The Value Of Phillips 66

| About: Phillips 66 (PSX)

We've been following the ongoing story of the spinoff of ConocoPhillips (NYSE:COP) into two independent companies, ConocoPhillips and Phillips 66 (NYSE:PSX) and it is time for an update.

The situation came onto our radar screen last December when we pointed out that there was an immediate 5% or so upside. I thought that the true value of the deal would be realized at some point afterward, when these two stocks finally reached their own level in the marketplace. For the complete story, I hope you will click on this article.

As of this morning here is the current value of the deal if you had gone long last December, after reading my article:

Price Shares Value
COP-PreSpinoff 68.55 1000 68550
Deal as /8/142012of
COP 57.33 1000 57330
COPDividends 1.98 1000 1980
PSX 40.148 500 20074
PSXDividend 0.2 500 100

At the moment, you would be pretty happy with your trade, with a profit of 15% in just a bit more than 8 months, considering the dividends.

Here are my original price estimates:

COP-PreSpinoff 68.55 1000 68550
COP PostSpin 56 1000 56000
PSX-PostSpin 30 500 15000

As it turned out, the COP portion ended up just about where I thought it would. But, the PSX portion did much better. That stock is trading at 40 this morning.

So, it's time to try to make some sense of what happened.

The first thing that happened, it appears, was that PSX made more money than I expected. The company reported income of $1.86 per share for the second quarter, which was $0.48 per share higher than the analysts expectations. This was on a pace similar to what the company expected based on the management presentations, and would suggest a stock price in the mid-40's if the company were valued at the typical PE ratio in this industry of 8.

2011 2012Est 2Q (ActualAnnualized) 2012NewEst
EPSEst 4.3 5.92 1.86 5.84
Shares ,650,000000 ,650,000000 ,650,000000 ,650,000000
EstEarnings ,2,795,000000 ,3,848,000000 ,1,209,000000 ,3,796,000000
(NYSE:PE)Typical 8 8 8 8
Est StockPrice 34.4 47.38 59.52 46.72

The company is currently being valued with a trailing PE of only 5.1, and a forward PE of around 8, which is close to the historical typical for this industry.

The second thing that happened was that the company announced a 20 cent per share dividend. At a stock price of 40, and assuming the company is able to maintain the dividend, which in this cash-heavy business is a reasonable expectation, you're looking at a 2% dividend yield. If you had gone long on COP in December, you would have had an effective dividend increase. It is difficult in the current era to compute the dividend premium, but the dividend does reduce the risk of the stock.

There are a couple more data points to add:

Yesterday, Tesoro Corporation (NYSE:TSO) and BP Corporation (NYSE:BP) announced a refinery transaction, in which we derived a value for TSO of about $11,000 per BPD refining capacity.

Here is the calculation using the current market capitalization of PSX:

Value PSXofCapacity
MarketCapitalization ,25,250,000000
Debt ,7,900,000000
Total ,33,150,000000
Discount for ChemicalsBusiness ,26,520,000000
Refining ()BPDCapacity ,2,200000
Dollars BPDper 12055

Here is the same calculation for Marathon Petroleum Corporation (NYSE:MPC) which is one of the leaders in this industry.

Value MPCofCapacity
MarketCapitalization ,16,760,000000
Debt ,3,350,000000
Total ,20,110,000000
Refining ()BPDCapacity ,1,177000
Dollars BPDper ,17085.81

So if MPC is fairly valued, with a forward PE of 7, and the value of the company's refining capacity at $17000 per BPD, both TSO and PSX may be underpriced at their current values.

What about the future?

Well, we know for sure that PSX managed to generate $1.7B in cash flow in the last quarter, and a total cash flow of $3B this year. While past performance is no guarantee of future results, even if the cash flow is zero for the rest of the year, you're still looking at generating about 1/8 of the market cap of the entire company in cash. The management has stated their intention to buy back shares in their most recent presentation.

So, I'm ready to say that the current price of PSX is plausible, and there is probably at least $5 worth of upside.

As to the risks: Well, this is the refining business, the nastiest part of the oil industry, and there are lots of risks inherent in the business, including weather issues, environmental problems, and maintenance issues in these big, hot, expensive, dangerous operations. There is the problem of vulnerability to a downturn in the economy which might depress refining margins, particularly in regions like Europe where PSX still has some exposure. Also, there is always oil price peril, which for some of the refiners has been partly offset by the fact that there is a glut of crude oil capacity in the middle of the country. We're also headed into the third and fourth quarters, which are typically the weakest in this industry. Conditions are subject to change without notice.

The world is full of chaos and there are no guarantees on anything.

Disclosure: I am long TSO.

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