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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Good morning, and welcome to the Loews Corporation Q1 2019 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. [Operator Instructions].
Thank you. I will now turn the call over to Mary Skafidas. Please go ahead.
Thank you, Christie, and good morning everyone. And welcome to Loews Corporation's first quarter earnings conference 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 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 those comparable GAAP measures.
In a few minutes, our CFO, David Edelson, will walk you through the 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 is off to a good start in 2019, due primarily to CNA, our largest subsidiary. Building on its momentum over the last several years, CNA had strong quarterly results. Since Dino Robusto became the CEO at the end of 2016, CNA's key financial metrics have been steadily improving. In comparing full-year 2016 results with first quarter 2019 results, the progress is clear. The underlying combined ratio improved by 3 points with the loss ratio decreasing by 2 points, and the expense ratio decreasing by 1 point.
Notwithstanding this solid progress, CNA is still not satisfied. The company remains committed to further improving its underwriting performance, continuing to strengthen relationships with distributors to grow its book of business, and managing its expenses diligently.
CNA continues to mitigate risk in its long-term care book of business by carefully managing claims and obtaining rate increases from state regulators when justified. CNA is also exploring new strategies that would simultaneously lessen the effects of rate increases on policyholders and meaningfully reduce CNA's exposure.
As CNA moves forward, we are confident that the company will continue to grow its business profitably and responsibly, and that it can and will deliver even stronger operating results in the future. CNA's financial stability and strength as well as this continually improving operational performance is a major reason why Loews has recently purchased so many of its own shares.
Through last Friday, we've bought 7.8 million shares or about 2.5% of the outstanding shares spending about $370 million so far in 2019. But this is nothing new for us. In 2018, we repurchased more than 20 million shares of Loews common stock representing about 6.1% of our outstanding shares at a cost of just over $1 billion. In our view, these share repurchases benefit from what I’d call a triple discount. First, we believe Loews is trading at a discount to its intrinsic value; second, CNA is a high yielding stock with great prospects yet it's trading at a PE discount to its peers; and third, CNA's peer companies in the P&C insurance industry are trading at a notable discount to the S&P 500.
In my view, this triple discount makes repurchasing our shares an attractive value creation lever for us. I feel like the stock market is giving us a gift, and to the extent that our shares continue to trade at what we consider to be an extraordinary discount, we are comfortable buying them in.
Before I turn the call over to Dave, I want to mention some good news from Diamond Offshore. Earlier this morning, the company announced new contracts for two of its drillships with Woodside Petroleum, a major Australian E&P company. These contracts would add more than four years of backlog at attractive market rates with potential for follow-on work. The first rig is expected to start drilling in late 2020. While the day rate is not disclosed, the growth in Diamond's backlog suggests that this charter with Woodside represents a significant uptick in charter rates, due in large part I believe to Diamond's stellar operating record.
David, over to you?
Thank you, Jim, and good morning.
For the first quarter, Loews reported net income of $394 million or $1.27 per share compared to $293 million or $0.89 per share in last year's first quarter. This healthy increase was driven by two main factors. Number one, strong investment results at both CNA and the parent company stoked by the first quarter's robust equity market performance; and number two, Boardwalk Pipeline whose contribution to our net income more than doubled year-over-year mainly due to the increase in our ownership from 51% to the current 100%.
While our net income was up 34% over the prior year, earnings per share increased 43% as average shares outstanding declined 5.6% from last year's first quarter.
Now let me walk through the ins and outs of the quarter, starting with CNA which accounted for over 75% of our net income in Q1 2019. CNA contributed net income of $305 million. This 17% increase was driven by three main factors. Number one, higher net investment income; number two, a higher level of investment gains; and number three, improved performance in CNA's corporate segment.
Before describing these three drivers, I'd highlight that CNA continues to successfully execute on its strategy of profitable premium growth.
P&C underwriting income was down, however, year-over-year as CNA posted an all-in combined ratio in the quarter of 97.8% versus 93.1% in Q1 2018. The increase in the combined ratio was attributable to higher year-over-year cat losses, a lower level of favorable prior-year development, and a slightly higher underlying combined ratio.
