Get Your Kicks Out Of Phillips 66

| About: Phillips 66 (PSX)

One of my biggest regrets is not buying Phillips 66 (NYSE:PSX) when it was spun off from ConocoPhillips (NYSE:COP) last year.

You see, I recommended the company as a Buy in our sister publication, Wall Street Daily. So it would have been unethical - and even illegal - for me to scoop up shares for myself while simultaneously using my position as a reporter and analyst to encourage readers to do the same. In the year since Phillips 66 spun off from its parent, PSX stock has soared about 64%. And sadly, I still can't buy it, because today I'm going to tell you the same thing I did 12 months ago…

Phillips 66 is a huge profit opportunity. In fact, the case for buying the stock now is even better than it was last year. Here's why…

Refining Rebound

Phillips 66 is the largest independent refiner by sales in the United States. It has stakes in 15 operating refineries and the capacity to refine 2.2 million barrels of oil each day. For that reason, Phillips 66 benefited greatly from a sector-wide rebound among refiners. Indeed, all of Phillips 66's major competitors have enjoyed huge gains over the past year:

  • Valero (NYSE:VLO) is up 57%.
  • Marathon Petroleum Corp. (NYSE:MPC) is up 83%.
  • And Tesoro (TSO) is up a stellar 121%.

The main reason refiners are doing so well is a serious improvement in the so-called "crack spread." If you're not familiar, the crack spread is the difference between a refiner's input cost (the price of oil) and the price for which it can sell its products (gasoline, natural gas liquids, etc.). Refiners' input costs have been falling over the past year, because increased shale production has created a glut of West Texas Intermediate (WTI) crude in the United States.

For instance, Phillips 66 is currently running about 20,000 barrels per day of cut-price crude from North Dakota's Bakken shale. And the company aims to double that when a new offloading facility is built. What's more is that the U.S. supply glut is projected to broaden over the next few years.

Indeed, U.S. oil production has surged a stunning 28% since 2008 thanks to new, unconventional supplies. And the Energy Information Administration (EIA) predicts that it will expand by another 900,000 barrels per day (bpd) - the largest amount on record - to 7.3 million bpd this year. That means oil prices are likely to remain muted and refiners will continue to benefit from abundant U.S. supplies.

So if you're thinking it's too late to get in, it's not. In fact, recent developments have left many U.S. refiners - including Phillips 66 - trading at bargain levels.

A Temporary Setback

PSX stock is up 13% this year, but it's also down 13% over the past month. So what happened?

Well, the government, for one thing. At the beginning of April, the Environmental Protection Agency (EPA) proposed new regulations to reduce sulfur in gasoline beginning in 2017. The proposal has not yet been approved, but if it does happen, refiners will have to spend hundreds of millions of dollars to upgrade their refineries.

Still, those capital expenditures don't justify the 10% to 15% price correction refiners have seen over past few weeks. And here are two reasons why. First, financing those costs won't be a problem. Refiners are among the most credit-worthy companies in the world and interest rates are still near zero. So money isn't an issue. And second, at least part of the cost will be passed on to consumers, namely through higher gas prices. The EPA says Americans will be forced to pay $0.01 more per gallon for gasoline, but the American Petroleum Institute, a lobbying group, says prices will rise by at least $0.09 per gallon.

So, the knee-jerk reactions to the proposal are well overblown - especially considering that Phillips 66's net income more than doubled in the first quarter. Not only that, but the company has even bigger plans to enhance its cash flow.

The Master Plan

Last month, Phillips announced that it would be using some of its midstream assets to create a new entity - a master limited partnership (MLP) called Phillips 66 Partners. The MLP will list on the NYSE in the second half of this year, generating about $400 million from its IPO. Its midstream operations include pipelines, terminals and port facilities. These are fee-based operations, which means they make money based on volume. So the price of oil and gas has no bearing on their operating income.

MLPs are all the rage these days, as they generate steady cash flow and take advantage of a separate tax structure. As the general partner of Phillips 66 Partners, Phillips 66 will get tax-advantaged distributions and more access to capital markets. That will enhance its ability to grow and increase value for shareholders.

So while it's struggled over the past month, Phillips 66 has a lot going for it. That includes low input costs, access to U.S. shale plays, strong midstream assets and a serious plan to boost both growth and shareholder value. If you're looking to go long on refiners, Phillips 66 is as good a bet as any.


I 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. I have no business relationship with any company whose stock is mentioned in this article.

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