When Warren Buffett plows billions into a stock, investors should at bare minimum pin their ears back.
The Oracle of Omaha and his team at Berkshire Hathaway (BRK.A, BRK.B) doesn’t usually make hasty investment decisions. And one of his more recent, least hasty decisions comes in the form downstream energy player Phillips 66 (PSX), of which Buffett recently made two huge purchases of.
This is certainly an instance where investors should follow the guru’s lead — PSX is killing it in this lower oil price environment.
And with prices for crude oil still being range bound, PSX has the goods to keep it going over the longer haul. The time to buy Phillips 66 could be now.
PSX Stock: Buffett Buys Back Big
Despite selling huge stakes in many of BRK’s energy holdings — including National Oilwell Varco (NVO) and Exxon Mobil (XOM) — Buffett did find some value in energy, making two huge purchases of PSX over the last quarter.
The first was $4.48 billion stake announced at the tail end of August. The second came over the last week, when Berkshire added an additional 3.5 million shares, rebuilding the stake that Berkshire once held, but sold after deciding to buy chemicals firm Lubrizol. Today, Buffett now owns 11.4% of PSX.
So why the change of heart with regards to Phillips 66 and PSX stock? For one, oil prices are in the toilet.
As we’ve recently said, now is the halcyon days at the refining stocks. Downstream players like PSX have been able to feast on cheap crude oil prices thanks to the oversupply of West Texas Intermediate and Western Canadian Select benchmarked oil. The refiners earn based on the difference between that input price and the price for refined products, such as gasoline, jet fuel and heating oil.
And margins at the refiners haven’t been better.
For PSX — and now Buffett — that means plenty of cash flows. The refiner continues to be a free cash flow machine. From 2009 to 2014, across Phillips entire business lines, it managed to average $3.4 billion in FCF, with core refining leading the way. Those hefty FCFs don’t even take into account the recent continued fall in oil, nor PSX’s continued growth plans.
Those growth plans include plowing some serious cash into natural gas processing and chemicals manufacturing. Like crude oil refining, they come with outrageously low feedstock costs thanks to an abundance of cheap natural gas.
The difference is that these businesses’ margins are much higher than turning oil into gasoline. PSX should be able to generate more FCF once its expansion plans take hold.
Also adding to Phillips growth and cash flows are its continued smart use of its two master limited partnerships. Phillips 66 Partners (PSXP) remains PSX’s core MLP and has already received a hefty dose of “drop-downs” from its parent. But the lion’s share, as well as big backlog of midstream projects, still remain.
Then there’s its 50% stake in DCP Midstream and DCP Midstream Partners LP (DPM). PSX continues to add and strengthen the natural gas-focused midstream operator. The latest was a cash infusion designed to pay down debt and boost acquisition potential. Distributions, IDRs and other payments will continue to flow from PSXP and DPM back into Phillips wallet.
It’s no secret that Buffett loves cash flows, not to mention the dividends and buybacks that come from them. And PSX has delivered on those fronts. Since becoming a standalone company back in 2012, PSX has managed to grow its dividends by 180%. Those dividends should continue to increase as margins remain fat and new growth is generated. Currently, Phillips yields 2.7%.
So Should You Follow Buffett Into PSX Stock?
The short answer: Yes.
PSX continues to fire on all cylinders, and remains FCF positive as the current range-bound market for crude only serves to strengthen that fact. Add in the growth in midstream and chemicals, and you have a recipe for a dividend machine. Buffett certainly made a great buy.
And you can too.
PSX stock currently trades at 10.5 times earnings, and while it’s not the cheapest refiner as far as price-to-earnings metrics go, it is one of the best at consistently increasing cash flows. That’s exactly what investors should want when it comes to the downstream sector — growing cash flows.
Additionally, that low P/E makes it one of the cheapest over all energy stocks. And since the production side of things isn’t doing so well — or in some cases, even making enough to keep the lights on — buying the downstream sector makes a whole lot of sense.
The Bottom Line: The Oracle of Omaha made a great decision to buy PSX stock. Investors should follow his lead and buy shares of the downstream player, as it has the goods to keep paying dividends over the long haul.
As of this writing, Aaron Levitt did not hold a position in any of the aforementioned securities.