While the broad market, measured by the S&P 500, swooned a little on Wednesday, shares of oil refiners were hammered. Part of the sell-off can be blamed on pure profit taking. Shares of Phillips 66 (PSX) are up nearly 18% year-to-date, and shares of Marathon Petroleum (MPC) are 29% higher. Both stocks were taken to the proverbial woodshed on Wednesday. Phillips 66 declined 6.55% and Marathon 4.78%.
What triggered the profit-taking was new rules introduced by the EPA to reduce the amount of sulfur in gasoline. The EPA suggests that its new rules will only increase the price of gasoline by one cent. However, investors worry that the new rules will require upgrades that will be costly to the refiners.
I currently own shares of Phillips 66 and am pleased with the way management has been unlocking shareholder value since it became a public company last April. Phillips 66 is able to take advantage in the large spread between the price of WTI crude and Brent crude. Since refined product, i.e. gasoline, is priced off Brent prices, Phillips 66 benefits by refining much cheaper WTI. It is able to use this so-called "advantaged" crude because it owns the assets that transport WTI to its refineries.
In addition, Phillips 66 is unlocking shareholder value by spinning off its infrastructure assets into a publicly traded master limited partnership later this year. Existing PSX shareholders will not receive shares of the newly formed MLP, which will be called Phillips 66 Partners and trade under the symbol PSXP. However, PSX shareholders can expect to benefit from the value unlocked by the transaction. Phillips 66 will receive cash distributions from the partnership and will benefit as the MLP grows with its own access to the public markets. For more information on PSXP, you can read the company's S-1 filing on the SEC website.
Since the sell-off that occurred on both Tuesday and Wednesday, Phillips 66 trades with a P/E ratio of less than 10. Analysts expect Phillips 66 will earn $7.40 in 2013, giving it a forward P/E of 8.44. The company pays an attractive dividend of 1.8%, which is roughly equivalent to the yield on a 10-year Treasury. Management has stated their intention of consistently raising the dividend. As the company generates more cash by monetizing its infrastructure assets, it should have no trouble with dividend increases.
As many investors have used recent news as an excuse to book profits in Phillips 66, I have been using it to increase my holdings. In my view, there's still plenty of value in the refining companies, particularly Phillips 66. Even if new EPA regulations increase one-time costs for the company, eventually that will be made up from future price increases at the pump. There's also plenty of time to sort out the details of the EPA proposal and often these proposals are changed multiple times. Investors would do well to focus on the high profit margins and the value being unlocked at Phillips 66. This is an opportunity to scoop up shares while they're oversold.
Disclaimer: Mr. Constantino is a proprietary investor and does not provide individual financial advice. The stocks mentioned in this article do not represent individual buy or sell recommendations and should not be viewed as such. Individual investors should consider speaking with a professional investment adviser before making any investment decisions.