Phillips 66: Is The Stock Cheap?

Feb.24.14 | About: Phillips 66 (PSX)

Phillips 66 (NYSE:PSX) was one of the best performers in the energy sector during the last year. The stock gained about 40% during the last year, compared to about a 19% gain by ConocoPhillips (NYSE:COP). Other energy giants such as Exxon Mobil (NYSE:XOM) and Chevron (NYSE:CVX) also recorded gains substantially lower than Phillips 66 at 14% and 13%, respectively. Let's look at the valuation and the future prospects of the company, and see how much potential is there for the stock to grow.

Valuation: Is the Stock Cheap?

Firstly, let us look at the price-to-cash flow ratio - the price-to-cash flow ratio shows how much you are paying for each dollar of cash generated by the company. The ratio for Phillips 66 is 7.3, compared to the industry average of 6.4. The ratio is slightly above the industry average levels, which means that the stock is trading at a premium compared to the industry based on price-to-cash flow ratio. Phillips 66 has managed to increase its cash flow impressively in a very short period of time. On an annual basis, Phillips 66 has achieved a 140% increase in its free cash flow to equity. If the growth in cash flows continues (which I believe will happen due to the growth projects underway), the ratio might come down over the next few quarters. As the company has been growing cash at an impressive rate and there is considerable excitement about the future prospects, the premium is justified, in my opinion.

Moving on to the price-to-book value - Book value represents the assets of the company deducting all its obligations. Price-to-book value of Phillips 66 is 2.1, same as the industry average. This means that for each cent of company's book value, you are paying 2.1 cents. However, it should be kept in mind that the book value includes intangible assets such as goodwill, which may distort the book value to some extent. Based on this ratio, I think that the stock still has some potential to grow since the company is performing better than the industry in terms of cash generation.

Finally, let us take price-to-earnings ratio into consideration. Price-to-earnings is one of the simplest ratios depicting how much you would pay for every cent that a company makes. P/E ratio of Phillips 66 is 13 while the industry average is 12, slightly expensive than the industry. As I mentioned above, there is some excitement around Phillips 66 since the spin-off from ConocoPhillips, and the growth prospects made it very popular among the investors. As a result, the stock has been trading a slight premium and it despite the premium - it has generated substantial returns for its investors. The company has managed to increase its earnings at a rate of 16% as of 2013.

Future Outlook, Cash Flows and Dividends

According to the annual results announced by the company, most of the growth in earnings came from the Midstream segment and refining. The company is further working to increase its capacities in these areas. In the Midstream segment, Phillips 66 is starting a project to build 100,000 barrel per day liquid natural gas (NGL) fractionators in Old Ocean, Texas. Moreover, the company is also looking to build an NGL terminal in Freeport, Texas. In refining, the company is on its way to increase its refined product export capacity by 20%. As these projects come into play, it will further enhance the earnings of the company.

Let's now take a look at the cash flows - the company generated over $6.4 billion in cash flows from operations, showing growth of about 50% during the last twelve months. At the moment, the company is paying about $4.5 billion in cash dividends and investing about $2 billion in capital expenditures annually. As a result, the payout ratio based on free cash flows is over 100%. However, if the growth in operating cash flows continues, the company should be able to bring its payout ratio down substantially and grow the dividends at the same time. As I mentioned above, the growth projects currently underway should enhance the cash flows substantially, which should allow the company to meet its dividend obligations as well as invest in capital projects.

Conclusion

The future prospects of Phillips 66 are bright and the company has not disappointed in the past either. In my opinion, the company will grow even further this year. Phillips 66 has structured its product mix efficiently, which should allow it to grow earnings as well as cash flows. Moreover, the refining business is already proving to be a great success. As these projects start operations, the company will grow its earnings with even a higher rate than it achieved last year. Taking into account the valuation, growth including ash flows and dividends, and future growth prospects, I believe Phillips 66 is a buy. The price-to-earnings and price-to-cash flows ratio suggest that the stock is slightly expensive, but I believe the premium is justified as the company is growing its earnings an cash flows at an impressive rate and there is considerable excitement about the prospects of the company.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Business relationship disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. IAEResearch is not a registered investment advisor or broker/dealer. This article was written by an analyst at IAEResearch and represents his/her personal opinion about the companies mentioned in the article. The article is for informational purposes only and it should not be taken as an investment advice. Investors are encouraged to conduct their own due diligence before making an investment decision. I am not receiving any compensation (other than from Seeking Alpha) for this article, and have no relationship with the companies mentioned in the article.