Earlier last week, Dividend Growth Newsletter holding Phillips 66 (PSX) reported strong first-quarter results on the back of fantastic refining margins. Adjusted earnings per share surged 83% year-over-year to $2.19, handily exceeding consensus estimates. The firm generated over $1.4 billion in free cash flow, which it returned to shareholders in part via the repurchase of 6.4 million shares for $382 million and $194 million in dividends.
Refining profitability drove a high percentage of the earnings growth at Phillips 66, as refining profits doubled to $909 million. The firm realized a profit margin of $13.94 per barrel. Advantaged crude, which the firm purchases at a discount to relative global benchmarks, jumped 800 basis points year-over-year to 68% of product. CFO Greg Maxwell believes the company can become 100% advantaged, and said there could even be room to expand margins from that point, saying:
So our targets are 100% advantage crude and then you start taking advantage crudes and replacing it with more advantage crudes, i.e., in the Mississippi line or doing around Ponca City or displacing a WTI barrel with a better barrel, more consistent quality, better pricing. There is a theoretical limit on the clean product yields and so we're approaching that limit, but and then yeah, we're already high on distilled yields, industry leading distilled yield. So but there is still lot of room left in the fairway for us in terms of the advantage crude and the value capture for advantage crude.
With an increase in the domestic oil supply, we believe refiner margins could become permanently elevated as long as the United States is hesitant to increase refinery supply. A greater amount of domestic pipelines could lead to a decrease in advantaged crude discounting, but we think high supplies and lower demand should favor Phillips 66 in the long run.
Higher gasoline margins helped drive a large boom in the firm's Marketing & Specialties segment, which saw its earnings grow over three-fold to $202 million. Although competitor Valero (VLO) will spin off its retail arm, we do not believe Phillips 66 will follow suit at this time.
Chemical earnings were also rather strong, growing 30% year-over-year to $282 million driven by strong performance in polyolefins and olefins. The firm sees some expansion opportunities in the space, and it believes cash flow will be strong for the remainder of the year. Chemicals tend to be commodity products, but strong demand can drive earnings expansion.
Overall, we thought Phillips 66 posted a strong quarter, and fears of declining crack spreads have yet to materialize thanks to the company's focus on increasing its exposure to advantaged crude. Management doesn't give much guidance, but it did reiterate its capital expenditures forecast of $1.9 billion (and said the firm's utilization rate will be in the high 90s). While the refinery business remains cyclical, we think some long-term trends in crude could somewhat reduce earnings volatility. We continue to hold shares in the portfolio of our Dividend Growth Newsletter.
Additional disclosure: PSX is included in our Dividend Growth Newsletter.