Bloomberg recently released figures that are possibly ominous to oil refiners. According to the news agency, earnings in the oil industry this second quarter will turn out to be brighter. This is possible because of the lower oil prices in the quarter that led to better margins for the oil-refining business. This better margin attracted much production in the refinery products that eventually led to a glut. Specifically, global refining margins were at $13.80 a barrel in the second quarter and at $11.40 in July.
“The more you build product inventories that are not absorbed by demand, the greater the pressure will be on refining margins and thus crude-oil demand,” said Harry Tchilinguirian, head of commodities research at BNP Paribas SA in London.
This may induce some thoughts to oil and gas stock investors. Also, people who followed Warren Buffett (Trades, Portfolio) in Phillips 66Ă‚ (PSX, Financial)Ă‚ should probably review their investments accordingly.
Phillips 66
Headquartered in Houston, the company was incorporated in Delaware in 2011. Phillips 66 operates as a mid- and downstream business. The company was actually a part of ConocoPhillips (COP, Financial) prior to its incorporation. Phillips 66 had given an annual average total return of 25.5% since it began trading in May 2012, while the Standard & Poor's 500 returned 15.09%.
The downstream sector commonly refers to the refining of petroleum crude oil and the processing and purifying of raw natural gas as well as the marketing and distribution of products derived from crude oil and natural gas.
According to its annual filing, Phillips 66 has four business segments:
- Midstream — Gathers, processes, transports and markets natural gas; and transports, fractionates and markets natural gas liquids (NGL) in the U.S.
In addition, this segment transports crude oil and other feedstocks* to Phillips 66’s refineries and other locations. The segment also delivers refined and specialty products to market, and provides terminaling and storage services for crude oil and petroleum products.
(*The most common feedstocks, or raw materials, for petrochemical manufacturing are naphtha and light gas oil, which are derived from the oil refining process, and individual gases such as ethane, propane and butane.)
The Midstream segment includes the company’s master limited partnership, 69% ownership of Phillips 66 Partners LP, as well as its 50% equity investment in DCP Midstream, LLC (DCP Midstream).
- Chemicals — Manufactures and markets petrochemicals and plastics on a worldwide basis. The Chemicals segment consists of Phillips 66's 50% equity investment in Chevron Phillips Chemical Company LLC (CPChem).
- Refining — Buys, sells and refines crude oil and other feedstocks at 14 refineries, mainly in the U.S. and Europe.
- Marketing and Specialties — Purchases for resale and markets refined petroleum products (such as gasolines, distillates and aviation fuels), mainly in the U.S. and Europe. In addition, this segment includes the manufacturing and marketing of specialty products, as well as power generation operations.
Midstream and transportation businesses
As of Dec. 31, 2015, Phillips 66's transportation business managed over 18,000 miles of crude oil, natural gas, NGL and petroleum products pipeline systems in the U.S.
Phillips 66 is actively increasing its terminal for crude oil and refined product storage capacity. The company has formed its largest terminal, named Beaumont Terminal, which is situated in Nederland, Texas. The company aims to improve the Terminal’s capacity from 7.1 million barrels of storage capacity to 16 million barrels.
In addition, Phillips 66 has several ownership interests in major pipeline systems and finished product terminals that can be found in a table format from pages 4 to 7 of its recent annual report. Further, the company also had chartered 12 double-hulled, international-flagged crude oil and product tankers.
The marine vessels are used primarily to transport feedstocks or provide product transportation for certain refineries, including delivery of domestic crude oil to Phillips 66’s Gulf Coast and East Coast refineries. Phillips 66 also transports its products via truck and rail.
DCP Midstream
Phillips 66 has a 50% stake in DCP. DCP owned and operated approximately 68,000 miles of pipeline for natural gas transmission. DCP also has natural gas processing facilities that have a total capacity of 8 billion cubic feet per day.
According to Phillips 66, DCP purchases or takes custody of substantially all of its raw natural gas from producers, principally under contractual arrangements that expose DCP to the prices of NGL, natural gas and condensate.
Through these and other not mentioned business arrangements, Phillips 66 eventually transports and stores 1 billion cubic feet of natural gas and thousands of crude oil barrels each day.
Chemicals
Phillips 66’s chemical business is centered in its 50% equity investment in CPChem, which is headquartered in The Woodlands, Texas. CPChem is ranked among the top 10 producers of many of its major product lines, based on average 2015 production capacity. CPChem, including through its subsidiaries and equity affiliates, has manufacturing facilities located in Belgium, China, Colombia, Qatar, Saudi Arabia, Singapore, South Korea and the U.S.
CPChem’s operations are around two primary business segments: Olefins and Polyolefins (O&P) and Specialties, Aromatics and Styrenics (SA&S). These segments are necessary for Phillips 66 to develop unique oil chemical products that can become polyethylene pipe among a variety of specialty chemical products used for industrial, drilling and mining businesses.
