Seeking Alpha
Research analyst, valuentum
Profile| Send Message|
( followers)  

Phillips 66's (NYSE:PSX) third-quarter results revealed significantly weaker worldwide refining margins, as expected. The company's third quarter earnings fell to $535 million, down from adjusted earnings of $1.9 billion in the third-quarter of 2012. Results in the company's 'Refining' segment remain highly volatile.

Phillips 66's 'Midstream' segment generated earnings of $148 million compared with adjusted earnings of $88 million in last year's period. Third-quarter earnings in Phillips 66's 'Chemicals' segment came in at $262 million, down modestly from adjusted earnings of $275 million in the year-ago period. The company's quarterly earnings for its 'Marketing and Specialties' segment totaled $240 million, up from $98 million in the same quarter last year. Corporate and other expenses were roughly flat during the period.

The biggest driver behind the quarterly earnings decline came from the firm's 'Refining' segment, where the segment roughly 'broke even' compared to earnings of $1.5 billion in the third quarter of 2012. Management indicated that the decrease was primarily due to lower realized refining margins (the average worldwide market crack spread), which experienced roughly a 40% decline.

Still, Phillips 66's worldwide refining utilization was 95% in the third quarter (a healthy number), and the company continues to execute on its 'advantaged crude' strategy. The company's cash position is also strong, with the firm boasting $5.9 billion in cash and cash equivalents at the end of the quarter. Its year-to-date annualized adjusted return on capital employed (ROCE) was 14%, above our estimate of its cost of capital.

In July, the company also successfully completed the initial public offering of Phillips 66 Partners (NYSE:PSXP). Phillips 66 Partners is a fee-based business supported by a number of long-term contracts that have minimum volume commitments and price escalators indexed to inflation. We expect its spin-off to have stable cash flows and minimal direct commodity price exposure.

Valuentum's Take

Phillips 66 continues to be our favorite idea in the 'Refining' industry, but the group as a whole is now facing stiff headwinds as it relates to declining refining margins. What had been a material tailwind and a boon to earnings through much of last year has now become a material headwind to performance. We prefer that management continue to deleverage its balance sheet given the significant and inherent volatility in refining margins, but the firm no longer has plans for any further reduction of debt, which stood at over $6 billion at the end of the quarter.

We hold Phillips 66 in the portfolio of our Dividend Growth Newsletter (following its spin-off from ConocoPhillips, which had been a holding), but we are evaluating an exit point in shares given deteriorating earnings. The firm's operating (crack spread volatility) and financial risks (balance sheet leverage) have become too great for us at current pricing levels. Shares have more than doubled since being added to the Dividend Growth portfolio.

Source: Phillips 66's Q3 Reveals Difficult Refining Environment

Additional disclosure: PSX is included in the portfolio of our Dividend Growth Newsletter.