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Little evidence for Loews as a value play [ClearOnMoney]
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Little evidence for Loews as a value play

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Investment

Little evidence for Loews as a value play

8 Aug 2012 by Jim Fickett.

Loews Corporation is often compared to Berkshire Hathaway, but in fact the two are not at all similar. It is also often put forward as a good investment for conservative value investors. Loews does have a 50-year record of good returns, but the current CEO has been in place for only 13 years, and much of the good performance of the last 13 years has been delivered by returns on the bond portfolio of an insurance subsidiary, as yields have fallen. The company might be a value play but, if so, the evidence is well hidden.

It is fashionable to compare Loews Corporation to Berkshire Hathaway, and to advocate purchase of Loews stock for conservative value investors. For example, from a recent Motley Fool article:

In today's edition, Paul and Matt discuss Loews, a diversified holding company that looks and feels a lot like Berkshire Hathaway. … This company has rewarded shareholders for more than 50 years and is trading for only 80% of book value, a cheap price to pay for a quality business. Paul thinks the company is worth a look for investors who love the Berkshire model but would like additional diversification.

The comparison to Berkshire Hathaway is frequently repeated but is far from the mark:

  • A core part of Warren Buffett's strategy is to use the float of his insurance businesses to creatively invest in many other areas; Loews owns most of a large insurance company, CNA Financial, but CNA is required by state rules to keep most of its money in bonds (all information not otherwise attributed is from documents in the investor relations section of the company website)
  • Buffett buys strong companies that throw off a lot of cash, and almost never sells them, instead letting returns compound; the single largest company in Loews portfolio, CNA, has underperformed for decades, and Loews often sells companies after buying them
  • Berkshire Hathaway owns dozens of businesses diversified across many sectors; Loews owns majority interests in five businesses and three of them are in the energy sector

Still, even if Loews is not much like Berkshire, it might be a value play. A recent Bloomberg article gives some examples where Loews' management made smart purchases of cheap assets:

[Jim] Tisch [now CEO] made his reputation as a contrarian value investor. In 1982, as a vice president in Loews’s investing department, he bought seven supertankers for $6 million each, less than their scrap value, and unloaded the last of them in 2004 for almost 10 times that amount. In 1992, he bought 39 offshore drilling rigs for about $372 million, half what a single new rig costs today. And it was on Tisch’s watch in 1999 that CNA turned a $9 million investment in telecommunications giant Global Crossing Ltd. into a $1.9 billion profit in three years. …

Beginning in 2003, Tisch made another series of sweet deals, this time with pipelines. Heavily indebted power companies were scrambling to unload assets to raise cash following Enron Corp.’s bankruptcy. In May of that year, Loews paid $1.05 billion to buy Texas Gas Transmission LLC from Williams Cos. The next year, Loews paid $1.14 billion for Gulf South Pipeline LP. The assets were combined and christened Boardwalk Pipeline, which was taken public in 2005.

As of April 10, the listed partnership units had a market value of $5.5 billion. Last year, Loews reaped $282 million in distributions from its various Boardwalk holdings.

The company brags of 50 years of good performance – the 2011 annual reports says, “Over the past 50 years, the price of Loews common stock has grown at an average annual rate of approximately 14%, compared with an approximate 6% growth rate for the S&P 500.” But Jim Tisch, the current CEO, has only been in place since 1998, so it is reasonable to scrutinize the last 13 years a bit more closely, to judge whether outperformance is likely in the future.

Income is nothing special, with the P/E on trailing twelve month earnings currently at 18.8 and, on average earnings over the last 13 years, at 12.4. Free cash flow is much worse; using average free cash flow over the last thirteen years, the price to free cash flow is 23.9.

With income and cash flow not impressive, that leaves building value through buying low, managing well, and selling high.

The Bloomberg piece offers some hope: “Growth in Loews’ book value per share – a metric favored by Buffett – has averaged 10 percent annualized from 1998 through 2011 compared with 8.1 percent for [Berkshire Hathaway].” But as I skimmed the last 13 annual reports, it seemed to me that Loews was not consistently very smart.

  • Even though they own almost all of CNA, they have put up with the company underperforming for decades.
  • They jumped into the natural gas boom and bought assets in 2007, near the top in gas prices
  • They made no big investments at all in the 2008/2009 crash, when bargains abounded

So where is that growth in book value coming from? As I tried to track down an answer to that question in the consolidated financial statements, I noticed that the variation in the investment portfolio of CNA (mostly bonds) seemed rather closely correlated to changes in book value. Here are the data:

Obviously the correspondence is not perfect, but the performance of CNA's bond portfolio does explain a great deal of the variation in book value. So Jim Tisch's record has benefited greatly from the huge drop in interest rates in the last few years, and it is less than clear that his record of increasing book value will continue when bonds do less well, as they surely will in the future.

One Loews investment strategy I can agree with is a long-term program of stock buybacks. The rationale is explained in a recent company overview flyer:

Of our five subsidiaries, three are publicly traded companies, making our stakes in them easy to value based on New York Stock Exchange trading prices. As of February 17, 2012, our shares of Boardwalk Pipeline, CNA Financial, and Diamond Offshore had a total combined value of approximately $14 billion, or just over $36 per Loews share. If you add in our holding company cash and investments and back out our $700 million of holding company debt, the value of Loews increases to about $42 per share. Finally, you can add to that figure the value of Loews’s non-public assets, which include the Loews Hotels and HighMount subsidiaries, and the Boardwalk general partnership interest and Class B units. Compare all this to Loews’s closing stock price on February 17, 2012 of $38.30. That’s what we call a real bargain.

In such a case, buybacks do benefit continuing shareholders. Imagine a company with two shares selling for $40 each, and with a balance sheet consisting of $100 in cash. Each of the two shares is $10 underpriced. If $40 of the cash is used to buy back one share, then the remaining share now corresponds to $60 in remaining cash, and so is $20 underpriced. So ongoing buybacks are likely, indeed, to help the share price. Of course, these buybacks improve the pricing of the conglomerate stock relative to the value of underlying assets. It does not guarantee that the underlying assets are a good value.

All in all, I have no opinion on whether Loews stock will provide a solid return over time. But I am skeptical that those who promote the investment really understand the company well enough to make a good case. I don't see the evidence, and will not invest.