PSX - The Play On Phillips 66

2023-03-09 14:01:19 ET

Summary

• Shareholders of Phillips 66 (PSX) enjoyed a ~50% return in FY22 after refining margins expanded significantly courtesy of surging oil prices.
• Despite posting a disappointing $0.35 a share miss in 4Q22, management seemed optimistic in its ability to return a significant sum of capital to its shareholders over the next two.
• With a $5 billion share repurchase program and a 4.2% yield, the first insider buying in two and a half years merited a deeper dive.

Logic becomes illogical at the point that it assumes that everything can be explained logically .”? Craig D. Lounsbrough

Today, we take a deeper look at a refiner with reasonable valuations, a solid dividend yield, a management determined to return cash flow to shareholders and a decent entry point despite a nice run up in 2022. An analysis follows below.

Company Overview

Phillips 66 ( PSX ) is a Houston based diversified energy concern with midstream, chemical, refining, and marketing operations. With roots dating back to 1917, the present company was formed when Phillips Petroleum merged with Conoco to form ConocoPhillips ( COP ) in 2002. As part of the regulatory approval of that combination, the new company agreed to divest of its refining, chemical, and retail businesses (a.k.a. downstream operations), which was accomplished in a 2012 spin off. Its first trade was transacted at $33.25 a share and the stock now trades around $100.00 a share with an approximate market capitalization of $46 billion.

Operating Segments

The company operates through four segments: Midstream; Chemicals; Refining; and Marketing and Specialties.

Midstream provides crude oil and refined petroleum product transportation, terminalling, and processing services, along with natural gas and NGL transport, storage, fractionation, processing, and marketing services. It consists of more than 22,000 miles of pipeline and 64 terminals for various products. The unit also houses its 16% investment in anode material supplier NOVONIX ( NVX ) . It generated FY22 segment Adj. earnings of $1.75 billion and Adj. EBITDA of $2.68 billion.

Also, Phillips 66 announced in early January that it would be acquiring the remaining publicly held LP units of natural gas gathering and processing concern DCP Midstream ( DCP ) for $3.8 billion, or $41.75 per share. The move, when combined with a 15% economic interest acquisition of DCP from Enbridge ( ENB ) in August 2022, will increase the company’s economic interest from 28% to 87% and is expected to generate incremental Adj. EBITDA of $1.3 billion, of which $300 million will come from synergies integrating into its Midstream segment over the next two years. The transaction is slated to close in 2Q23.

Chemicals represents the company’s 50% investment in petrochemical and plastics manufacturer CPChem, which it co-owns with Chevron ( CVX ) . It contributed FY22 segment Adj. earnings of $856 million and Adj. EBITDA of $1.40 billion, both down significantly from FY21, when it accounted for segment Adj. earnings of $1.90 billion and Adj. EBITDA of $2.50 billion. The falloff was due to a severe drop in polyethylene prices in FY22 vs. FY21.

Refining is conducted at 12 facilities in the U.S. and Europe. It is by far the Phillips 66’s largest segment, providing FY22 segment Adj. earnings of $7.89 billion and Adj. EBITDA of $8.85 billion.

Marketing and Specialties consists of more than 7,100 filling stations under the Phillips 66 , Conoco , or 66 banners in the U.S. and ~1,300 (primarily) under the JET brand in Europe. This segment also manufactures and markets specialty products such as automotive and industrial lubricants. It was responsible for FY22 segment Adj. earnings of $2.40 billion and Adj. EBITDA of $2.64 billion.

On a consolidated basis – after factoring in corporate overhead – Phillips 66 generated FY22 Adj. earnings of $8.9 billion, or $18.79 a share, and Adj. EBITDA of $15.1 billion after earning $2.5 billion, or $5.70 a share, and Adj. EBITDA of $5.9 billion in FY21. It was a strong year for the company and the market rewarded it with a nearly 50% return in calendar 2022.

Looking Ahead

Phillips 66 has always been very investor friendly, having returned over $30 billion to investors through both share buybacks and dividends since its inception in 2012. On its Investor Day presentation in November 2022, management indicated that it intended to return an additional $10 to $12 billion to investors via dividends and share repurchases through YE24.

Operationally, in addition to smoothing the volatility of its earnings with more midstream exposure vis a vis DCP Midstream, the company’s investment in CPChem is embarking on two major petrochemical cracker projects (on the Gulf Coast and in Qatar) that should both be self-funded and come online in 2026. Phillips 66 is converting its San Francisco refinery in Rodeo, California to a renewable fuels facility with over 50,000 barrels per day capacity. Commercial operations are expected to start in 1Q24. On the expense side, it has reduced headcount by over 1,100 since FY21, which when combined with its refinery turnarounds to improve efficiency, should reduce overhead by $800 million annually by 2025.

4Q22 Earnings & Outlook

Despite its strong year and bullish commentary on its Investor Day, Phillips 66’s 4Q22 was disappointing. On January 31, 2023, the company reported Adj. earnings of $1.90 billion ($4.00 a share) and Adj. EBITDA of $3.3 billion versus Adj. earnings of $3.12 billion ($6.46 a share) and Adj. EBITDA of $4.9 billion in 3Q22 as realized refining margins fell 27% sequentially to $19.73 per barrel due to lower crack spreads – the difference between market prices for refined petroleum products and crude oil – as well as tighter clean product differentials. The bottom line was also hindered by thinner marketing margins, as well as lower margins and volume in its Chemicals sector. The market was looking for $0.35 a share better from Phillips 66 and sold its stock down 8% in the subsequent two trading sessions to $97.99 a share.

That said, FY22 was a boon for the company with its worldwide refining margins averaging $21.55 a barrel versus $7.42 in FY21.

Balance Sheet & Analyst Commentary

Even though the quarter was short of consensus, Phillips 66 managed to generate cash from operations (before working capital) of $2.7 billion in 4Q22 and, owing to a positive change in working capital, was able to pay down debt by $500 million, spend $713 million on capex, return $1.21 billion to shareholders through stock repurchases and dividends, and yet increase its cash balance by $2.4 billion to $6.1 billion at YE22 (against debt of $17.2 billion). Furthermore, the board added $5 billion to its share repurchase program – first announced in November 2022 – while management indicated that additional dividend increases were coming shareholders’ way. Phillips 66 just boosted its quarterly dividend payout by 8.2% and now yields just north of four percent.

The Street is not nearly as optimistic as management, somewhat evenly split between seven holds and a total of seven buy and outperform ratings. Their median twelve-month price objective is $125. On average, they expect the company to earn $14.97 a share (non-GAAP) in FY23, followed by $13.40 a share (non-GAAP) in FY24.

In addition to voting on the $5 billion repurchase authorization in November 2022, Director Gregory Hayes ponied up $1 million of his own money to buy 10,250 shares at an average price of $97.75 on Groundhog’s Day, marking the first insider purchase since August 2020.

Verdict

Phillips 66 is in a position to generate significant cash in the coming years, and it seems intent on returning it to the shareholders. That said, aside from the pandemic-induced lunacy in the energy complex during 2020, Phillips 66’s stock has traded in fairly tight range since 2014, generally between $75 and $120 with an all-time intraday high of $123.92 in 2018. With some upside potential – and its downside buttressed by a share repurchase program valued at ~10% of its current market cap, a very reasonable EV/TTM Adj. EBITDA of under 4, and a 4.2% dividend yield – Phillips 66 is a solid covered call candidate.

Science is a broad church full of narrow minds, trained to know ever more about ever less .”? Steve Jones, The Single Helix

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