Investors Should Follow Buffett Into Phillips 66 Stock

phillips 66 - Investors Should Follow Buffett Into Phillips 66 Stock

Source: Mike Mozart via Flickr (Modified)

Warren Buffett clearly knows his way around the stock market. There’s no reason to go over America’s favorite value investor’s history of great returns and generating gains for Berkshire Hathaway (NYSE:BRK.A, NYSE:BRK.B). But it is worth repeating how he generated those mega-sized returns.

The key for Buffett’s and Berk’s success comes down to buying companies with large economic moats that generate huge amounts of rising cash flows. And in Buffett’s case, it’s buying them on sale and on the cheap.

Using this framework, he clearly struck gold with refiner and logistics giant Phillips 66 (NYSE:PSX).

Buffett’s investment in PSX has been nothing short of amazing. And there’s plenty of reasons why. Perhaps the best part is that Phillips 66 still has plenty of gas left in the tank to continue generating great dividends, cash flows, and returns for investors today.

Buffett Can’t Enough Phillips 66

Buffett, Berkshire and Phillips 66 have a long love affair, with Warren first buying shares of the firm back in 2012. That initial stake was sold when Berkshire decided to buy chemicals firm Lubrizol outright.

But Buffett couldn’t let a good dog go, and since that time, he has continued to load up on shares at a fevered pace. That included two massive purchases — totaling around $5 billion — back in the summer of 2016.

With those buys, Berkshire’s stake exploded to owning roughly 11.4% of the company.

This love affair actually proved to be a problem. That huge stake in PSX stock became subject to various regulatory requirements, and as a passive owner, that’s something Buffett didn’t want. With that, Phillips 66 entered into a deal to repurchase 35 million shares of PSX in order to bring Berkshire’s stake in the company to slightly below 10%, or about 45.7 million shares.

But Buffett has repeatedly said that the sale had nothing to do with Phillips 66’s merit as an investment. It was simply to reduce his stake for regulatory requirements.

The Big Opportunity at Phillips 66

And Buffett’s reasons for holding PSX are vast. For starters, Phillips 66 is one of the nation’s largest refiners and features a vast complex of facilities on American’s Gulf Coast.

Increasingly, those refineries and operations have been focusing less on gasoline and diesel fuel and more on higher-margin chemicals processing. While oil and natural gas prices have risen in recent quarters, margins and crack spreads for feedstocks are still pretty decent. Moreover, rising economic demand has pushed up prices for refined chemicals/fuels.

Secondly, PSX has become a midstream giant. When it was spun out from ConocoPhillips (NYSE:COP), PSX’s initial pool of assets did hold several thousand miles worth of pipelines. Phillips 66 used those initial lines to build out a vast system of terminals, gathering interstate transport lines for a variety of fuels.

These midstream assets are generally tied to volumes and not underlying commodity prices. As such, they threw off stable cash flows. Even better is that PSX has been quite successful at using the master limited partnership (MLP) model, via Phillips 66 Partners LP (NYSE:PSXP). This has allowed it to save on taxes and enhance these assets even further.

For Buffett, these business lines are just what he’s looking for. Namely, they provide steady and rising cash flows.

In its latest reported quarter, PSX managed to see its operating cash flows increased 23% year-over-year to clock in at $488 million. That’s pretty impressive for a set of pipes.

But what’s really great is thanks to the firm’s fixed costs, Phillips 66 is able to hand plenty of that cash back to investors. Over the quarter, the firm managed to hand out $3.8 billion in share repurchases and dividends. Over its history and IPO in 2012, PSX has handed back more than $20 billion in dividends and buybacks.

And the love for shareholders keeps coming. Phillips recently upped its dividend again by 14%.

Following Buffett Into Phillips 66

So, it’s easy to see why Buffett continues to love Phillips 66. PSX has a huge economic moat and produces steady cash flows, which is exactly the kind of investment that he looks for. And so far his investment has paid off.

When Buffett first announced his stake, shares of PSX were trading in the low $80s. Today, Phillips 66 can be had for around $115 per share. This doesn’t include all the dividends that Buffett has received along the way.

Is Buffett is still right on the firm’s prospects, and should you follow him into PSX stock?

The short answer is yes. Many of the reasons why Buffett first took a stake in the firm are still there.

Phillip 66’s midstream portfolio has only gotten better, and the crack spreads have improved. Increased chemicals demand has also strengthened these underlying businesses. With a forward P/E of 15, shares are also cheap when looking at the broader market. With that, shares are still a big-time buy.

While Buffett had to reluctantly sell his stake lower, you don’t have to make that sacrifice. PSX still remains a buy that has Buffett’s blessing.

Disclosure: None

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