PSX - Phillips 66: As Good As It Gets

2023-09-28 10:24:00 ET

Summary

• Phillips 66 is a complex business with stakes in refinery, midstream, chemical and other energy sectors.
• The stock has had a nice recent run and is up some 33% over the past three months of trading.
• However, some insiders have started selling their equity in September, raising concerns about the stock's future performance.
• Can the rally continue?  An analysis follows below.

Formula for success: rise early, work hard, strike oil." - J. Paul Getty.

Today, we put Phillips 66 (PSX) in the spotlight. I took a position in this large refinery play in mid-February of this year via covered call orders. I have since " rolled " the option on the holding once, picking up another nice premium. The position is solidly in the money now. However, insider selling has picked up in this name and the stock is not as cheap as when I established my position. Still more upside in Phillips 66? An analysis follows below.

Company Overview:

Phillips 66 is headquartered in Houston, TX. In addition to its refinery operations, the company has a large midstream business that transports crude oil and other feedstocks and delivers refined petroleum products to market. It also provides terminal and storage services for crude oil and refined petroleum products; transports, stores, fractionates, exports, and markets natural gas liquids as well as natural gas. The company expanded this business with the recent $3.8 billion acquisition of the DCP Midstream, LP public common units.

Finally, Phillips 66 has a chemical business as the result of an equity investment in Chevron Phillips Chemical Company LLC (CPChem). The stock currently trades at around $120.00 a share and sports an approximate market capitalization of $53 billion.

Second Quarter Results:

The company posted its second quarter numbers on August 2nd. Phillips posted non-GAAP earnings of $3.87 a share, beating expectations by just over 30 cents a share.

Breaking down results by business line:

Refining pre-tax income fell significantly to $1.1 billion from $1.6 billion in the same period a year ago. Lower net income was attributed to falling margins. This negative was partially offset by higher volumes and lower operating expenses. Phillips realized a margin of $15.32 a barrel in the second quarter, down sequentially from $20.72 a barrel in the first quarter of this year. Marketing and Specialties was a bright spot for the company this quarter, as pre-tax income soared to $644 million from $426 million in 1Q2023. This was due to high global demand which drove margins significantly higher.

Midstream pre-tax income fell to $604 million from $702 million in 2Q2022, while transportation pre-tax income was up slightly to $284 million from $270 million a year ago. NGL and Other adjusted pre-tax income dropped to $357 million from $420 million in 2Q2022. The fall was due mainly to falling commodity prices. Finally, the chemical division contributed $192 million in pre-tax income from $198 million in the first quarter of this year.

Analyst Commentary & Balance Sheet:

Since second quarter results were posted, eight analyst firms including RBC Capital and Wells Fargo have reissued Buy/Outperform ratings on the stock. Price targets proffered range from $122 to $144 a share. Morgan Stanley ($125 price target), Bank of America ($143 price target) and Mizuho Securities ($131 price target) have maintained 'Hold' ratings on PSX.

After no insider activity since early February, insiders are starting to dispose of some equity here in September. So far in the month, four insiders have sold nearly $40 million worth of stock collectively in September. Just over two percent of the outstanding float in the shares is currently held short.

The company produced $1 billion in operational cash flow in 2Q2023, $2 billion excluding working capital impacts. During the quarter, Phillips spent $1.3 billion on stock buybacks and $474 million. Phillips ended the quarter with approximately $3 billion of cash and marketable securities on its balance sheet. Thanks to the acquisition of DCP Midstream, leverage did increase in the quarter. At the end of the first half of 2023, Phillips had a consolidated debt-to-capital ratio of 39% and its net debt-to-capital ratio was 35%.

Verdict:

Phillips 66 made $18.79 a share of profit in FY2022 on a tad under $14 billion in revenues. The current analyst firm consensus has earnings dropping to $16.42 a share in FY2023 as revenues fall in the high teens. Profits are projected to fall to $13.37 a share in FY2024 as sales fall an addition five percent.

The stock currently trades around 12 times forward earnings with a 3.5% dividend yield. Reasonable but not compelling valuations given the cyclical nature of the refinery and chemical businesses. In contrast, giant refiner Valero (VLO) (Which I also own at much lower levels via covered call holdings) sells for less than six times earnings with a 2.9% dividend yield.

Projections have earnings declining both in FY2023 and FY2024. In addition, two refineries in Nigeria and Mexico are coming online soon, which could negatively impact margins. That is not an indictment on Phillips management that has done a solid job running the company, taking costs out of its operations, keeping its balance sheet lightly leveraged and returning funds to shareholders. It is more of a sector call.

In addition, a likely recession is on the horizon, as I detailed in " Shades of 2007 ." With PSX hitting up against the floor of Buy-rated analyst firm price targets, now is not the time to buy Phillips in my opinion.

This is a sentiment that might also be shared by some insiders, given some recent large selling of shares in September. In conclusion, I will let my stake in PSX expire in the money (they have $105 option strikes), but I will not initiate a new holding in PSX at these levels and will deploy those funds elsewhere when they become available.

Three great forces rule the world: stupidity, fear and greed ." - Albert Einstein.

For further details see: