Cliff or no Cliff, This is One Energy Stock to Own

Frank is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Breaking up is hard to do.  That may be the case, but sometimes it’s for the best.  Such is the case with the spin-off of Phillips 66 (NYSE: PSX) from parent ConocoPhillips (NYSE: COP) in April.  ConocoPhillips, the integrated oil company, had been a laggard.  The stock never recovered to where it traded before the financial crisis.  The spin-off of the refining unit lifted a burden off the back of Phillips 66 and unleashed massive outperformance.

Phillips 66 is now a well-run refining giant and is one of the largest domestic producers of natural gas liquids and a top producer of petrochemicals.  Through its refining and marketing segment, Phillips 66 purchases, refines, markets and transports crude oil and petroleum products.  The company’s midstream business gathers, processes, transports and markets natural gas and fractionates and markets natural gas liquids.  The midstream business is primarily made up of its 50% stake in DCP Midstream, LLC.  Its chemicals segment manufactures and markets petrochemicals and plastics worldwide.  The chemicals segment is made up of a 50% stake in Chevron Phillips Chemical Company LLC (CPChem).  The company’s third quarter earnings breakdown shows its earnings by segment.  The third quarter represented the second quarterly report as an independent company.  Comparisons are year-over-year.

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(Source: Company Website Third Quarter Earnings Presentation)

The refining and marketing segment is firing on all cylinders.  The company was able to run its refineries at 96% of capacity in the third quarter.  At the same time, the company expanded its profit per barrel to $6.37 from a year earlier $4.30.  Even after being affected by Hurricane Sandy, management believes they will run refineries at a percentage of capacity in the low nineties  for the fourth quarter.  Management also believes there are more efficiencies that can be attained and has taken on an investment strategy that will get lower priced crude oil (shale, Canadian heavy and WTI crude) to the company’s refineries in a more cost effective manner.  The company has already made investments in rail cars and better pipelines to help realize these efficiencies.

If Phillips 66 is struggling in any segment, it’s the midstream segment.  Profits are down this year but it’s simply a product of much lower NGL prices.  The company is continuing to make heavy investments in the midstream business.  This should position the company well in the future, when gas prices return to more normalized levels.

The petrochemicals segment is strong.  The company increased its year-over-year adjusted earnings by 42%.  Return on capital employed increased to an annualized 31% from 28% in the prior year.

Just like the company, Phillips 66’s share price has been an outperformer too.  Since the spin-off in April, the stock has risen more than 50%.  It has well outperformed the broad market as well as other refiners, Marathon Petroleum Corporation (NYSE: MPC) and Valero Energy Corporation (NYSE: VLO).

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Still, Phillips 66 is too cheap.  Arguably, it’s the best run of the refiners and by most metrics it’s the cheapest.  It’s currently trading at just over six times earnings and just over five times cash flow.  The stock has a price-to-earnings growth (PEG) ratio of 0.86.  Its enterprise value-to-EBITDA is a low 4.27.

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As an investment, Marathon Petroleum gives Phillips 66 a run for its money.  However, I believe Phillips 66 has the slight edge despite its greater share price gains this year.  Phillips 66 seems to have the best management team in the industry.  With an overall ROCE of 21% and ROE of 23%, management is already showing that they are good stewards of capital. In addition, they are focused on creating efficiencies that didn’t exist before to maximize profits.  Below is a ratio comparison of Phillips 66, Marathon Petroleum and Valero Energy.

Valuation

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Management Effectiveness

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Phillips 66 pays a dividend of $0.25 per quarter and yields 1.9%.  This is lower than the other two major refiners, but management has stated that they want to make sure they can raise the dividend annually and continue to buy back shares of the company.  With a payout ratio of under 5%, ongoing dividend raises shouldn’t be a problem.  In fact, the company has already raised the dividend 25% this year.

As the company continues to maximize profits in its refining business, the bottom line will continue to grow.  While the company isn’t immune to an economic downturn, the refining business is at least somewhat recession resistant.  As investors are looking for companies that will continue to outperform even if the United States plunges off the fiscal cliff, they should feel very comfortable owning Phillips 66 no matter what politicians in Washington do.  In the long run, Phillips 66’s investments in the NGL business segment should also pay off.  There is a bright future in the natural gas business and eventually price will catch up to that fact.  Meanwhile, rest assured that refining and petrochemicals are making up the difference.  Phillips 66 is a great company to own and might just refine your portfolio for the long haul.


fjconstantino owns shares of PSX. The Motley Fool has no positions in the stocks mentioned above. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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