Much like Marathon Oil (MRO) spun-off its refiner business, Marathon Petroleum (MPC), to allow the market to better value its businesses, Dividend Growth Portfolio holding ConocoPhillips (COP) recently spun-off its refiner and retail oriented business, Phillips 66 (PSX) for the same reason. This translates into Conoco being the "upstream" company, while Phillips 66 will be the "downstream" company. Since the downstream oil refinery and retail business is more volatile and generally runs on thinner operating margins, we do not think the company represents the ideal investment for our Dividend Growth Portfolio. However, at just 6x 2012 earnings, we think the stock is too cheap to sell after its recent sell-off, so it will remain a small holding within our portfolio for the time being.
Phillips 66 is not a terrible company, in our view, and intends on paying a dividend of around $0.20 per quarter or $0.80 per year. This translates into a yield of approximately 2.7% at current levels, which is a tad shy of what we'd ideally like to see in our Dividend Growth Portfolio. The company intends to focus on changes in capital allocation over the next several years and focus on its more profitable midstream and chemical assets, instead of its refinery and retail businesses.
Unfortunately, this shift in capital allocation won't take place overnight. As we stated earlier, we think Phillips 66 has some interesting assets. Its 50/50 controlled chemical business with Chevron (CVX) is fairly profitable and working to add capacity, and its mid-stream business is already represented in our portfolio by Kinder Morgan (KMP). Although the company does have some strong chemical and midstream assets, the majority of its assets are still refinery and retail operations. The earnings from these businesses tend to be more volatile and more cyclical than the earnings from chemicals and midstream assets. Thus, though management claims to be committed to increasing dividend payouts annually, we aren't sure that's achievable. The company posted negative operating cash-flow in the first quarter of 2012, and still has around $6 billion in debt on its balance sheet.
On the other hand, we think Conoco still looks very attractive. The stock currently has a yield north of 5%, and the company continues to operate a very profitable upstream operation, engaging in exploration and production of oil and natural gas. We're also big fans of its Valuentum Dividend Cushion score, which remains comfortably north of 1. We use the Valuentum Dividend Cushion as a way to predict both potential dividend growth and dividend cuts for companies. Conoco has a robust project pipeline literally spanning the globe. We suspect the global demand for oil will remain relatively stable, and that natural gas price levels are not likely to remain depressed forever. The separation of the two businesses makes each easier to evaluate, in our view, and thus we think Conoco is still attractive at these levels.
Additional disclosure: COP, CVX, and PSX are included in the portfolio of our Dividend Growth Newsletter.