Get Your Dividend Kicks With Phillips 66

Phillips 66 has incurred a 25% correction in the last three months, along with the energy sector, primarily due to concerns that the Delta variant of the coronavirus may delay the recovery of the energy market. However, we view this headwind as temporary. Phillips 66 has a diversified business model, with promising growth prospects. As the stock is also offering a 5.1% dividend yield, income investors could consider purchasing the stock around its current level. Business Overview Phillips 66 was spun off from ConocoPhillips in 2012. It operates in four segments: refining, midstream, chemicals, and marketing. The refining segment includes 13 refineries with total capacity of 2.2 million barrels per day (2% of global capacity) while the midstream segment includes approximately 22,000 miles of pipelines in the U.S, which transport crude oil, refined products, natural gas liquids and LPG. Phillips 66 is a diversified company, with each of its segments behaving differently under various oil prices, in the absence of a severe recession. In the severe downturn of the energy market, which was caused by the collapse of the oil price from $100 in mid-2014 to $27 in 2016, Phillips 66 achieved record earnings, as low oil prices improved demand for refined products and boosted refining margins to nearly all-time highs. In 2019, the refining segment generated 48% of the total earnings of the company. The pandemic caused an unprecedented downturn in the energy sector last year. The global demand for refined products plunged from 100.9 million barrels per day in 2019 to 92.3 million barrels per day in 2020 due to the extended lockdowns imposed in most countries. This decrease in the demand for oil products caused a collapse in refining margins and hence all the U.S. refiners incurred material losses last year. The midstream and chemical segments of Phillips 66 performed better than its refining division but they did not prevent the company from posting its first loss last year. Nevertheless, Phillips 66 proved much more resilient than pure refiners and oil producers last year, as it posted an adjusted loss of only -$0.89 per share last year. Phillips 66 has begun to recover strongly from the pandemic this year. Thanks to the massive distribution of vaccines, the pandemic has begun to subside and the global consumption of oil products is expected by Energy Information Administration (EIA) to surge from 92.3 to 97.6 million barrels per day this year. It is also expected to climb to a new all-time high of 101.25 million barrels per day next year, slightly above the pre-COVID level. The improved conditions in the business of Phillips 66 were evident in its earnings report for the second quarter of this year. Refining margins improved significantly but the benefit was offset by higher RIN costs. However, the chemical segment achieved record earnings thanks to impressive margins, which resulted from strong pent-up demand, and high utilization of producing units. As a result, Phillips 66 switched from an adjusted loss per share of -$1.16 to an adjusted profit per share of $0.74. Growth Prospects As soon as the coronavirus crisis subsides, Phillips 66 will benefit from the new international marine standard, IMO 2020. According to this standard, all the vessels that sail in international waters are now forced to burn ultra-low sulfur fuel oil or diesel instead of heavy fuel oil. As the former are much more expensive than the latter, refiners will enjoy a strong tailwind in the upcoming years. The pandemic struck just after the implementation of the new marine standard and hence the benefit has been muted so far. However, when the condition of the energy market normalizes, the benefit will be material. Phillips 66 is ideally positioned to benefit from IMO 2020, as it is the refiner with the highest yield (38%) of distillates. Moreover, Phillips 66 is well-known for the discipline of its management to invest only in high-return, quick payout growth projects. Warren Buffett has repeatedly endorsed the management of Phillips 66 for its focus on returns and had a 10% stake in the company until a few years ago via Berkshire Hathaway . Most of the growth projects of Phillips 66 aim to enhance the yield of high-value products and increase the flexibility in the processing of crude oil so that the company takes advantage of the mispricing of some grades during some periods. The company also has many midstream growth projects in place right now. Thanks to their high return and quick payout, these growth projects have minimum risk and generate strong free cash flows. Thanks to the expected recovery from the pandemic and its promising growth prospects, we expect Phillips 66 to grow its earnings per share by 6.0% per year on average over the next five years off its mid-cycle (5-year average) earnings per share of $7.03. Competitive Advantages Phillips 66 has a significant competitive advantage, namely the discipline of its management to invest only in high-return projects. Many investors do not pay attention to the quality of the management of the stocks they own but the importance of a high-quality management cannot be overemphasized. Phillips 66 is in the top quartile in non-energy operating expenses, and its maintenance and personnel costs have been trending to the top quartile as well. This is a major competitive advantage, as it renders Phillips 66 more resilient to downturns than its peers. During severe downturns, the least efficient players are forced to shut down their refineries while the most efficient ones remain in operation. More importantly, the above data comes from a strict, impartial research company, Solomon, and therefore they are much more reliable than other performance indicators, which are computed by managements. Overall, Phillips 66 is one of the most efficient companies in its peer group. Dividend Because Phillips 66 was spun off from ConocoPhillips in 2012 it has a short history. Nevertheless, its management has repeatedly stated that one of its top priorities is to secure an attractive and growing dividend. Phillips 66 has proved remarkably shareholder-friendly, as it has raised its dividend at a 19% average annual rate in the last nine years. It has also reduced its share count by 34% throughout this period, and hence, it has returned to its shareholders approximately 150% of its initial market capitalization, in 2012. Phillips 66 is currently offering a 5.1% dividend yield. Its annual dividend of $3.60 exceeds the expected earnings per share of $2.50 this year while the company has paid the same dividend for 10 consecutive quarters. The dividend freeze indicates that Phillips 66 is struggling to maintain its dividend due to the coronavirus crisis. On the other hand, the annual dividend of $3.60 is only 64% of next year's expected earnings per share of $5.60. Phillips 66 also has a healthy balance sheet, which has earned an A3 credit rating from Moody's and a BBB+ credit rating from S&P. Furthermore, its net debt of $26.0 billion is only 83% of its market capitalization and hence it is manageable. To cut a long story short, as soon as Phillips 66 recovers from the pandemic, it is likely to be able to cover its dividend with a wide margin of safety. Finally, Phillips 66 is offering an attractive 5.1% dividend yield, which has resulted primarily from the correction of the entire energy sector in the last three months. Broad corrections are great investing opportunities because they usually hurt the solid stocks along with the weak ones. This is certainly the case for Phillips 66. It is a well-diversified energy company, with exemplary management and promising growth prospects. Investors should take advantage of the recent correction of Phillips 66 and lock in its 5.1% yield before the market appreciates the virtues of the stock.

Get Your Dividend Kicks With Phillips 66

Investors should take advantage of the recent correction of PSX and lock in its yield before the market appreciates the virtues of the stock.

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