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Shares of Phillips 66 (PSX) have seen a little volatility in Wednesday's trading session. Shares traded within a $2 interval following the release of its first-quarter results for 2013 before the market open. Towards the end of the trading session, shares of the refining and marketing company were trading with losses of 2%.

First-Quarter Results

Phillips 66 generated first-quarter revenues of $42.33 billion, down 9.0% on the year before. Revenues came in ahead of consensus estimates of $41.44 billion.

The decline in revenues is mostly attributable to lower realized prices. The company did really well in its attempt to boost its margins. Operating margins rose from 11.9% to 14.5%. Tighter operating expense control and constrain on selling, general and administrative expenses boosted operating income.

Operating income almost doubled to $2.08 billion. As a result of a much lower effective tax rate, net income rose by 121% to $1.41 billion. Diluted earnings per share rose to $2.23 per share, up from $1.00 a year ago. Adjusted diluted earnings per share of $2.19 came in ahead of consensus estimates of $1.89 per share.

CEO and Chairman Greg Garland commented on the first quarter developments, "We achieved strong financial results in the first quarter by capturing favorable chemicals and refining margins. Operating excellence is our top priority, and in the first quarter we continue to improve upon our solid safety and environmental performance."

A Look Into The Results

The midstream business, which includes the transportation activities, recorded adjusted earnings of $83 million, down from $110 million a year earlier. Strength in the transportation business was more than offset by weakness in the midstream activities amidst lower volumes and prices.

The chemicals business reported earnings of $282 million, up from $217 million a year ago. Earnings improved on lower feedstock costs, higher sales and wider margins.

Of course, earnings at Phillips 66 are driven by its refining segment. Adjusted earnings roughly doubled to $909 million on higher gasoline and distillate market crack spreads. The company took advantage by capturing wider Canadian differentials, among others. The company processed 563,000 barrels per day of crude oil, driven by an increase in the Eagle Ford, Bakken and Mississippi Lime crude plays.

The marketing and specialties segment, which includes wholesale and retail fuel marketing activities, had a solid quarter as well. Adjusted earnings of $202 million compare with just $55 million a year earlier.

Valuation

Phillips 66 ended its first quarter with $4.8 billion in cash and equivalents. The company operates with $7.0 billion in short- and long-term debt, for a modest net debt position of $2.2 billion.

Phillips 66 generated full-year revenues of $182.9 billion for 2012, on which the company net earned $4.1 billion. Factoring in a 2% drop in Wednesday's trading session, the market values the company at $37 billion. This values the company at around just 0.2 times annual revenues and 9-10 times annual earnings.

Phillips 66 currently pays out a quarterly dividend of $0.31 per share, for an annual dividend yield of 2.1%.

Some Historical Perspective

Phillips 66 has gone public as recent of May of last year when the company was spun-off from ConocoPhillips (COP). Shares steadily rose from levels around $33 to highs of $70 earlier in 2013. After a recent correction in refining stocks, shares are currently exchanging hands at $60 per share.

Between 2009 and 2012, the company has boosted its annual revenues by a cumulative 60% to $182.9 billion over the past year. Net profits almost ten-folded over the same time period to $4.1 billion.

Investment Thesis

The well-documented improved operating environment for U.S. refiners has sent shares of Phillips 66 and its competitors, including Valero (VLO) and Tesoro (TSO), to very high levels at the start of 2013. Many of the refining firms have seen their share price more than double in merely six months' time.

The spread between WTI and Brent Crude rose to fresh lows, but recently narrowed a bit resulting in a violent sell-off in refining stocks in recent months.

During the first quarter, the refining and marketing division generated roughly two-thirds of total net income, despite the fact that Phillips 66 now operates with five different divisions. Under command of CEO Garland, Phillips 66 will focus on its other businesses including chemicals and pipelines, to make the company less reliant on volatile refining earnings. Despite the good intentions, Phillips 66 will continue to be heavily reliant on its refining activities in the coming years.

In the meantime, Phillips 66 continues to pay presents to its shareholders. The company repurchased 6.4 million shares for $382 million during the first quarter, retiring roughly a percent of its shares outstanding. The company also paid out $194 million in dividends, for a total annualized returned of 6.1% to its shareholders.

As the refining conditions have softened in recent months, and we are far into the cycle of recovering refining margins, the short to medium risks are to the downside. Valuations have actually increased as earnings have gone up, which is a dangerous cocktail. Yet multiplies are still acceptable, but for now I remain on the sidelines for Phillips 66 as I prefer Tesoro's prospects.

Source: Phillips 66 - Shares Fall As Narrowing Refining Margins Outweigh An Earnings Beat