Phillips 66: Favorable Refining Environment Makes This Stock A Favorite Value Play

| About: Phillips 66 (PSX)
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Shares of Phillips 66 (NYSE:PSX) ended the week 9% higher after the oil refiner and marketer reported its second quarter results.

Second Quarter Results

On Wednesday last, Phillips 66 reported a decent set of second quarter results, the first earnings release as an independent company. In May, Phillips 66 separated from its parent company ConocoPhillips. Phillips 66 reported second quarter earnings of $1.2 billion, compared to $1.0 billion in the period last year.

Adjusted-earnings came in at $1.4 billion, or $2.23 per share. Adjusted profits came in higher than net income as a result of the sale of the Trainer refinery and other one-time charges.

CEO and Chairman Greg Garland commented on the results, "We're off to a solid start, running well in a positive margin environment. The location of our domestic refining, midstream and chemicals faculties enabled us to access advantaged feedstocks, creating strong earnings and cash flow."

As a vote of confidence, the board of Phillips 66 approved the repurchase of $1 billion of the company's outstanding shares.

Segmental Information

Refining and Marketing

Adjusted net profits at the refining and marketing division came in at $1.18 billion, compared to $748 million last year.

Refining activities contributed $851 million in adjusted net profits, compared to $353 million last year. Refining margins were strong, coming in at $12.56 per barrel. Margins were particularly high in the US mid-continent and in Europe. The company's 15 refineries operated at a worldwide utilization rate of 93%. In total, Phillips 66's refineries have a total processing capacity of 2.2 million barrels per day.

Adjusted net profits at marketing, specialties and other activities came in at $334 million, compared to $250 million last year. Wholesale fuel margins improved as product prices fell less than spot-based products.


The midstream operations reported a $91 million loss, as a result of a $170 million non-cash impairment of the Rockies Express Pipeline investment. Adjusted earnings came in at $79 million compared to a profit of $111 million last year. Earnings fell as NGL prices declined and operating costs increased.


Adjusted earnings at the chemicals division came in at $242 million. This compares to earnings of $190 million last year as a result of improved margins and lower utility costs.


Phillips 66 did not issue any specific financial targets for the rest of 2012 in its earnings release. It did, however, give an update on the strategic initiatives. The company will acquire 2,000 rail cars to transport shale oil and other cost-advantaged feedstocks. This will increase the access to domestically produced oil. Development continues at its Sand Hills Pipeline project with first phase production anticipated in the third quarter. The joint venture with Saudi Polymers Company has completed construction of a petrochemical complex in Jubail.


Phillips 66 ended its second quarter with $3.1 billion in cash and equivalents. It operates with roughly $8.0 billion in short- and long-term debt for a net debt position of $4.9 billion. For the first six months of 2012, the company reports revenues of $94.3 billion on which the company reported net profit of $1.8 billion, or $2.86 per diluted share. Normalized diluted earnings per share came in at $3.52

At this pace, the company is on track to generate $190 billion in annual revenues for 2012, with normalized earnings per share coming in at around $7 per share. This values the company at 0.1 times annual revenues and roughly 6 times annual earnings. This valuation compares to a 0.1 times annual revenue multiple for Valero Energy (VLO) and 0.1 times for Tesoro (TSO) - which trade at merely 3 and 6 times trailing annual earnings, respectively.

Phillips 66 currently pays a quarterly dividend of $0.20 per share for an annual dividend yield of 2.0%.

Investment Thesis

Shares of Phillips 66 commenced trading around $33 per share in May when the company was spun off from ConocoPhillips. From that point in time, shares have steadily risen to $39.67 at the moment. The run-up marks a 20% return in just three months. Falling spot prices, crude price differentials and refinery outages at competitors, have boosted refining margins and send shares upwards.

After the spin-off from ConocoPhillips, Phillips 66 is the largest independent refiner in the US. The spin-off got the okay from value investor Warren Buffet, who said that Berkshire Hathaway (BRK.A) invested in the stock.

Furthermore, CEO Garland already indicated that future growth will be geared toward pipeline and chemical investments. He hopes to diversify away from the refining activities, which typically report low and volatile earnings.

Phillips 66 operates in an extremely beneficial environment for refiners, with lower spot prices and price differentials between crude. Short-term profits will enjoy a boost from these market conditions, allowing the company to boost the payout to shareholders and finance its growth plans.

Phillips 66 is an excellent addition to any long-term portfolio. Despite a 20% rally, shares remain attractively valued.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in PSX over the next 72 hours.