Diamond to capitalize on an eventual recovery. We also have some news from our packaging subsidiary CCC, which made an exciting acquisition at June of this year. It bought Tri State Distribution which expanded CCC's footprint in the pharmaceutical packaging space, a specialty growth segment in the industry. Pharmaceutical packaging now accounts for more than 11% of CCC's total sales. A way of background, Loews acquired CCC a little over two years ago. Since then the company has made six tuck-in acquisitions for a total purchase price of $300 million, all of which were funded at the CCC level. These acquisitions either added scale at extremely attractive post synergy multiples or increased CCC's presence in specialty segments. The management team continues to evaluate other possible targets that could add size and scale or diversify CCC into segments, with strong growth potential. Finally, it wouldn't be a Loews earning call without a mention of share repurchases. Fun fact, 10 years ago, Loews had about 40% more shares outstanding than it does today. As for this year, to date, we've repurchased just over 10 million shares. And in the second quarter of this year, we repurchased a little over 3 million shares. We've continued to buy low stock because in our view, it's still trading below its intrinsic value, not to mention the fact, that share repurchases remain an important way that we create long-term value for all Loews shareholders. And with that, I'd like to turn the call over to David Edelson, Loews' CFO, who will explain key drivers for the quarter.

Thank you, Jim, and good morning. For the second quarter, Loews reported net income of $249 million or $0.82 per share compared to $230 million or $0.72 per share in last year's second quarter. Our net income was up 8% over the prior year, while our earnings per share increased 14%. As average shares outstanding declined almost 5% from Q2 2018, given our share repurchase activity CNA continues to be by far the largest contributor to our net income and it posted a slight year-over-year increase. The bulk of the quarterly increase, however, was driven by Boardwalk Pipelines as its net income contribution more than tripled mainly due to two factors; number one, our ownership increase from 51% last year to the current 100%; and two, Boardwalk booked a net benefit of $19 million resulting from a customer bankruptcy and related contract cancellation. Offsetting the increases from Boardwalk and CNA were lower year-over-year contributions by Diamond Offshore and Loews Hotels. Despite the fact that Loews Hotels had an excellent quarter operationally. Let me now delve into the results in more depth. CNA contributed net income of $249 million, up from $240 million last year. This modest increase resulted from several nearly offsetting factors, underlying underwriting income, which excludes catastrophe losses and prior year development improved with CNA posting an underlying combined ratio of 94.6%, which was 0.7 points better than last year's second quarter. Despite the increase in underlying underwriting income, however, total underwriting income declined because of a lower level of favorable prior year development and marginally higher cat losses. CNA's calendar year combined ratio was 95.7%, which was 1.9 points above last year's second quarter result, but still highly respectable. CNA's after-tax investment income in its P&C segment was essentially identical to Q2 2018. The Corporate and Life & Group segments both had significant favorable variances. In last year's second quarter, CNA incurred one-time costs from transitioning to a new IT infrastructure service provider. These non-recurring costs were booked in CNA's Corporate segment. And in Life & Group, results improved largely from continuing favorable persistency and long-term care as many policyholders chose to lapse coverage or reduce benefits in lieu of premium rate increases. Finally, an early redemption charge on the retirement of debt reduced CNA's contribution to our net income by $15 million. In summary CNA posted strong P&C underwriting and investment results and improved results in its non-P&C segments. Turning to Diamond Offshore. Diamond contributed a $52 million net loss compared to a $37 million net loss in last year's second quarter. Diamond's results continue to be negatively affected by the challenging conditions in the global offshore drilling market, while numerous factors impacted Diamond's quarterly results and comparison, let me highlight three of them. Number one, contract drilling revenues were down 22% year-over-year as revenue earning days declined 8%, and average daily revenue per working rig was down 14%. Downtime, contract timing and lower day rates drove these declines. Number two, contract drilling expenses were up 19%, with the increase largely attributable to the adverse impact of the amortization of deferred contract prep and more costs incurred to ready certain rigs for their current contracts. And number three, Diamond booked a rig impairment charge last year which reduced Diamond's contribution to our Q2 2018 net income by $12 million and a gain on sale this year, which increased our net income by $5 million. As we have highlighted