Importantly, the underlying combined ratio, which excludes cat losses in prior year development came in at 94.9%. While this is higher than last year's first quarter, it is below CNA's full-year 2018 underlying combined ratio of 95.4%. CNA's underlying loss ratio in the quarter was extremely strong coming in below 61%, about one point better than the underlying loss ratio for full-year 2018.
On the CNA earnings call earlier today, CFO James Anderson highlighted why it makes sense to compare this quarter's underlying underwriting results to full-year 2018. Let me return to the three things that drove CNA's year-over-year earnings increase.
Number one, CNA reported after-tax net investment income of $465 million, up $60 million over last year's first quarter and $186 million better than fourth quarter results. The fourth quarter was negatively impacted by the sell-off in the equity markets. The year-over-year improvement in NII was attributable almost entirely to returns on CNA's portfolio of limited partnership in equity investments. This portfolio returned 4.5% in Q1 2019 versus 1.3% last year and a negative 5.7% last quarter.
Number two, CNA reported after-tax investment gains of $24 million versus $10 million last year. CNA records the mark-to-market on its non-redeemable preferred stock holdings in investment gains and losses.
And number three, the after-tax loss in CNA's corporate segment declined to $6 million in Q1 2019 compared to a $60 million loss last year as the company recorded a net retroactive reinsurance benefit this year as compared to a net charge in Q1 2018.
As a reminder, the retroactive reinsurance results relate to the 2010 loss portfolio transfer with National Indemnity involving CNA's asbestos and environmental pollution reserves. CNA conducted an LPT reserve review in last year's first quarter. Subsequently, however, the company decided to conduct these reviews in the fourth quarter going forward. As such there was no review or charge in Q1 2019. In fact, results benefited from the amortization of the deferred gain associated with the LPT.
Taken together, the year-over-year favorable variances in CNA's investment income, investment gains, and corporate segment amounted to $114 million after-tax for Loews.
Turning to Diamond Offshore. Diamond contributed $37 million net loss in the first quarter compared to a $10 million positive contribution in last year's first quarter. As a reminder, Diamond's after-tax contribution last year would have been a $13 million loss if not for the favorable impact of the reversal of an uncertain tax position in the quarter.
The increase to year-over-year loss was an outgrowth of the challenging conditions in the global offshore drilling market. Diamond experienced a 21% year-over-year decline in contract drilling revenues as revenue earning days were down 9% and average daily revenue per working rig was down 12%. Contract drilling margins declined 10 points from 36% to 26%.
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 more than doubled to $79 million predominantly due to the increase in our ownership from 51% to 100% in the third quarter of 2018. Operationally, Boardwalk had a good quarter. Net revenues were up 3.6% and EBITDA margins expanded by about two points. Pre-tax income at Boardwalk rose 11% over Q1 2018.
The revenue increase was propelled by growth projects and the transportation storage of natural gas liquids. Revenue offsets included a decline in parking and lending and natural gas storage and the net impact of contract restructurings, expirations, and renewals.
Moving on to Loews Hotels which contributed $13 million to our net income in Q1 2019 the same amount as last year. Those hotels underlying year-over-year earnings gains from ongoing operational improvements were obscured by strategic repositioning activity as the company both develops new hotels and selectively divests properties that no longer fit its strategy.
The company booked unusual charges of $3.6 million after-tax in Q1 made up largely of an impairment charge on a property held-for-sale and pre-opening expenses on properties under development. Such charges were negligible in last year's first quarter.
Those hotels adjusted EBITDA which excludes non-recurring items and as reported and defined in our quarterly earnings summary was $61 million in the quarter, up from $57 million in last year's first quarter.
Turning to the Parent company, investment income was up markedly with higher returns on equities driving the year-to-year increase. At March 31, the Parent company portfolio of cash and investments totaled $3.4 billion with over 70% in cash and equivalents and the remainder mainly in marketable equity securities and a portfolio of limited partnership investments. As a reminder, the Parent company portfolio totaled close to $4.9 billion on March 31, 2018. The decline over the past 12 months resulted primarily from share repurchase activity together with the purchase last summer of the Boardwalk LP units not previously owned by Loews.
