In the last few years, U.S. refining companies have benefited from a high Brent-WTI crude spread, high refining margins due to cheap North American crude oil as feedstock and strong demand for refined products. As a result, their profit has soared, and their shares have surged. However, the large Brent-WTI crude spread has vanished because of the U.S. Congress decision on December 18 to repeal the 40-year ban on exporting U.S. crude oil, and shares of refiners have significantly retreated since then, as a consequence. Phillips 66 (NYSE:PSX), which has 14 refineries with a net crude capacity of 2.2 million barrels per day, has shown the lowest drop in its price among the major U.S. refiners in the last 13 weeks, as shown in the table below.
Since the beginning of the year, PSX's stock is down 1.1% while the S&P 500 Index has decreased 4.8%, and the Nasdaq Composite Index has lost 8.7%. Since the beginning of 2013, PSX's stock has gained 52.3%, in this period, the S&P 500 Index has increased 36.4%, and the Nasdaq Composite Index has risen 51.4%. Considering its compelling valuation, the recent drop in its price creates an excellent opportunity to buy the stock at an attractive price, as Mr. Warren Buffet has done. According to TipRanks, the average target price of the top analysts is at $85, up 5.1% from its February 22 close price, however, in my opinion, shares could go much higher.
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On January 29, Phillips 66 reported its fourth quarter results which beat EPS expectations by $0.06 (4.8%). Quarterly revenues totaled $22 billion, down from of $35.61 billion in the fourth quarter of 2014. The consensus estimates called for revenues of $27 billion. Phillips showed earnings per share surprise in its last six quarters, as shown in the table below.
Source: Yahoo Finance
In the report, Greg Garland, Chairman and CEO, said:
We operated well in the quarter, as refining capacity utilization remained high and clean product yield increased. We also reached a significant milestone with the Sweeny Fractionator One and Clemens Caverns coming online. Solid execution in the fourth quarter generated $1.5 billion of cash from operations, and we returned over $700 million to shareholders through dividends and share repurchases.
Refining adjusted earnings were $376 million in the fourth quarter, compared with $1,052 million in the third quarter. The decrease in earnings was largely driven by lower realized margins due to a 35% decline in global market cracks compared to the third quarter. Fourth-quarter gasoline market cracks dropped to $12.72 per barrel, compared with $21.44 per barrel during the third quarter, while distillate cracks declined from $15.67 per barrel to $12.86 per barrel for the same period.
Trying to estimate the refining margin for the current quarter, I have calculated the average price of Brent crude oil, WTI crude, gasoline, natural gas and heating oil in the third quarter, the fourth quarter and thus far in the current quarter. The results are shown in the table below.
*until February 22
According to these findings, the decline in the price of crude oil, thus far, in the current quarter compared to the previous one is about 8% greater than the drop in the price of gasoline. However, it is about the same of the fall in the price of heating oil (heating oil is a part of the "distillate fuel oil" product family, which includes heating oil and diesel fuel). As such, we can expect a slightly better margin in the current quarter compared to the fourth quarter of 2015. Also, the natural gas price is about 13% lower than in the previous quarter. That should contribute to the improvement in the refining margin in the current quarter. Refiners use natural gas as an energy source for the process; cheap natural gas helps to lower production cost.
I see continued healthy growth prospects for the company. Phillips' results in the last quarter were hurt by lower earnings from its midstream and chemicals businesses. However, the company made significant progress on its growth projects in midstream and chemicals. Despite the challenging environment experienced throughout the energy industry, a diversified asset portfolio has performed well. Phillips is investing hard in midstream projects, which in my view, will contribute to the company's future growth. According to Phillips, 2016 will be another busy year for the company with several other midstream projects scheduled for completion. In chemicals, cash margins fell during the fourth quarter; however, they remain strong by historical standards. Phillips explained that CPChem's geographically advantage footprint allowed it to remain profitable and able to self-fund its growth projects. Development continues on CPChem's US Gulf Coast Petrochemicals project, which will increase CPChem's US ethylene and polyethylene capacity by over 40%.
PSX's valuation is very good, the trailing P/E is very low at 9.44, the forward P/E is also very low at 10.89, and its price-to-sales ratio is extremely low at 0.39. Furthermore, its Enterprise Value/EBITDA ratio is low at 8.26, and its PEG ratio is very low at 0.99.
Moreover, most of PSX's Efficiency, Financial Strength and Return on Capital parameters have been much better than its industry median, its sector median and the S&P 500 median, as shown in the tables below.
The company has returned substantial capital to shareholders through dividends and share buybacks. under its current authorization. Phillips 66 returned $704 million to shareholders during the quarter, consisting of $298 million in dividends and the repurchase of 4.7 million shares of common stock for $406 million. For the year, the company repurchased 19.3 million shares of common stock for $1.5 billion, paid $1.2 billion in dividends, and increased the quarterly dividend by 12%.
In June 2015, PSX raised its quarterly dividend by 12% to $0.56, or $2.24 annually. The forward annual dividend yield is at 2.77% and the payout ratio is only 24.6%.
PSX Dividend data by YCharts
Source: Investor Update February 2016
According to Portfolio123's "Momentum Value" ranking system, PSX's stock is ranked first among all 64 Russell 1000 energy stocks.
The "Momentum Value" ranking system is quite complex, and it is taking into account many factors like; Yield, price to book value, trailing P/E, price to sales, return on equity, sales growth, and relative strength, as shown in the Portfolio123's chart below.
Back-testing over sixteen years has proved that this ranking system is very useful; the reader can find the back-testing results of this ranking system in this article.
Phillips 66 delivered another quarter with better than expected results; the company showed earnings per share surprise in its last six quarters. I see continued healthy growth prospects for the company, Phillips made significant progress on its growth projects in midstream and chemicals. According to my calculations, we can expect a slightly better refining margin in the current quarter compared to the fourth quarter of 2015. Phillips 66 has compelling valuation metrics and healthy earnings growth prospects; its P/E ratio is very low at 9.44. Moreover, the company returns substantial capital to its shareholders by stock buyback and increasing dividend payments. The average target price of the top analysts is at $85, up 5.1% from its February 22 close price, however, in my opinion, shares could go much higher.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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.