Gavin Graham writes:
I have a new stock pick for you this week: Loews Corporation (NYSE:L). Your first reaction may be: oh, that's the big box home improvement chain that competes with Home Depot (NYSE:HD). Nope – that one is spelled Lowe's (NYSE:LOW).
The Loews I'm recommending is a U.S. conglomerate that is often described as another Berkshire Hathaway. It trades on the New York Stock Exchange under the one-letter symbol L.
Loews Corp. is managed and partially owned by the Tisch family. Initially, brothers Larry and Bob Tisch were in control but they died in 2003 and 2005 respectively. They were succeeded by Larry's sons James and Andrew and Bob's son Jonathan who continued to build the multi-billion dollar company that follows many of the same investment rules as Warren Buffett’s much better known Berkshire Hathaway.
Loews even invests in many of the same industries, with its largest divisions comprised of insurance (90%-owned CNA Financial) and pipelines (66%-owned Boardwalk Pipeline Partners). It also owns a 50.4% stake in deepwater driller Diamond Offshore Drilling and 100% of Loews Hotels and natural gas company HighMount Exploration & Production.
Loews describes itself as “a diversified holding company with the flexibility to pursue investments and acquisitions wherever we see opportunity.” It lists three primary means of achieving superior risk-adjusted returns for its shareholders:
1. Optimizing its subsidiaries’ operating performance and capital structure.
2. Making opportune investments and acquisitions.
3. Effectively managing and allocating holding company capital.
The second route, making opportune acquisitions, is identified by Loews as one of its most important means of adding value. The company says: “We rarely pull the trigger, but continually review opportunities across many industries...the common thread connecting all of our investments and acquisitions over the years is that we saw each as representing attractive value for Loews shareholders.” Therefore, as with Berkshire Hathaway, the nature of the company will change over time as the Tisch family perceives certain industries as becoming more attractive and others less so, making investments and divestitures accordingly.
The company actually started as the Loews Theaters cinema chain, which MGM was required to sell off in the 1950s. Having started their career by buying a 300-bed hotel in New Jersey in the late 1940s, Larry and Bob Tisch used its profits to buy several more hotels in the Catskills and Atlantic City. They then used their hotel profits to buy control of the Loews theatre chain in 1960.
Over the next two decades they sold off the valuable city centre cinema locations for redevelopment while expanding the hotel business. They purchased several other businesses in the 1960s and 1970s, including the Lorillard Tobacco Company in 1968, insurer CNA Financial in 1974, and Bulova Watches in 1979. As Loews grew, revenues expanded from $100 million in 1970 to $3 billion by 1980. (Figures in U.S. dollars.)
Larry Tisch became the controversial CEO of broadcaster CBS after buying a 24.9% stake through Loews in 1986. He cut costs and sold off the publishing and music businesses but almost doubled the value of the company before selling it to Westinghouse in 1995. By the early 2000s, Loews revenues had climbed to $17 billion.
Among the specific examples that Loews cites of its value-oriented contrarian approach is the creation of a subsidiary in the late 1980s to buy offshore drilling rigs at the depressed prices then prevailing after oil fell to $10 per barrel. Forming the predecessor company to Diamond offshore with these initial rigs, it took the company public in 1995, retaining a controlling 50.4% stake.
It also acquired pipeline operator Texas Gas Transmission in 2003 during a period when several owners of natural gas pipelines were experiencing financial distress in the aftermath of the Enron collapse. One year later, Loews acquired Gulf South Pipeline, a strategic fit with Texas Gas as their pipelines were contiguous. In 2005, Loews contributed both pipelines to Boardwalk Pipeline, a newly created master limited partnership (MLP). Boardwalk completed an initial public offering of 34% of its units in 2005 while Loews retained complete ownership of the general partner, which manages the pipeline network. Finally, in 2007, Loews created a new subsidiary, HighMount Exploration & Production, to purchase depressed natural gas assets from Dominion Resources for $4 billion.
Meanwhile, Loews is equally ready to sell all or part of those businesses in which it does not foresee favourable developments or where it believes that full value has been achieved. In 2006, it created a tracking stock, Carolina Group, for its Lorillard tobacco business, the market leader in menthol cigarettes. Loews raised $740 million by selling shares in Carolina and subsequently spun off its own stake in the company to its shareholders in 2008. It also sold Bulova Watches in 2007.
The only business that it has retained through the last half century has been hotels. It's the smallest of the Loews divisions (2% of 2010 revenues) but the family seems to have an attachment to it as it is the original business that started the company on its way. Loews owns 18 luxury hotels in the U.S. and Canada.
Loews has a very strong balance sheet with $4.64 billion in cash, up from $3 billion at the end of 2009, and only $870 million in debt. That leaves the company with over $3.75 billion in cash available to make acquisitions. While noting that this high cash position is not unusual at the moment amongst U.S. corporations, Loews makes the point that its cash is neither held offshore (and thus liable to heavy taxation if repatriated to the U.S.) nor encumbered. However, the company noted that while it values the flexibility that a cash surplus provides, it was not considered a permanent holding.