Importantly, over the past year, we have kept our focus on liquidity by reducing our holdings of non-cash assets in favor of maintaining a high-level of cash and equivalents.
We received $596 million in dividends from our subsidiaries during the first quarter, $26 million from Boardwalk, and $570 million from CNA which includes the $0.35 regular quarterly dividend and the $2 special dividend.
As Jim mentioned, we repurchased 6.8 million shares of our common stock during the first quarter for a total of $322 million. After quarter-end, we repurchased an additional 960,000 shares for $47 million.
Let me now hand the call back to Jim.
Thank you, David.
Before we open up the call to questions, I want to quickly talk about Loews investment portfolio. You may recall that in the fourth quarter of 2018, our portfolio, the Loews investment portfolio had a $71 million loss leading to a pre-tax investment loss of $10 million for the year of 2018. Fast forward to the end of the first quarter in 2019 and we have recouped that fourth quarter loss and then some having ended the quarter with net investment income of about $84 million.
The stock market declined 14% in the fourth quarter and has increased 13% in the first quarter. In other words, the volatility in the stock market over that time period was the driver of the volatility in our portfolio.
Mary, back over to you.
Thank you, Jim. Before we open up the call for questions, we have four questions submitted to us from shareholders. We encourage shareholders to send us questions that they would like us to answer, and we hope that they continue to do so. Our first question is to Jim. Jim since the P&C industry has always traded at a discount to the market, why is today's discount significant as you think about share repurchases?
I believe that the insurance industry, the property and casualty insurance industry, the commercial property and casualty insurance industry where CNA is dramatically less cyclical today than it was previously. 10, 20 or 30 years ago in the insurance industry, companies would earn money, they would accumulate on their balance sheet as capital, and with increasing levels of capital, they would feel they had to write more business. They would write that business, they would compete rates down significantly, and then things would get bad in the industry and they would stop writing so much business because capital had dried up and then things would move up again.
The industry today is no longer cyclical like that. And the reason is I believe that Jay Fishman of blessed [ph] memory who is the CEO of Travelers for more than a decade started to buy, started to use his earnings to pay dividends and repurchase shares. And if you look at Travelers over his time as CEO, you see that statutory capital which is an index of how much business you can write never increased. But the stock price went up dramatically and that was a lesson to a lot of other companies in our sector of the market, so you see today that there is dramatically less price competition.
I believe to the fact that capital, unnecessary capital is not accumulating on the balance sheets of insurance companies but rather it's being used to pay dividends and repurchase shares?
So, I think that going back to the question, the property and cas, our sector of the P&C industry trades my guess at about a 25% discount to the S&P 500. I think in view of the dynamics today in the market such an enormous discount is just not warranted anymore.
Okay, thank you, Jim. Our next question is from a shareholder who wants to know about CCC Loews' recent acquisition or most recent acquisition. So they ask, it’s been about two years since you acquired CCC. Can you please give us an update?
Sure. So just as a reminder, we got into -- when we got into CCC, we’ve been studying the packaging industry for a few years, and then when we had the opportunity to buy CCC, it was just the right company in just the right sector of the market. Its sector of the market is fragmented meaning that there are opportunities for roll-ups. There are significant economies of scale to be had by buying smaller mom and pop businesses in this industry.
And the other thing, there are really good cash on cash returns to be had especially in an environment where short-term interest rates are 0%, 1%, 2% or 3%. So that was why we got into CCC in the first place.
Now let's fast forward. We've had approximately the cash on cash returns that we've expected. We have the platform for growth which has been I think very compelling for us. We're able to buy businesses to the seller at say a nine times EBITDA multiple but in our hands because of our economies of scale; we're able to own them at a six multiple.
We have what I think is a really defensive business that in good times and bad is going to do reasonably well. And I think most important now that we've lived with them for two years, we have a really, really strong management team who knows how to manage their business, knows how to acquire other businesses, are interested in profitable growth not growth at any cost.
