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Adding to Our Position in This Compounding Machine

Paul Chi
March 28, 2013

As I detailed in my initial write-up of the company, I believe Loews (NYSE: L) is a value-creation machine. The company has a returns-focused management team, several subsidiaries in which capital can be deployed, and a long track record of compounding wealth. Since that write-up, none of this has changed. Loews remains undervalued, and I'm going back for a second helping of this well-run business.

Since I bought shares of Loews, the company has reported earnings per share of just $1.43 in 2012, down from $2.62 in 2011. These results included catastrophe losses at CNA Financial (NYSE: CNA), and impairment charges from Highmount, its wholly owned oil and gas E&P. There's nothing CNA could've done to avoid these catastrophe losses. This is essentially what insurers do -- they price risk. When events occur, they must pay out.

Catastrophe loss aside, the slow turnaround at CNA, Loews' biggest subsidiary, continues. The company continues to push through rate increases across its portfolio. Last year, CNA achieved rate increases of 6% across its property and casualty portfolio. It's going to be a while before we see overall return on equity climb sustainably from the current level, but the company's headed in the right direction.

On the other hand, Highmount's writedown was purely an accounting convention that occurred simply because some of Highmount's natural gas reserves were uneconomical based on 12-month trailing prices. This is hardly a surprise. In fact, we saw similar writedowns at many other E&Ps with natural gas production in North America.

While natural gas has recovered very nicely to about $4 today, it wasn't always this way. Just last year, natural gas momentarily dipped below $2, prompting explorers to reduce their rig counts as natural gas drilling became a money-losing endeavor. What the writedown did was reduce the carrying value of its properties on its balance sheet. This led to a $433 million after-tax hit to earnings, which could've amounted to a $1.11 increase in book value per share for the year.

Going forward, as the price of natural gas continues to recover, many of these written-down properties will become economical once again. However, they've already been written down. While the writedown caused a big hit to earnings last year, the smaller carrying value now means that depreciation and amortization will be lower per thousand cubic feet of gas produced.

That's a long way of saying that the writedown was no big deal in the grand scheme of things. In fact, book value is now understated by the $1.11 figure I mentioned because Highmount is likely to derive value from its properties future, even though they've already been written down.

Growing from within
Finally, Loews continues to invest for future growth in its subsidiaries. Loews Hotels and its partners committed to projects worth more than $1 billion in 2012. Loews h