It won't be surprising if Phillips 66 (NYSE:PSX) turns out to be a good long-term pick since it should benefit from the underlying opportunity in the chemical and midstream businesses. For example, the size of the polyolefins industry is forecasted to increase at a compound average growth rate of 7.82% to $297.09 billion by 2021. Likewise, the methanol market is also expected to grow at a CAGR of 12.4% to $54.16 billion by 2021 from last year's levels.
So, in this article, we will take a look at the different factors that will drive Phillips 66's growth going forward and try to judge the impact of the same on the company's financials and stock price.
A look at the growth drivers in the chemical segment
Phillips 66 will benefit substantially from the U.S. Gulf Coast Petrochemicals Project that it is developing as a part of its CPChem joint venture with Chevron (NYSE:CVX). This project has reached 85% completion and Phillips 66 expects to start the polyethylene units in the first half of the year, with the ethane cracker units going online in the second half of 2017. Once the project is complete, Phillips 66 will be able to increase its global ethylene and polyethylene capacity by approximately one-third for its CPChem joint venture.
More specifically, Phillips 66 currently has a net petrochemicals capacity of 34 billion pounds per year, which means that after the expansion, its CPChem capacity will increase to 45 billion pounds per year. The increased capacity of Phillips 66 will allow it to take a larger share of the petrochemicals market going forward.
As a result of the expansion, Phillips 66 can tap expected annual growth of 7.82% and 12.4% in the polyolefins and methanol markets, respectively, over the next five years as mentioned earlier in the article. Now, last year, methanol demand was anticipated at 70 million metric tons, or 154 billion pounds. At an annual growth rate of 12.4%, methanol demand will grow to 276 billion pounds by 2021. Similarly, global polyolefins demand was 88.1 million tons in 2015, or 176 billion pounds. So, at a growth rate of 7.82%, this market's size will increase to 256 billion pounds in 2021.
This means that by enhancing its capacity at CPChem to 45 billion pounds per year, Phillips 66 will be able to tap 8.45% of the 532 billion pound methanol and polyolefins market by 2021.
In comparison, Phillips 66 currently has a market share of 5.6% in the chemicals segment. This means that the company is well-placed to grow its market share in the long run in the petrochemicals segment due to an increase in capacity and a strong utilization rate of more than 90%. Now, I will be using the potential growth in Phillips 66's market share to forecast the company's probable revenue in 2021. Then I will use the company's net profit margin to arrive at the potential bottom line impact, which will then lead us to the potential stock price in 2021.
Valuation using potential sales and net profit margin
As discussed above, Phillips 66's share of the petrochemicals market could grow to 8.45% in 2021, which means that it will be able to tap 45 billion pounds of the overall market. As a result, Phillips 66's annual petrochemical sales in 2021 should be 45 billion pounds, or 22.5 million tons.
Currently, the price of methanol in North America is $416/ton. Assuming that an equivalent price is prevailing in my forecast year, then Phillips 66's petrochemical sales after the capacity expansion should be $9.4 billion. Now, Phillips 66 currently has a net profit margin of almost 3%. If this net profit margin remains constant, Phillips 66's petrochemicals segment will add $282 million to its bottom line.
On the other hand, the polyolefins market is expected to be worth $297 billion by 2021. So, a market share of 8.45% in this segment will allow Phillips 66 to enhance its sales to $25 billion approximately. At a net profit margin of 3%, this translates into a net profit of $750 million. Therefore, the chemicals segment, including both methanol and polyolefins will add over $1 billion to the company's bottom line in the next five years.
Now, in 2016, Phillips 66's net income should be $1.77 billion as it has 531,650 thousand shares outstanding and is expected to report earnings of $3.33 per share for 2016. Hence, in 2021, Phillips 66's net income will increase by $1 billion on the back of the contribution from the chemicals segment, taking its total net income to $2.77 billion.
This will translate into earnings per share of $5.22, assuming Phillips 66's shares outstanding remain constant. Given Phillips 66's price to earnings ratio of 23, this will lead to a stock price of $120 per share in 2021, indicating an upside of more than 40%.
Therefore, driven by the growth in the chemicals segment, Phillips 66 is on track to report substantial earnings growth in the long run, which will eventually lead to an improvement in the company's stock price. So, it will be a good idea to remain long Phillips 66 in light of the points discussed above.
Disclosure: I/we 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 (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.