After spin off Phillips 66 (PSX) earlier this week, the stock may be artificially depressed due to selling pressure from institutional investors more accustomed to holding the parent than a spin-off entity that is less well known to them and may not meet their investment mandate. Quantitative analysis of past spin-offs supports this view.
In addition, on a fundamental valuation basis Phillips may be reasonable. The exact timing on a Phillips 66 purchase is hard to finesse, but it is probable that the month of May will present a good opportunity to purchase Phillips 66 stock and anticipate strong expected one year outperformance in the region of 22% if history is any guide, albeit with relatively high volatility - there is a 1 in 3 chance based on historics than a spin off underperforms the market.
Opportunities related to spin-offs
Looking back historically, spin-offs offer opportunity for investors. This typically comes in two ways:
- At the time of the spin-off announcement, the parent company tends to trade up on the news of the spin-off. The opportunity has now past with ConocoPhillips (COP).
- Post spin offs, investors have a tendency to sell the asset they are less familiar with. Without the pomp and ceremony of an IPO (and associated fees for investment bankers) there isn't the attention paid to the new company, and the spin off tends to decline. The opportunity may be present today with Phillips 66.
An interesting, if dated, paper by Credit Suisse here details the above findings.
The specifics of Phillips 66
Phillips 66 comprises a refining, midstream and chemicals business. Earnings are volatile given the commodity nature of refining, and the intent is to invest disproportionately in midstream and chemicals which offer higher and less volatile returns than refining.
Over the past three years, Phillips 66 has averaged $1.96B of net income on an adjusted basis, chiefly backing out asset sales and impairments. However, this has ranged from $0.5B in 2009 to $3.6B in 2011, driven largely by refining margins.
|P/E 2011 (adjusted earnings)||5.7x|
|P/E 2009-2011 average (adjusted earnings)||10.4x|
A shareholder friendly business
Phillips 66 appear shareholder friendly in terms of their commitment to the idea of dividend growth and buybacks, and indeed sold a refinery for cash of April 30. The dividend policy is likely to be $0.80 per year growing at 5% per year, and management indicated they see little point in paying down debt given the favorable interest rates they have currently. The proof will be in their actions, but they certainly talk a shareholder friendly game currently.
- Investing on the view that spin offs tend to outperform has made money historically on average, but lead to losses in one out of every three opportunities. In addition, the historical correlation may not hold going forward. Finally, the exact timing of the purchase is important, generally the 30 days after the company starts trading appear to present the best opportunities.
- As a predominantly refining business, Phillips 66 will be cyclical and would suffer stock price declines with declining refining margins.
- Although management appear investor friendly, we will learn significantly more from their actions in the coming months
Phillips 66 appears an attractive investment for two reasons. Firstly as a spin off it may outperform if history is any guide. Secondly it appears relatively cheap on an absolute basis (below market p/e and above market yield) with shareholder friendly management.