Phillip 66 (PSX) is a relatively new addition to the market as ConocoPhillips (COP) separated its refining business last year. The shares of the company have gained over 82% since the management announced its spin-off. The stock has followed a steep upward movement and currently trades at around $60. Upward movement since the spin-off puts PSX among some of the best-performing stocks over the past year. It is for this reason PSX seems to top the headlines as investors carefully eye its performance as a strategic player in the energy sector.
Phillips 66 specializes in three core operations: Marketing and Refinery, Midstream and Chemicals. The company is heavily reliant on the latter two segments as a source of earnings. One of the biggest strengths of the company is its pioneer position in all the three segments providing a lucrative return on investment to its stakeholders. The company's assets are primarily concentrated in the U.S. However, it has diversified its operations in other parts of the world, mainly the Middle East. The American shale revolution has proved to be a huge blessing for the domestic producers giving them an edge against the international players.
The business model of Phillip 66 makes use of operational synergies to achieve cost-efficiency in its operations. The management announced its desire to formulate a Phillip 66 Master Limited Partnership in December - the company has already registered for IPO, which is expected to happen in the second half of the year, and it would raise $300 million. The idea is to support its growth in logistics with that of infrastructure culminating in higher earnings. The proposed plan is expected to payoff in the near future.
The company relies on organic revenues to support its high-return projects i.e. growth from within. This helps explain the business's inclination towards low leverage. The management plans to keep the debt-to-equity ratio up to 20-30% this year. Despite a large equity base, the company reports an extraordinary ROE of 18.7%, outperforming the industry average of 12.6%.
Future Growth Prospects
Future growth prospects for refineries are bright as the energy sector is looking to increase production over the next two years. Due to a recovery in the global economy, demand for energy is expected to rise. Two strategic investments undertaken by the management for 2013 include DCP midstream project and the logistics agreement with Enbridge Energy partners (EEP) - both the projects are expected to be massively beneficial to the company. More importantly, the projects were financed through cash flows generated from operational activities, thus partly cushioning them from market risks.
PSX is not attractive for income investors at the moment, due to its meager dividend yield. However, the company offers probably the best growth potential in the sector. Spin-offs often result in unlocking the hidden value in businesses, which I believe has been the case with PSX as well. The spin-off has resulted in better value creation for shareholders.
The biggest threats to the energy sector have always come from the regulatory environment and global economic conditions. Global economic conditions are getting better and the energy giants are looking to increase production to meet this demand. On the other hand, the regulatory environment is favorable for the companies at the moment as the governments look to fuel their economies. Oil and natural gas prices are likely to go up over the next two years due to an increase in domestic and international demand.
Geopolitical risks also arise from operations carried out in other parts of the world subject to changing state regulations. However, the risks for the company are at a low level at the moment, and there should be no hindrance from these factors in achieving the growth targets.
In my opinion, PSX is one of the best picks in the industry at the moment. Overall, the energy sector is expected to perform well in the next five years; as a result, most of the companies in the sector are set to grow. However, I believe PSX stands at the top of the queue when it comes to exploiting the expected growth. At the moment, the majority of the analysts are confident that the company will outperform the market. The management is doing an extremely efficient job of identifying and implementing growth strategies, which are expected to pay handsomely in the long term.