Phillips 66's (PSX) Q2 2012 earnings were up 40% year-on-year on an adjusted basis, with very strong refining margins, and refining profit up 70% year-on-year, somewhat offset by higher corporate costs post-spin and weaker midstream profitability due to natural gas pricing. The company announced a significant buyback and is still undervalued relative to its intrinsic value with 21% upside; a transportation MLP later in the calendar year remains a potential catalyst.
Buyback announcement - 4.1% of market cap
Phillips 66 announced a $1B share repurchase program; this would be 4.1% of total market cap if implemented in full (though repurchases seldom are), and complements the company's 2.2% yield and Trainer refinery disposal for $230M - all these actions are recently announced and testimony to Phillips 66's emphasis on shareholder value creation. This is in line with the spirit of ConocoPhillips (COP) - the company Phillips spun-off from.
No new news on transportation MLP
A further catalyst could come from the establishment of an MLP of the company's transportation assets, which currently do not receive much analyst attention and this financial engineering may give it greater exposure. However, this is not likely to happen until later this calendar year and is still uncertain.
21% upside remains to $46
I have a $46 price target for Phillips 66 as detailed here. Yesterday,the stock was up in a weak market to $38 leaving 21% upside, with the potential MLP of transportation assets, together with growing confidence in, and awareness of, this relatively new company, as catalysts to realize that valuation. Yesterday's announcement, though encouraging, does not change my valuation of the business, given the inherent cyclicality and that refining margins are currently relatively strong. Refinining margins are up 70% in Q2 year-on-year, but of course, this will not continue indefinitely and skeptics may want to look at 2009 to see what a bad year looks like.
Phillips 66 remains a relatively attractive investment, particularly for those seeking yield, given the company's 2.2% dividend.
See Michael Fitzsimmons' Phillips 66 earnings coverage on Seeking Alpha here, and Bret Jensen's recent analysis of the refining sector - which is performing very well of late relative to the broader market.
- We must not ignore the cyclicality of refining and focus on normalized earning through the cycle, rather than the current relatively high earnings driven by relatively high refining margins. See 2009 for an example of what a bad year looks like for Phillips 66 when it generated $476M in earnings. Phillips 66 currently trades at 50x that, admittedly very depressed, earnings number.
- Management continues to make the right moves in terms of shareholder value, but Phillips 66 is still a new company and only a few months old. Management's track record is not yet well established and it's possible it overpays in the course of its stated desire to expand its chemicals exposure.
- Midstream earnings have weakened in line with declining gas prices, though this is a relatively small part of the business.
Additional disclosure: I would exit my position were the PSX share price to exceed $46.