for the past several quarters, Diamond remains focused on maintaining a healthy liquidity position while investing in its fleet to ensure its rigs are considered top tier by customers. Boardwalk's net income contribution was $53 million, up from $16 million in Q2 2018, mainly due to the increase in our ownership from 51% to 100% and the contract cancellation payment referenced earlier. Operationally Boardwalk had a good quarter, absent the contract cancellation payment, net revenues were up 5.7%, EBITDA margins expanded by about 50 basis points and EBITDA rose 6.3%. The underlying revenue increase was propelled by growth projects recently placed in service, revenue offsets included the net impact of contract restructurings, expirations and renewals. Let's turn to Loews Hotels, which contributed $12 million to our net income, down from $17 million last year. Loews Hotels underlying year-over-year earnings gains were obscured this quarter by pre-opening expenses on properties under development and by the write-off of capitalized costs related to our terminated development project. These items totaled $7 million after-tax in Q2 versus almost no such expenses last year. Revenues declined mainly due to the sale of two owned hotel properties during the past 12 months as well as renovations at a few owned hotels. As a reminder, Loews Hotels uses the equity method of accounting for its joint venture properties meaning the revenues for those properties, which include the hotels at the Universal Orlando Resort are not shown as revenue in our GAAP financial results. Loews Hotels adjusted EBITDA which excludes non-recurring items and is reported and defined in our quarterly earnings summary was $68 million in the quarter, up from $67 million in last year's second quarter. Year-to-date, adjusted EBITDA is $129 million versus $123 million last year. I would note that the renovation activity cited above and the sale of three properties over the last 12 months, two owned in one JV, held back the year-over-year adjusted EBITDA comparison. The opening of almost 4,100 rooms in Kansas City, Orlando, St, Louis, and Arlington, Texas from Q2 2019 through Q4 2020 should provide a boost to adjusted EBITDA. Turning to the parent company. Investment income was down modestly. Contributing to the decline was a lower level of invested assets including a much smaller portfolio of limited partnership investments. At June 30, the parent company portfolio of cash and investments totaled $3.5 billion with 80% in cash and equivalents and the remainder, mainly in marketable equity securities and a portfolio of limited partnership investments. The LP portfolio has declined from about $950 million at June 30, 2018 to $250 million at quarter end, consistent with our decision to shrink the size of this portfolio. As a reminder, the parent company portfolio totaled $4.7 billion on June 30, 2018, which was just prior to the July 2018 purchase for $1.5 billion of the Boardwalk LP units not previously owned by Loews. Consolidated Container, which is reported as part of other corporate results completed the acquisition of Tri State distribution late in the second quarter. Non-recurring expenses connected to the acquisition negatively affected other corporate results in Q2. We received $110 million in dividends from our subsidiaries during the past quarter, $25 million from Boardwalk and $85 million from CNA. Dividends received year-to-date totaled just over $700 million. We repurchased 3 million shares of our common stock during the second quarter for a total of $151 million. After quarter end, we repurchased an additional 421,000 shares for just under $23 million. Year-to-date, we have repurchased 0.4 million shares or 3.3% of our shares outstanding at the beginning of the year. I will now hand the call back to Mary.

Thank you, David. We have three questions submitted from shareholders. Our first question is, a few months ago, a few months back, Jim you talked about moving Loews cash out of hedge funds. Can you give us an update on that?

Sure. So as David said, a year ago, we had about $4.7 billion in cash and liquid investments and today that number is about $3.5 billion. The reason the cash and liquid investments has declined is because offsetting the close to $1 billion of cash inflow that we had from dividends over the past year from our subsidiaries, we spent $1.5 billion acquiring the minority interest in Boardwalk, we also spent approximately $1 billion on share repurchases. So with $3.5 billion rather than close to $5 billion, we decided that we needed to make some adjustments in our investment portfolio. And one of the areas where we especially wanted to make an adjustment was in our hedge funds. We've decided that the returns that we've received on the hedge funds haven't been sufficient for the risk. My guess for why that's been the case, is that, the hedge fund space, as I think everybody knows is very, very crowded and returns have been competed away. So we still retain about $250 million in hedge funds, and we also have approximately $600 million in equities and other than that, our investments are primarily in treasury bills, treasury notes and other short-term money market instruments.

