Having just passed the second anniversary of the spin-off of Phillips 66 (NYSE:PSX) from ConocoPhillips (NYSE:COP), it is a good time to appraise how this has played out for shareholders and look to see if there is value still to be made. Q1 2014 results have just been reported by both companies, and both beat on profits. Mirroring Cabot Oil and Gas (NYSE:COG) from a week ago, COP reported over 40% production increases in shale production as well as ongoing growth from Canadian oil sands. Worldwide, COP is progressing on several exploration and new drilling projects that should lead to continued production growth far into the future. On the other hand, PSX reported adjusted earnings of $866M in Q1 2014 compared to Q4 2013 adjusted earnings of $808M. Improved margins in the Midstream and Chemical businesses were somewhat offset by Refining results, which were impacted by refinery downtime and tightened crude spreads.
Review of COP 2013 Results:
Year on year, COP had revenues fall 9.38% from $62.00bn to $56.19bn, though the company grew net income 8.64% from $8.43bn to $9.16bn. COP had a gross margin of 46.57%, net profit margin of 14.30%, operating margin of 22.78% and return on equity of 15.94%. For COP, both dividends per share and earnings per share excluding extraordinary items growth increased 2.27% and 8.80%, respectively. The dividend growth rate over the last five years has been 7.5% with an average yield of 3.78%. In 2013, COP increased its cash reserves by 72.64%, or $2.63bn. COP earned $16.09bn from its operations for a Cash Flow Margin of 28.63%. In addition, COP used $6.25bn on investing activities and also paid $7.13bn in financing cash flows. COP ended the year with a book value per share of $42.49. COP reduced the Debt to Capital Ratio in 2013 from 43.28% in 2012 to 29.21%.
Review of PSX 2013 Results:
Year on year, PSX's revenues fell 4.29% from $179.29bn to $171.60bn. This, along with increased costs in selling, general and administrative costs contributed to a reduction in net income from $4.12bn to $3.73bn, a 9.65% decrease. PSX had a gross margin of 13.61%, net profit margin of 2.15%, operating margin of 1.48%, and return on equity of 17.13%. PSX had growth in dividends per share increased 195.00% while earnings per share excluding extraordinary items fell by 7.58%. PSX increased its cash reserves by 55.44%, or $1.93bn. PSX earned 6.03bn from its operations for a Cash Flow Margin of 3.51%. In addition, PSX used $444.00m on investing activities and also paid $3.68bn in financing cash flows. PSX ended 2013 with a book value per share of $37.19. Like COP, PSX reduced the Debt to Capital Ratio in 2013 from 33.51% in 2012 to 21.56% in 2013.
Since May 1, 2012:
When the split took place, existing shareholders received 50 shares of PSX for every 100 shares of COP. As an exercise, let us see how this holding would have fared over the last two years. The original holding of 100 COP shares post split using the adjusted close prices (from Yahoo Finance) on the day of split would be worth $6749 (100x[51.71]COP+50x[31.56]PSX). Using yesterday's closing prices, the same holding would be worth $11,592, a very substantial gain.
So has all the value already been had, or could accumulating either or both at the current levels still be a good long-term strategy? All below metrics are sourced from Yahoo finance unless otherwise noted.
COP remains the world's largest independent pure-play exploration and production company, and looking at the wide array of projects it is developing across the globe, there is no threat of this changing anytime soon. Viewing COP shares using the metrics I use most often, they are very solid with a PEG ratio of 1.75 and a Price/Book of 1.76. The dividend of 3.71% is robust and dependable, and the target price of $79.13 is a 6% increase from the previous close of $74.31.
Currently, COP sits just about 1% below the 52 week high, which is a bad time to begin accumulating shares. Additionally, in the most recent reporting period, there are net negative insider transactions and a quarter of a percent negative institution transactions. The Analyst Opinion Mean Recommendation rating is 2.4, a very positive number.
Looking Ahead for COP:
This morning, Barclays raised its price target for COP from $83 to $88, a further 5.6% increase and representing a 15% increase from today's open price of $74.88. Expanding gross profit margins and a better than industry average net profit margin of 18.76% bode well for future value growth. A big plus for shareholders now and into the foreseeable future is that COP is growing while keeping capex relatively flat until at least 2017.
If the dividend growth rate stays at the previous five year rate of 7.51%, COP could continue to hover hear the 3.7%-4% dividend yield while still achieving almost all of the expected price appreciation in the next few years. COP already leads both Chevron (NYSE:CVX) and ExxonMobil (NYSE:XOM) at both PEG and Dividend Yield. It also has less than half of the equity value of CVX and more than four times less than XOM, which is another strong indicator of possible future value growth.
PSX is also very solid across almost all metrics, with a PEG of 1.52 and a Price/Book of 2.32. The dividend is almost exactly half of COP's in percentage terms as of now, and the target price of $87.35 is just 4.7% above the previous close of $83.22. Where the real positives appear for PSX is in bullish positive trends in insider transactions and institutional transactions (per FinViz.com). The Analyst Opinion Mean Recommendation is 2.1, a significant bit higher than the 2.4 for COP. Where I see possible additional opportunity is in the relatively low payout for PSX (12.30% compared to 36.3% for COP) despite the much lower margins.
Looking Ahead for PSX:
While the strength in COP is the continued expansion of its core business, this is the risk inherent in PSX as it sits now. PSX is determined to make itself a player in the US export market and grow its midstream assets. To achieve these goals, capex would need to expand a great deal, which may require cuts to distributions to shareholders or share dilution via secondary offerings. Due to the low payout of PSX, it may be possible for the retained earnings to fund the expansion efforts, but this could impair any ability for the dividend yield to increase over time. If additional sourcing is eventually needed, the effect could be a double whammy.
Another risk that PSX faces is that it may be caught in its strategy if other areas of the globe develop their own local or regional shale industries, negating the attempt at the development of PSX's export capabilities. For a project representing as large of capex as this build up will, this reversal in fortune would be catastrophic.
If PSX is able to deliver on its strategy and maintain or increase dividends while avoiding dilution or crippling debt, PSX could definitely prove itself to be both a value-growth and dividend-income play on par with COP, perhaps exceedingly so in the longer term.
I remain very positive on both COP and PSX. One of my most profitable positions of all time has been my holding in Sunoco Logistics Partners LP (NYSE:SXL) (196.12% for SXL and +148.49% for PSX), and I can see that PSX has closely trailed SXL since May 1, 2012. While my two current accumulation theses are geared toward high-yield and value-growth via turnaround, it is very likely that I will end up changing my opinion on one or more of the current slate of stocks I am buying. When this happens, COP and PSX would most certainly be on my short list of stocks to replace them with. The determining factor if I had to choose between the two of them, or in comparison to other stocks I like, would have to be the relative position to the 52 week high. I would likely pull the trigger on the one furthest away from the peak at the time if all other things are subjectively equal.
Disclosure: I am long COP, PSX, SXL, COG. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.