So from my perspective, the thesis on CCC is really playing out and we see more opportunities for acquisition, we see opportunities for organic growth, and we're very pleased with how this is working out for Loews and its shareholders.
Excellent, thank you. Our next question is about Diamond. How does Loews feel about Diamond especially in this protracted down cycle?
So my guess is we feel much better about Diamond than the market does. Diamond reported excellent earnings -- excellent prospects today yet the stock is down significantly. My view is that at $10 a share, Diamond is trading more like a stock option than it is a stock. We’ve got into Diamond now over 30 years ago and the thing that I've seen about offshore drilling it is highly cyclical.
Let me take you on a short trip down memory lane. When we bought into Diamond, before it went public, we had invested a total of about $300 million. It went public; we got all of our cash back. And then, nothing really happened for a while. I forget what price the stock went public at. As such, come 2007 when the drilling business was really good, the stock got to $140 a share, $140 a share. Diamond used those good times to pay dividends to shareholders. And as I think you all know paid in excess of $40 per Diamond share in dividends.
So now let's fast forward from 2007 to today. Today, Diamond trades just above $10 and just if I couldn't believe that Diamond could get to $140, likewise I can't believe that Diamond has gotten to $10. For what it's worth, I see the seeds of change in the industry. Since 2014, 120 floater rigs have been scrapped.
When you also take out as a fleet, the cold stacked rigs most of which will never come back to work, there are about 200 floating rigs left in the market, and they're operating at about 65% or 70% operating rate. So, I saw this in the shipping industry in the early 80s, and I've seen this in the offshore drilling business. As long as the market stays at the level that it's at, there will continue to be scrapping from the fleet. And additionally, I believe that with oil prices at these levels, $65 on WTI and $70 on Brent, there is more than enough opportunity for our customers to have good operating profits on drilling prospects.
So I think that there will be increases in demand for rigs. I think the size of the fleet will continue to come down, and then one day bam, it's going to happen, supply will have come down, demand will go up. Demand is highly, highly, highly inelastic, and it would not be surprising at all for me -- for all of us to see day rate increases of $50,000, $100,000, $200,000 a day. There's no doubt in my mind that over the next four to five years that can happen.
And the thing, I like about Diamond's position in this industry is that it's got a lot of runway for that to happen. So I actually feel pretty good about where Diamond is. One additional thing, Diamond has for us an $800 million market value. Yet as you can see from the earnings, it has an oversized effect on Loews Corp.'s overall earnings. So it's one of the reasons, I looked at some of the parts for Loews as a value measure as opposed to earnings per share.
Okay, thank you, Jim. Our last question from shareholders has to do with CNA, Jim obviously you think CNA is trading cheap to its peers. What do you think about that valuations of Loews other subsidiaries?
I love all my children both in family and at work. And I've spent a lot of time talking about CNA this morning and in the past because CNA represents a significant portion of the value of Loews. But I also think that all of our other subsidiaries have very good prospects.
I just talked about Diamond Offshore and the upside potential, I see for offshore drilling. I see that in our hotel business where we have lots of opportunities to build hotels at what we consider to be very, very attractive rates of return for us.
I see it in Boardwalk Pipelines where we've had down EBITDA and chances are -- sorry flat EBITDA and the possibility of down EBITDA going forward. But over the past year, I think there are up -- we've also seen some opportunities for some upside.
Likewise, CCC has opportunities in front of it. And so when I put it all together, I see overall lots of opportunity for Loews.
The other thing, as I said before, is we're happy buying in our shares. Last year we bought in billion dollars of our shares, we're on a similar pace this year and to the extent that Loews shares are like Rodney Dangerfield and not getting any respect, we're happy to buy them in.
Thank you. Okay. Christie we'd like to turn it --
This is not Christie.
Clearly. Christie, we'd like to turn the call over to you and open up the call for additional questions from conference call participants.
Sure. [Operator Instructions].
And your first question is from Josh Shanker of Deutsche Bank.
Good morning. So I don't mean to be reductive but I call Loews a multiline investment conglomerate. I hope you won't be too disappointed.