Next question is recent capital allocation at Loews has primarily focused on share buybacks. Is Loews actively looking to add another business at the holding company level?

So what I find so amazing is that dry powder within the private equity world continues to move upwards and the leverage markets have also been very accommodating to highly levered transactions. So in my mind this has created a massive supply demand imbalance between assets that are for sale and buyers that are equal - that are eager to buy them. So what's happened is that multiples have moved up rather significantly and they've moved up in just about every sub-sector of the market. Making matters worse, investment bankers and sellers have found adjustments to earnings with which to market their assets. There is now a term called adjusted EBITDA, and as you might imagine, when someone is selling a business, adjusted EBITDA is higher oftentimes, significantly higher than the stated EBITDA. Those adjustments reflect what sellers considered to be one-time cost that should be excluded and future benefits, that should be included. So as a result, while the fancy charts may show private asset multiples approaching their 07 peaks. It's my estimation that in fact, they far surpass it. And as I would like to say, welcome to the world of low interest rates. My guess is that what we've seen going on will persist for some time and while we remain dutifully on watch for any potential opportunities, I'm basically pretty skeptical that we'll be adding a new leg in this environment. What I'm seeing today is that you really need synergies in order to make the math on any corporate acquisition work. So for all of these reasons, we continue to acquire assets where we currently have strong businesses that can make use of the synergies, but it seems to me, highly unlikely that we'll get into any new industry or business at this point in time.

Last question from shareholder is, can you talk about CCC and what the company is doing to differentiate itself and add value to its customer base? Can you also address, how CCC is addressing the impact of its products on the environment?

So let me start with an update on our investment thesis in CCC, a reminder for you. We were attracted to CCC because it was a good size player in a highly, highly fragmented market that we felt could serve as a platform for growth for Loews in the packaging industry. As I mentioned on the call, in the past several years, Loews - since Loews acquired CCC, we've made six tuck-in acquisitions. These acquisitions have helped us to diversify CCC away from the dairy and water packaging business which has been declining and it's also these acquisitions have also added very significant post acquisitions synergies. These tuck-ins were all financed self funded by CCC. But all is not entirely sunshine in those, there are headwinds on the - in the industry, including increased labor costs and also a steeper decline in the dairy and water volumes than we had previously expected. But overall, the original investment thesis still holds. Now in terms of adding value to their customers, CCC's first step with any customer is to try to understand what their priorities are and to develop our customized packaging solution for them. So one example of providing value added is our recent CCC innovation that adds value not only by helping customers meet their needs, but also by reducing the impact of plastic packaging on the environment, and specifically, what I'm talking about is a product from CCC called Dura-Lite, it's a - in the packaging world, it really is a major leap forward. Dura-Lite was introduced in 2016, and it's a technology that creates a plastic container that is as strong or stronger than the original, but using the 10% to 20% less resin. So Dura-Lite bottles now make up more than 50% of all the dairy and water gallon bottles that CCC ships. And a side effect of that is that the Dura-Lite product has translated into 9 million fewer pounds of resin being used by CCC which gets us to the environmental part of the question. CCC is also, I'm proud to say, the second largest producer in United States of recycled high-density polyethylene, which is the major resin that CCC uses. In the past, manufacturers have been reticent to use recycled resin in packaging, because it was more expensive per unit than virgin resin. But more recently, do I believe to the focus on sustainability, that picture has started to change and we're seeing that more companies are taking an interest in using this greener somewhat more expensive packaging material. I'd like to add that CCC takes very seriously the impact the plastic packaging has on the earth and it continues to develop solutions that are better for the world and better for CCC's customers. Thanks.

Thank you, Jim. Stephanie, over to you for questions on the call.

