Will Phillips 66 Surprise Again?

| About: Phillips 66 (PSX)

Summary

Phillips 66, which has 14 refineries with a net crude capacity of 2.2 million barrels per day, has shown the best performance in the last year among major U.S. refiners.

Warren Buffett's Berkshire Hathaway has taken a 10% stake in Phillips 66.

According to my calculations, we can expect a slightly better refining margin in the first quarter compared to the previous quarter.

The average target price of the top analysts is at $88.80, up 3.3% from its April 1 close price, however, in my opinion, shares could go much higher.

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Phillips 66 (NYSE:PSX) is scheduled to report its first-quarter 2016 financial results on Friday, April 29, before market open. According to 16 analysts' average estimate, Phillips 66 is expected to post a profit of $1.15 a share, a 23.8% decline from its actual earnings for the same quarter a year ago. The highest estimate is for a profit of $1.77 a share while the lowest is for a profit of $0.73 a share. Revenue for the first quarter is expected to decline 13.1% year-over-year to $20.36 billion, according to 3 analysts' average estimate. There was one EPS up revision and one down revision during the last thirty days. Since Phillips 66 has shown earnings per share surprise in its last six quarters, as shown in the table below, we can expect that the company will beat estimates also in the first quarter.

Source: Yahoo Finance

Phillips 66, which has 14 refineries with a net crude capacity of 2.2 million barrels per day, has shown the best performance in the last year among the major U.S. refiners. In fact, only two refiners stocks among the six leading refining companies that are included in Russell 1000 index have recorded a positive return (including dividend) in the last 52 weeks, as shown in the table below. By the way, Warren Buffett's Berkshire Hathaway (BRK.A, BRK.B) has taken a 10% stake in Phillips 66.

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Since the beginning of the year, PSX's stock is up 4.7% while the S&P 500 Index has increased 1.4%, and the Nasdaq Composite Index has lost 1.9%. Since the beginning of 2013, PSX's stock has gained 61.3%, in this period, the S&P 500 Index has increased 45.3%, and the Nasdaq Composite Index has risen 62.8%. According to TipRanks, the average target price of the top analysts is at $88.80, up 3.3% from its April 1 close price, however, in my opinion, shares could go much higher.

PSX Daily Chart

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PSX Weekly Chart

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Charts: TradeStation Group, Inc.

Trying to estimate the refining margin for the first quarter of 2016, I have calculated the average price of Brent crude oil, WTI crude, gasoline, natural gas and heating oil in the fourth quarter of 2015 and the first quarter of 2016. The results are shown in the table below.

According to these findings, the decline in the price of crude oil, in the first quarter compared to the previous one is about 8% greater than the drop in the price of gasoline. However, it is about the same as 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 refining margin in the first quarter compared to the fourth quarter of 2015. Also, the natural gas price is about 23% 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.

However, according to the Howard Weil report from March 30, U.S. Gulf Coast's average crack spread in the first quarter has been $9.08 per barrel, compared to $9.28 in the fourth quarter of 2015. While geographically diverse and totaling 2.2 million barrels per day of throughput capacity, the U.S. Gulf Coast represents the largest portion at 738,000 barrels per day. Approximately 81% of total throughput capacity is located in the U.S., with international locations that include Ireland, the United Kingdom, Germany, and Malaysia. In any case, I do not expect a significant change in Phillips 66's refining margins in the current quarter compared to the previous quarter.

Source: howardweil.com

Source: Company Presentation

I see continued healthy growth prospects for the company. Total U.S. gasoline stocks have decreased to 242.6 million barrels in the week ended March 25, from 245.1 million barrels in the previous week and from 256.5 million barrels in the week ended on February 19. That indicates continued strong demand for gasoline. What's more, U.S. crude oil stocks have increased to 534.8 million barrels in the week ended March 25, from 532.5 million barrels in the previous week and from 507.6 million barrels in the week ended on February 19. As such, a significant increase in the price of crude oil is not expected soon, and refining margins are not expected to deteriorate.

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%.

Valuation

PSX's valuation is very good, the trailing P/E is low at 11.09, the forward P/E is also low at 11.39, and its price-to-sales ratio is extremely low at 0.54. Furthermore, its Enterprise Value/EBITDA ratio is low at 9.10, and its PEG ratio is at 1.16.

Moreover, PSX's Efficiency 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:

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Source: Portfolio123

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 last quarter, consisting of $298 million in dividends and the repurchase of 4.7 million shares of common stock for $406 million. For the year 2015, 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 2.61% and the payout ratio is only 22.7%. The annual rate of dividend growth over the past three years was very high at 69.2%.

PSX Dividend Chart

PSX Dividend data by YCharts

Summary

Phillips 66 is scheduled to report its first-quarter 2016 financial results on Friday, April 29, before market open. According to 16 analysts' average estimate, Phillips 66 is expected to post a profit of $1.15 a share, a 23.8% decline from its actual earnings for the same quarter a year ago. Since Phillips 66 has shown earnings per share surprise in its last six quarters, we can expect that the company will beat estimates also in the first quarter. According to my calculations, we can expect a slightly better refining margin in the first quarter compared to the previous quarter. Phillips 66 has compelling valuation metrics and healthy earnings growth prospects; its P/E ratio is low at 11.09. 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 $88.80, up 3.3% from its April 1 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.