by Aaron Levitt | February 18, 2014 9:52 am
When former integrated giant ConocoPhillips (COP) first spun off its refiner arm as Phillips 66 (PSX), the world was a vastly different place. The basic idea was that the slower and erratic profits produced by refining petroleum was hurting overall earnings for COP stock. Conoco was essentially being dragged down by PSX.
Once free of PSX stock and its refining units, COP would be able to trade at a much higher multiple. Meanwhile, Phillips 66 would be a plodding dinosaur churning out dividend income and slow share price growth.
Well, it seems like the joke is on COP stock.
Phillips 66 has turned out to be quite an exciting growth element for its shareholders. Perhaps more importantly, recent moves by the refining firm have only strengthened the appeal of owning PSX stock. For investors, turning their attention towards the transitioning “plodding” refiner could be one of the best long-term bets for their portfolios.
When COP spun-off Phillips 66 back in 2012, no one would have guessed that shares of PSX stock would have returned about 117% since its IPO. That performance managed to beat both the S&P 500 and PSX’s former parent in the returns category. But, there could be even more in store for refining stock.
That’s because PSX isn’t really just a “Plain-Jane” refining company anymore.
The firm has undergone a mass transformation into a more of a complete energy logistics and processing firm rather than being a straight petroleum refiner like rivals Western Refining (WNR) and HollyFrontier (HFC). The key is that more than 40% of PSX stock earnings come from non-standard refining businesses — namely chemicals processing and pipelines/storage.
And recent decisions by PSX will help those businesses grow by leaps and bounds.
Nearly 70% of Phillips 66’s recent capex spending budget of $4.6 billion will be plowed back into both its chemicals and logistics segments. This includes a brand new liquefied petroleum gas (LPG) terminal as well as a new fractionator facility. That facility will “crack” natural gas liquids (NGLs) — like ethane — for end use by petrochemical companies.
Those petrochemical firms include PSX’s own joint ventured with Chevron (CVX) plants. That means PSX can take advantage of its own cheap ethane production in order to make base chemicals for plastics, paints and other end-users.
And considering that both NGL midstream and these chemical processes already have higher margins than traditional gasoline and diesel refining, PSX is setting itself up for some sweet profits down the line.
Overall, the top brass at PSX stock expects that these non-refining businesses will grow to nearly two-thirds of the firm’s value in about four years. The company’s chemicals capacity will increase by roughly 33% in that time. Taken as a whole, this will boost profitability at Phillips 66 by around 50%.
And it’s still getting sweeter for PSX stock. That’s because it’s starting to use its new master limited partnership (MLPs) subsidiary — Phillips 66 Partners LP (PSXP) — in an effective manner.
PSX stock has finally begun to “drop down” assets into PSXP and take advantage of the tax savings. PSXP has agreed to purchase a 680-mile refined products pipeline system as well as two refinery-grade propylene storage systems from Phillips 66 for around $700 million.
The deal is expected to instantly accreditive to PSXP’s cash flows, which will flow back to PSX stock in the form of tax advantaged distribution payments. Meanwhile, the cash payment will be plowed back into more logistics and chemicals projects that it will drop-down into PSXP.
With Phillips 66 focusing more of its attention towards higher-margined chemicals and midstream assets, investors should treat PSX stock like one of those companies. And that means a higher multiple and stock gains ahead.
When looking at PSX versus chemically focused rivals, Phillips 66 is still quite cheap. PSX stock currently trades for a forward P/E of less than 10. Meanwhile, both Dow (DOW) and DuPont (DD) are in the 12 to 13 range. Yet, PSX’s chemical earnings and margins are increasing at much faster rate than both DOW and DD.
Based on similar metrics, PSX stock could be worth as much as $90 per share. That’s nearly a 20% gain from today’s selling price and doesn’t including PSX’s growing 2.2% dividend.
In the longer term, the situation is still rosy for Phillips 66 shareholders as the firm continues to plow more capex spending into chemicals/NGL processing capacity and drop-down assets in PSXP. These assets will ultimately cushion the volatility in traditional gasoline refining and provide plenty of growth/profits for shares.
While COP’s spin-off of PSX was originally done to free its former parent from the plodding refining sector, it looks like Phillips 66 is becoming a true portfolio growth engine. Investors should snag PSX stock now.
As of this writing, Aaron Levitt did not hold a position in any of the aforementioned securities.
Source URL: http://investorplace.com/2014/02/psx-stock-cop-psxp/
Short URL: http://invstplc.com/1kRPUx8
Copyright ©2016 InvestorPlace Media, LLC. All rights reserved. 700 Indian Springs Drive, Lancaster, PA 17601.