Your next question comes from the line of Josh Shanker with Deutsche Bank.

Now, Jim, I'm not trying to putting words in your mouth, but I did hear something that I was surprised in the prepared remarks. You said that given the valuation currently at Diamond if the - your downside was maximum $2 of value and overall low shares today, typically when people talk like that, it presents sort of a view that you think there is a possibility that maybe Diamond - the equity Diamond isn't worth anything. I don't think that's what you said. But I'd like to hear, why you share that data with us and what your outlook is?

So my outlook is that the offshore drilling business is going to come back at some point in time. What I'm pleased about with respect to Diamond is that it has a fleet that is very strong and capable and when the recovery comes which eventually will, I believe that Diamond will be able to do well in that environment. I think that a big problem for offshore drilling has been the price of oil, which has been not only volatile, but relatively low, it's competing with Shale production, which offshore drilling has been competing with Shale production and right now that is the flavor du jour for the oil markets. But while all this time has passed and while the offshore drilling market has been weak, what we've seen is a large amount of scrapping in the offshore drilling space. I've been through this movie once before in the supertanker business, in the early to mid '80s and there are two things that are going on simultaneously. Number one, we're seeing that demand is going down and we're also seeing that rigs are being laid up, and as they get laid up and those companies don't have the funds to maintain and invest in those rigs, they deteriorate sitting on the water as they do a highly corrosive environment and after a few years of that rigs become more and more expensive to reactivate. So my guess is that over the next several years, we're going to - if oil prices don't improve and if activity doesn't increase - does not increase significantly, we will see more rigs scrapped no longer in the market. And then at some point in time, the supply and the demand curve will change, there will be more demand for rigs and bingo, there won't be enough supply and before you know it, rates will go up again. So my view is that there will be at some point in time a change in the marketplace. Going back to my $2 comment, I mentioned that because Diamond Offshore is consolidated with Loews. And so it's earnings show up in our net income numbers and the mention of $2 was simply a reflection of the fact that even though those profit and loss numbers may be significant within Loews that the total value of our investment according to Mr. Market is less than $2 per Loews share.

And if the cost of financing Diamond outlast it is greater than this drought can support with Loews be willing to bridge finance Diamond to get it through the drought and your ownership stake would change of course in that situation?

So Diamond has added 4.5 years of backlog at attractive rates. We believe the Diamond based on the way it's financed has a very strong runway. And we believe that Diamond can do well in an improving environment which I think is coming. As for additional investments, we'll have to wait and see just what the opportunities are, and we will do whatever is in the best interest of the Loews shareholders.

I might be wrong in my timing a little bit, Jim, but I think, four years ago you raised some debt, I think at about a 2% yield. My numbers might not be completely right, mostly the reason was, as you couldn't believe the opportunity in the market to raise cheap financing. And so you issued some paper. Obviously, we are going into another trough period for interest rates, does Loews have any interest in expanding its balance sheet just because the timing makes sense?

No, not really. The - we have - the coupons that we have are Loews debt range from 2% and 5% ways to 6%. We don't feel that additional debt at the Loews level will make a significant difference for how we operate the business. So notwithstanding the low rates, Loews is now looking to raise any more debt. For our subsidiaries, they're using the opportunity to refinance some of their debts, but we're not borrowing speculatively at this point in time, and have no intention to do so.

And I understand that you want all of the businesses to be freestanding and supporting themselves, but at some point, does it make any economic sense for Loews to be an intermediate lender to the subsidiaries because Loews' cost of capitals much lower than theirs and they would take a loan from you and you would take a loan from the public?

So as you know from time to time, we have provided financing for our subsidiaries. But as a general principle, we want our subsidiaries to finance themselves and they all know and understand that and have structured the finances in such a way that they can get that outside financing.

Okay. Well, thank you for the answers to all my questions.

My pleasure.

Thank you, Josh. And that concludes the Loews call for today. As always, thank you for your continued interest. A replay will be available on the Loews website in approximately two hours. Again, that concludes the Loews call for today.

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