Owning the shares of ConocoPhilips (COP) in the past three months has been a real trader's game. But now that the creation of the new Phillips 66 downstream spinoff will take place on May 1, what should you do with the stock? I'll tell you -- smart investors should probably shed the refining piece of the stock when it separates, just as Conoco itself is doing as a company.
Since announcing the spinoff of its downstream assets into a separate company, shares of the third-largest U.S. integrated oil stock have been generally outperforming their domestic competitors, an old "sum of the parts" trade that has worked beautifully. An even more savvy trade employed by the hedge funders has been to trade the Conoco spinoff against Chevron (CVX) or Exxon Mobil (XOM). It was a particular winner through February and March as the shares of Conoco neared their vesting date on April 16.
But you can see from the chart above what happened to the trade as that date came closer and passed: Hedgies and savvy investors took all their outperformance profits out, leaving Conoco barely ahead of the other two large integrateds since the beginning of the year. But now what should you do? The issuance of one share of new Philips 66 stock for each two shares of COP owned might be mathematically simple, but undervalues the E+P portion in favor of the new refining and pipeline company. That might be OK for investors, but only if you believe in the transitions that new Phillips 66 CEO Greg Garland is planning to make, specifically to chemicals, liquids and pipelines.
Garland is suited to making that transition, having emerged from the chemicals division at Conoco to assume the CEO role. And chemicals and liquids, not to mention pipelines, have generally commanded a much higher multiple for production than just refining into gasoline and distillates. But even with the transition ideas at the new Phillips 66 company, you are dealing with a fully mature set of assets -- and not a very good set, either. Conoco's downstream divisions have lagged the sector, posting a $115 million profit in its worst year of 2009, and recovering to post a $2.6 billion profit in 2011, still well below the $5.33 billion the division made in 2007. It is still seeking a buyer for its big 533,000-barrel-a-day Trainer refinery in Pennsylvania, although Delta Airlines with a private-equity partner has been recently taking a look at it (for what reason, however, I cannot even fathom).
In short, while the name is changing, the tune will stay largely the same: Refining, even under a new CEO and long-term plan, represents the same difficult business it was before the split. And the stock is being overvalued at the start, owing to the full one-third of market cap it will initially get from the parent company.
If you are an owner of shares of COP, I recommend selling the refining shares when they begin trading on May 1. Wait for a far better value if you really want to own a refiner ... or a chemicals company, or a pipeline business, or whatever Phillips 66 will ultimately become. Whatever it does become, you'll almost certainly get a better price.