Refining
According to Phillips 66, its refining business buys, sells, and refines crude oil and other feedstocks into petroleum products (such as gasolines, distillates and aviation fuels) at 14 refineries, mainly in the U.S. and Europe. The company also has a 50/50 joint venture with a Canadian integrated oil company Cenovus Energy in WRB Refining LP. Further, WRB’s gross processing capability of heavy Canadian or similar crudes ranges between 235,000 and 255,000 barrels per day.
Marketing and specialties
Phillips 66 uses the brand names Phillips 66, Conoco or 76 brands to market gasoline, diesel and aviation fuel in the U.S. Overseas, the company uses the JET brand name to market retail and wholesale products in Austria, Germany and the United Kingdom. A partnership in retail sites in Switzerland made Phillips 66 use the Coop brand name in addition to JET.
The company also markets aviation fuels, LPG, heating oils, transportation fuels, marine bunker fuels, bitumen and fuel coke specialty products to commercial customers and into the bulk or spot markets in the above countries and Ireland.
Further, Phillips 66 also manufactures and sells a variety of specialty products, including petroleum coke products, waxes, solvents and polypropylene. Brand names associated with the specialty products are as follows: COPYLENE, Phillips 66, Conoco, 76, Kendall, Red Line, Smart Blend, Pure Performance and Ultra-S.
Berkshire Hathaway buys
Buffett has been an active buyer of Phillips 66 shares. According to Bloomberg, the most Buffett paid for Phillips 66 was $82.74 per share. It will probably safe to assume that Buffett’s average price would be somewhere between $75 and $80 per share. This will make an estimation of $5.9 billion investment in the refiner, placing it next to American Express’ (AXP, Financial) as the sixth-largest investment in Berkshire’s publicly listed investments. Berkshire owns 75.5 million shares or 14% of Phillips 66.
Sales and profits
Phillips 66 is expected to announce its second quarter earnings July 29.
As for its first quarter performance, Phillips 66 reported an overall decline in all of its business segments compared to the same quarter a year earlier. The company delivered negative 61% growth down to $385 million in its nonadjusted profits. In nonadjusted terms, Phillips 66 suffered most losses in its DCP Midstream business. The company had negative $159 million losses in the DCP business. Further, the company experienced negative 84% growth down to $86 million in its refining business.
These aforementioned figures should have deterred most value investors in purchasing Phillips 66 shares, but Buffett, interestingly, purchased more (see chart above).
Sales and earnings affectation per segment
According to Phillips 66, its midstream business segment earnings are closely linked to NGL prices, natural gas prices and crude oil prices. Chemical segment is mostly affected by crude oil prices.
The company’s refining segment, on the other hand, is driven by several factors including refining margins, cost control, refinery throughput and product yields. Most important of these factors would probably be the company’s refinery margins, often referred to as crack spreads.
Crack spreads are differences between wholesale petroleum product prices and crude oil prices. These spreads are often used to estimate refining margins. Basically, the higher the demand for Phillips 66 products, the better the earnings performance.
Cash, debt and book value
Phillips 66 had $1.7 billion cash as of April 29. The company had total debt of $8.8 billion, which gave it a debt-to-equity ratio of 0.37. According to GuruFocus data, Phillips 66 had a book value of $22.79 billion. In addition, chairman and CEO Greg Garland has the following quoted statement regarding its balance sheet:
“We are committed to maintaining our strong balance sheet and a disciplined approach to capital allocation. During the quarter we reinvested $750 million in the business and distributed $687 million to shareholders.”
Cash flow
(Phillips 66 Cash Flow Statement, p. 74 of 2015 annual report)
In fiscal year 2015, Phillips 66 reported a good 61.9% growth to $5.7 billion in its cash flow operations. This was made possible, despite the tough industry environment, secondary to increase in accounts and notes receivable and payables. The company also had $5.76 billion in capital expenditures.
The company had negative free cash flow in the fiscal year. Despite this, Phillips 66 was able to provide $2.68 billion in dividends and share repurchases. The refiner also issued $1.17 billion in debt.
Conclusion
Blindly following the Oracle of Omaha may induce unhealthy side effects later on. Buffett stated that investors shouldn’t try to get rich by piggybacking on his investment picks:
“I wouldn’t ever urge them to do anything based on what we do. If they want to do what Berkshire does then they should buy Berkshire.” –Â Warren Buffett (Trades, Portfolio)
There is no clear reason why Buffett and Berkshire had kept accumulating Phillips 66 shares despite consecutive poor profit performances. As a conservative investor, one should be cautious prior to initiating a long position in Phillips 66.
The company currently trades with a trailing 12-month price-to-earnings ratio of 11, price-to-book ratio of 1.74 while having a dividend yield of 3.34%. In addition, the company would surely be able to weather the ongoing turmoil in its industry given its good balance sheet and conservative debt ratios, but if holding onto its shares would cause sleeplessness at night due to lack of conviction in the company, then disposal of its shares is a must.
Disclosure: I am long PSX. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from GuruFocus). I have no business relationship with any company whose stock is mentioned in this article.
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