I have written about Warren Buffet’s accumulation of PSX shares on Gurufocus before. At that time, my reverse engineering of the Oracle’s actions led me to believe it was driven not by an interest in the oil and gas sector, but valuation driven. As Buffett continues to buy shares of Phillips 66 (PSX, Financial) and I have gained additional insights over time, it is time for an update.
First of all, I still believe Buffett is not very interested in the oil and gas sector. This is evidenced by a CNBC interview, late 2015, where Becky Quick asks him:
ARE THERE OTHER OPPORTUNITIES THAT YOU SEE IN THE OIL AND NATURAL GAS POSITIONS AT THIS POINT? JUST BECAUSE OF THE HUGE DROP WE’VE SEEN IN OIL AND GAS.
He answers:
I THINK THAT’S THE ONLY OIL COMPANY THAT’S CONNECTED WITH THE OIL AND GAS INDUSTRY THAT WE OWN. ALTHOUGH PRECISION CASH PARTS MAKES EQUIPMENT FOR THE OIL INDUSTRY AND OUR LUBRIZOL OPERATION PRODUCES CHEMICALS THAT ARE USED IN OIL AND GAS PRODUCTION.
Most of you are probably just as, or even more, familiar with Buffett’s way of expressing himself. When he holds a negative opinion or does not like something, he will either avoid the question or give you an answer that allows you to derive his opinion, but does not allow us to quote him as putting something down straight up.
Although the quote is fairly old (in financial news years), it is relevant today because I believe I left something important out of my original article:
Buffett likes Phillips management.
In the same CNBC interview, Buffett says:
WE’RE BUYING IT BECAUSE WE LIKE THE COMPANY AND WE LIKE THE MANAGEMENT VERY MUCH. EVER SINCE GREG GARLAND HAS TAKEN OVER AFTER IT SPUN OUT OF CONOCO PHILLIPS, HE’S DONE A TERRIFIC JOB. SO I’VE LIKED THE COMPANY.
Buffett is pretty much in love with chairman and CEO Greg Garland, who previously headed the E&P Americas segment at ConocoPhillips (COP, Financial), where Buffett invested back in 2006. PXS is the downstream and midstream spin-off of ConocoPhilips, of course.
Garland’s strategy entails directing capital from the refining towards chemicals and midstream segments (businesses Buffett likes much better given the Lubrizol and other chemical positions) and which carry higher multiples, but more about that in a second. Garland also emphasizes shareholder returns. One of the ways he tries to achieve great shareholder returns is through distributions:
Source: company presentation
Where many oil and gas companies generally prioritize dividends to attract the traditional oil and gas investor, Garland is dedicating over 2x as much funds towards share repurchases. If a company buys back its shares while they are undervalued, that is very value accretive. In addition, share repurchases are more tax efficient and Buffett knows it like no other. It is not a coincidence Berkshire never returned a single cent of dividend. At Berkshire they like companies that buy back shares in huge quantities (cannibals) a lot!
Hidden Asset Value
Many articles about PXS, as did mine, treat it primarily as a refiner even though I did discuss the value of the midstream assets as well:
A second interesting asset is the 62,000 miles of pipeline the company owns. I love asset valuations as it is a very simple way to demonstrate or show value present. My conservative but rough estimate is that the replacement value of the company’s network of pipelines is worth approximately $18.6 billion. That’s close to half of the company’s market cap. I got there by putting a replacement price of $300,000 on each mile of pipeline and multiplying it by the 62,000 miles owned. The figure comes from the Oil and Gas Journal, but it applies to 12-inch pipe, which is the smallest kind of pipeline the company owns in a large quantity. It also owns many miles of larger pipe, which are more expensive, but I wanted to keep my valuation conservative.
Now, I am thinking it is exactly these assets that are attractive to Buffett. The chemical and midstream assets tend to carry higher valuation multiples than the refinery business. The large PXS refinery business acts as a blanket, obscuring the value of the 62.000 miles of pipe. Refining is still the majority of PXS revenue, but Garland wants to drop that to 1/3rd by 2018. By that time, we will not be referring to PXS primarily as a refiner anymore. Consequently, that could change the multiple the market assigns the company.
The Philips 66 MLP is probably part of the plan to unlock the value by making the company less complicated.
There’s nothing better than investing in a company that successfully creates value and grows earnings over time and to also have those earnings get re-rated at a higher multiple. It is exactly those cases where you can make big gains and Buffett has been sniffing one out long before all of us, once again.
Disclosure: No position.
Start a free 7-day trial of Premium Membership to GuruFocus.
