(Published Feb. 1 by Bob Ciura)
Shares of oil refining giants Phillips 66 (PSX, Financial) and Valero Energy Corp. (VLO, Financial) have more than doubled in the past five years.
This might come as a surprise since the oil industry is currently in the midst of one of its worst downturns in decades.
Yet, Phillips 66 and Valero continue to pump out strong profits. Even better, they reward their shareholders with hefty dividend payouts.
Neither company is a member of the Dividend Achievers—a group of a group of 272 stocks with 10-plus years of consecutive dividend increases.
You can see the full Dividend Achievers List here.
That said, both stocks stand a great chance of becoming Dividend Achievers eventually. In the meantime, they offer above-average dividend yields and annual dividend increases of 10% or more.
But which dividend growth stock is better?
Business overview
Both Phillips 66 and Valero are oil refiners. Their main business model is to receive crude oil and process it into gasoline, diesel fuel, heating oil and other refined petroleum products.
Phillips 66 and Valero each have huge networks and assets.
First, Phillips 66 was spun off of oil and gas producer ConocoPhillips (COP, Financial) in 2012. It is a more diversified company than the average refiner—it has a chemicals and marketing segment.
Still, at its core, Phillips 66 is a refiner.
Source: November Investor Presentation, page 15
Valero is a refining pure-play. Like Phillips 66, it has a nationwide footprint.
Source: January 2017 Investor Presentation, page 4
One difference in their asset bases is that Valero has a concentration in the Gulf region. More than 55% of Valero’s refining capacity is located in the U.S. Gulf Coast, approximately double Phillips 66’s concentration in that region.
Business prospects for both companies remain sound, as it pertains to demand. Phillips 66 and Valero both have held utilization ratios above 95% over the past year.
Source: January 2017 Investor Presentation, page 24
For its part, Phillips 66 recorded a 97% worldwide utilization ratio last quarter.
Earnings per share for both companies grew at a high rate from 2014 to 2016. This might seem ridiculous because oil prices declined significantly during this time. The reason for this is because oil refiners are one of the few industry groups that benefit from falling oil prices.
When oil prices are volatile, it widens the spread that determines refining margins. Declining oil prices help widen spreads by reducing feedstock costs.
During downturns in the oil market, it is the exploration and production companies that bear the brunt of falling commodity prices.
Investors should be aware that the operating climate changed in 2016. Oil prices have nearly doubled off the 2016 low of $27 per barrel.
This has had the effect of shrinking refining margins, which has caused earnings to decline for both companies. For example, Phillips 66 posted a 53% decline in adjusted earnings over the first three quarters of 2016.
Valero’s EPS declined 38% in 2016.
Aside from another decline in oil prices, both companies will rely on new projects for growth moving forward.
Growth prospects
For oil refiners, their major growth catalyst moving forward is new projects. In this regard, both companies are actively pursuing growth initiatives.
Source: January 2017 Investor Presentation, page 13
Meanwhile, Phillips 66’s major growth initiative is its Sweeny Complex. The Sweeny fractionator has refining capacity of 100,000 barrels per day.
Source: November Investor Presentation, page 8
The facility was completed in the fourth quarter of 2016, meaning it should provide the company with a boost to EPS growth in 2017 and beyond.
In addition, another attractive opportunity for Phillips 66 and Valero moving forward is exports.
Valero is particularly aggressive when it comes to exporting.
Source: January 2017 Investor Presentation, page 10
For 2017, Valero expects to allocate $2.7 billion to capital investments, of which $1.1 billion is for growth projects and $1.6 billion is for maintenance capital.
Phillips 66 is not far behind. In December, the company announced its Freeport LPG Export Terminal became fully operational.
This project took four years to develop. It will source the supply from the Sweeny fractionator and the company’s Clemens storage facility.
In all, the Freeport LPG Export Terminal can load 36,000 barrels per hour. It is perfectly situated to provide U.S. natural gas and petroleum liquids to the international markets, where demand continues to rise at a strong rate.
Dividend analysis
Some of the best aspects of Phillips 66 and Valero are their dividend yields and dividend growth.
In May 2016, Phillips 66 increased its dividend by 13%. It was the sixth increase since the company went public.
Since its IPO, the company has returned more than $12 billion of capital to shareholders in the form of dividends and share repurchases.
Source: November Investor Presentation, page 18
Similarly, Valero is also a huge dividend grower. Its dividend increases in 2016, 2015 and 2014 were 17%, 20% and 25% respectively.
It has also returned billions to investors through share repurchases, meaningfully reducing its share count as a result.
Source: January 2017 Investor Presentation, page 22
Despite the difficult operating climate in 2016, both companies’ dividends are secure. Phillips 66 and Valero have payout ratios of 44% and 45% over the past four quarters.
This provides enough room for both companies to continue increasing dividends moving forward.
However, Valero has a much higher current dividend yield than Phillips 66—4.3% to 3.1%.
Valero’s dividend yield is 39% higher than Phillips 66’s due, in part, to their different stock valuations.
Phillips 66 stock trades for a price-earnings (P/E) ratio of 14 while Valero stock trades for a P/E ratio of 10.
One reason for this disparity could be that investor sentiment regarding Phillips 66 is highly positive. This is due to the fact that Warren Buffett (Trades, Portfolio)’s investment conglomerate Berkshire Hathaway (BRK.A, Financial)(BRK.B, Financial) is a major holder of Phillips 66, with a 15.5% stake.
An association with the most well-known investor in the world has likely contributed to Phillips 66 receiving a higher valuation multiple.
The downside is that it has lowered Phillips 66’s dividend yield level.
Final thoughts
Both Phillips 66 and Valero encountered difficulties from the rise in oil prices throughout 2016. But, they still remain highly profitable and generate more than enough capital to reward shareholders with attractive cash returns.
The companies have similarly strong growth prospects in terms of domestic and international projects.
As a result, the difference between the two comes down to valuation and dividend yield.
With a significantly cheaper valuation and higher dividend yield, Valero looks like the better stock to buy today.
Disclosure: I am not long any of the stocks mentioned in this article.
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