While receiving low interest rates on its cash, Loews feels no pressure to invest as the competition from private equity firms and low rates have made others willing to accept lower returns. In the meantime, Loews used some its cash to repurchase 11 million shares (2.6% of the outstanding total) in 2010 for $405 million. This continues a long-standing trend as the number of shares outstanding (adjusted for splits) has shrunk by two-thirds since 1971, from 1.3 billion to 413 million.
Loews is also willing to invest in its subsidiaries. It purchased $1.25 billion worth of special preferred shares in CNA, the seventh-largest commercial insurer and thirteenth-largest property and casualty insurer in the U.S., during the financial crisis in 2008. CNA redeemed the remaining $1 billion in 2010. It also sold its remaining asbestos and environmental pollution liabilities via a reinsurance deal to Berkshire Hathaway’s National Indemnity subsidiary for $2 billion. CNA booked a $365 million loss on the deal but increased its net income to $690 million from $419 million on revenues of $5.9 billion (63% of Loews’ revenues). The insurance company earned a 9.6% return on equity (ROE) before the exceptional loss and had an operating ratio of 94.8%, its best in 10 years. Book value increased 13% to $40.70 a share and it paid Loews $76 million in preferred dividends. With its share price recently at $29.90, CNA sells at a 26% discount to NAV.
Diamond Offshore was affected by the moratorium on drilling in Gulf of Mexico after the BP Macondo well blowout but had already been positioning its rigs outside of the U.S. where they were earning higher rates. As a result, 16 of its 46 rigs are offshore Brazil and Diamond moved two rigs to West Africa and Egypt during the moratorium, leaving only five (three semi-submersible and two jack-up) operating in the Gulf of Mexico.
While the moratorium affected Diamond’s second half, it had revenues of $3.3 billion (23% of Loews’ revenues) and net income of $955 million, making 2010 the third most profitable year in its history. It has a $6.6 billion contract backlog. With 90% of its deepwater fleet fully committed for 2011, Diamond has ordered two deepwater drill ships from Hyundai of South Korea for $1.2 billion for delivery in 2013 and paid Loews $368 million in dividends in 2010.
Boardwalk Pipeline is the other major contributor to the Loews bottom line. The company's 14,200 miles of pipelines in 12 states produced $1.1 billion in revenue in 2010 (7.7% of Loews’s revenues), up 23% from the previous year, while generating distributable cash flow of $448 million and net income of $289 million, up 78%. Having built three compressor projects to increase its average daily throughput to 6.8 billion cu. ft., Boardwalk will enjoy the benefits of higher volume from this expansion. About 78% of its revenues are derived from take or pay contracts which pay for capacity on its network whether the customer uses it or not, giving predictability of revenues. It paid Loews $276 million in dividends and distributions in 2010, making it the second largest contributor after Diamond.
HighMount has been suffering from the low price of natural gas, but Loews’ long-term approach means they are not overly concerned. However, they did replace the CEO last year while selling non-strategic acreage in Alabama and Michigan representing 17% of total proved reserves for $500 million to reduce debt to $1.1 billion. With net income of $58 million on revenues of $425 million (2.9% of Loews’ revenues), HighMount made a profit for the first time in three years, after writing off over $2.1 billion in 2009 and 2008 on the back of lower gas prices.
Finally, Loews Hotels made $1 million on revenues of $308 million (2% of Loews’ revenues), up 9% from 2009. Revenue per available room was up 10% to $147.89 on a 70.1% occupancy rate (66.4% in 2009) but that was still 18% below 2008 as the hotel industry struggled to recover from the recession.
Investors should buy Loews as a conservatively managed conglomerate which is selling at a double discount. The first is at a small discount to its 2010 year-end net asset value (NAV) of $44.51. The second discount relates to the fact the Loews NAV reflects the share price of CNA, Boardwalk, and Diamond and a couple of them are selling at discounts to their own NAVs.
Loews has demonstrated an ability to make successful strategic investments and disposals in numerous industries. The timing may sometimes appear to be premature, as with natural gas today, but the long-term track record, as with offshore drilling rigs in the late 1980s or tobacco in the 1970s, commands respect. Loews realized $4.4 billion on its disposal of Carolina Group in 2008 in addition to the initial $740 million raised in 2006, contributing to the 17.6% compound annual return from its stock since 1960. That compares to 9.6% for the S&P 500 Index.
Similar to Berkshire Hathaway, Loews has a lot of volatility in its earnings, which have varied between $1.30 a share and $9.05 in the last five years. Rather like the ultimate insurance-based conglomerate based in Omaha, Loews` management focuses on the long term and prefers book value, which has increased almost 50% between 2006 and 2010 from $30.17 to $44.51, as a better guide to performance than earnings.
The Tisches have almost as impressive a record as Warren Buffett and, unlike Berkshire, have successfully managed a transfer of leadership from one generation to the next. Loews even pays a (small) dividend of $0.0625 a quarter ($0.25 a year), giving you a yield of 0.6%, better than a U.S. dollar bank account.
Action now: Buy for capital appreciation. The shares closed on Friday at $44.26.