I call it -- we are -- I call it unabashedly a conglomerate. So no we're not upset with that.
Okay. So one of your not early competitor, but one of your peers who was a very established company said recently that he would expect to warn your shareholders over the long run that he doesn't think you can much outperform the S&P 500. And is that a function of -- you don't have to speak about his company. But when you think about Loews, is Loews ability, I'm thinking long-term, do so a function of size and does that diminish over time or is it that you have an unusual mix of businesses you believe that are better than market businesses?
So I know Loews really well. I don't know the S&P 500 as well as I know Loews. So I can't opine to you whether Loews is going to outperform or underperform the S&P 500. What I know is that the opportunity set that we have in front of us at Loews given our cash flow, given our five individual businesses, and given our share price. What I know is that I think there is a great opportunity for us to build value for our shareholders over the intermediate and long-term.
As for whether or not we'll outperform the S&P 500, I don't know that's not -- that's not my bogey because I can't control in any way what other companies are doing within their industries.
Okay. By extension look you're also -- you do generally a lot of free cash and you can use that to buy back your own stock or you can use that to become an expert in another company and buy that company. Do you believe that ultimately the valuation discount of Loews is so great that the benchmark necessary to put new money to work in a sixth business is quite high for you to try and exceed?
Yes. So there is one other factor that you didn't mention. And that is probably $1 trillion of unused equity at private equity firms and those firms can easily lever up by 100%. So that means that there's probably $2 trillion of dry powder sitting in those firms. And as a result, we see very high prices for businesses that are in what I would call the sweet spot of what we're looking for. We don't need to buy another business. And from the actions speak louder than words department, what you can see is that our investment focus has been and continues to be repurchase of our own shares.
And then I guess I might misquote you, Jim, but a few times you've had a Eureka moment, where you could say, "This little money buys this much stuff". I don't think that's exactly how you said it. Do you expect to have one of those again or is market efficiency gotten to the point where the idea that you're going to find oil tankers available at scrap value just doesn't possibly make sense anymore?
Yes, so that was the -- you're quoting the Jim Tisch $5 million test that I developed in about 1982 standing on the deck of a Supertanker where I looked to the front, I looked to the rear, I looked to both sides. I scratched my head and I said you mean you get all this for $5 million?
And in fact I thought that was a once in a lifetime opportunity. But in fact just eight years later, the Jim Tisch $5 million test came in handy in getting into the offshore drilling business where I stood on the deck of an offshore drilling rig, and uttered literally, the exact same words to myself. So since that day in 1988, no, we haven't seen another time when the $5 million test worked for us. I'm sure that it occurred to other people and we're always on the lookout for such opportunities. But at the present time, my crystal ball doesn't show any that are waiting for us to snatch them up.
All right. And one final question that may dovetail. You mentioned getting out of hotels that no longer fits the strategy of Loews Hotels and acquiring more properties that do. Can you enunciate in a concise way what the strategy is right now?
Sure. We have learned a lot from our experience in Orlando where we're operating six hotels at above market room rates and above market occupancy. And those hotels have earned very significant rates of returns for us and our partners at Universal.
And so we've translated that experience into our strategy for our hotel business. Rather than buying hotels in cities that may or may not fully fit, what we're trying to do, we are building our own properties oftentimes in partnership with municipalities that really fit into this strategy of having a demand driver nearby where we can do significant amounts of Group business and earn what we believe are above market returns on our equity investments. And we're building in Texas now, we're building in Kansas City, we're building in St. Louis, we're building more hotels in Orlando. And from my perspective, our plate is pretty full.
And we see, we're generating new opportunities every year. So I feel really good about the strategy. I feel really good about the opportunity set and now it's going to be up to us and the people in our hotel company to execute and generate the returns that we think are entirely within reach.
Great. I make sure that I call you after I develop my novels into a Theme Park as well.
Okay.
Thank you, Josh. That concludes our call for today. As always we want to thank you for your continued interest. A replay will be available on our website, loews.com in approximately two hours. Thanks again.
Thank you. This does conclude today’s conference call. You may now disconnect.