Berkshire Bought Phillips 66...You Should Too

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On May 1, 2012, ConocoPhillips (NYSE: COP) completed the spinoff of Phillips 66 (NYSE: PSX). Phillips 66 operates 15 refineries, 15,000 miles of pipeline systems, and 10,000 branded marketing outlets. The company owns a 50% interest in DCP Midstream, a midstream natural gas company, and a 50% interest in Chevron Phillips Chemical Company, a producer of olefins and polyolefins.

The company is the second largest independent refining company in the United States behind Valero Energy (NYSE: VLO). Phillips 66 has a refining capacity of 2.2 million barrels per day. Valero has a capacity of 3 million barrels per day.

Phillips 66 first caught my eye when I saw headlines that Warren Buffett had bought the stock. Warren Buffett is a genius investor and examining his investments is always a good idea. After a little digging, I found out that one of Warren Buffett’s investment managers had made the purchase and not Buffett himself. Regardless of my disappointment, the company is still a worthy investment.

In true refining fashion, the company is undervalued. As shown on the following table, Phillips 66 has a PE ratio of only 4.77. In comparison, Tesoro (NYSE: TSO) and Valero have PE ratios of 7.95 and 9.08, respectively.

<table> <tbody> <tr> <td> </td> <td>Refineries</td> <td>Capacity (Million Barrels Per Day)</td> <td>Market Cap (Billion)</td> <td>PE (ttm)</td> </tr> <tr> <td>Tesoro</td> <td>7</td> <td>0.665</td> <td>3.85</td> <td>7.95</td> </tr> <tr> <td>Valero</td> <td>16</td> <td>3</td> <td>13.95</td> <td>9.08</td> </tr> <tr> <td>Phillips 66</td> <td>15</td> <td>2.2</td> <td>22.57</td> <td>4.77 </td> </tr> </tbody> </table>

Looking at the balance sheet, Phillips 66 currently has a tangible book value per share of about $33.40 per share. The company has a current ratio (current assets/current liabilities) of 1.57. Furthermore, it has $9.627 billion in accounts and notes receivable and only $6.178 billion of short term and long term debt (only $207 million of short term debt). Thus, the company has a solid balance sheet.

Looking further at earnings, Phillips 66 had revenue of $196.1 billion and $4.775 billion in net income for year 2011. In the previous year, the company had revenue of $146.6 billion and $735 million in net income. In terms of earnings per share, the company earned about $7.64 per share for year 2011 and $1.18 per share for year 2010.

In year 2011, Phillips 66 benefited from the large WTI discount to Brent Crude oil. Since the differential will inevitably decline to a more normal level, it is likely that profits will return to more normal levels. Using discounted cash flow analysis (assuming zero growth, adding tangible book value, and assuming perpetuity of income from year 2010), Phillips 66 has an intrinsic value of about $45 per share. Thus, shares are trading at a discount of about 25%.

The advantage of Phillips 66 over other independent refiners is its diversified portfolio. In addition to its refineries abroad, the company has pipelines, a midstream segment, and a chemical production segment. As the following table shows, Phillips 66's midstream and chemical business segments had respectable growth over the last three years.

<table> <tbody> <tr> <td> </td> <td>2011</td> <td>2010</td> <td>2009</td> </tr> <tr> <td>Earnings - Midstream (million $)</td> <td>403</td> <td>263</td> <td>317</td> </tr> <tr> <td>Earnings - Chemicals (million $)</td> <td>716</td> <td>486</td> <td>228 </td> </tr> </tbody> </table>

The bottom line is that Phillips 66 is undervalued. Yes, ConocoPhillips did not want the Phillips 66 assets. However, Phillips 66 assets are not junk (proven by good earnings). By splitting, ConocoPhillips can focus on the upstream segment and Phillips 66 can focus on the downstream. Berkshire bought Phillips 66 and you should consider following.


Alvin owns shares of Valero Energy. 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.If you have questions about this post or the Fool’s blog network, click here for information.

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