(By Mani) Phillips 66 (NYSE:
PSX), which was spunoff on May 1st from
ConocoPhillips (NYSE:
COP), is set to provide maximum returns to investors by investing in profitable growth and controlling costs. The company intends to grow its cash dividend and repurchase its shares, while maintaining strong financial flexibility.
Phillips 66 is the largest independent refining and marketing company in the US by market capitalization, with more than 2.2 million barrels per day (mmbd) of refining capacity. It has three segments namely Refining & Marketing, Gas Gathering & Processing, and Petrochemicals.
The company operates 15 refineries with a gross, crude oil processing capacity of 2.8 mmbd, 10,000 branded wholesale marketing outlets, almost 80,000 miles of pipeline, 7.2 billion cubic feet per day (bcf/d) of gross natural gas processing capacity, and more than 40 billion pounds of gross annual petrochemicals processing capacity.
"We believe this unique asset mix, large scale and balanced operations give PSX a competitive advantage throughout the business cycle," Oppenheimer analyst Fadel Gheit wrote in a note to clients.
In the US, it supplies gasoline, diesel and aviation fuels to 8,250 outlets in 49 states under the Phillips 66, Conoco and 76 brands. Phillips 66 plans to grow earnings and improve returns by investing its cash flow in projects that will improve refining and marketing (R&M) margins and expand Chemicals and Midstream capacity.
It has identified R&M opportunities to reduce feedstock costs, improve operating efficiency, and increase light product yield, which should improve profit margins and return on capital.
"Capitalizing on the growth in North American natural gas and NGL production, PSX and its affiliates will continue to invest in natural gas processing plants and gathering systems," Gheit added.
Meanwhile, the company has one of the strongest balance sheets and financial flexibility among independent refining companies. Its investment-grade credit rating on its senior unsecured long-term debt and sufficient cash position and liquidity allow it to invest in high-return projects.
The company expects to use cash flow in excess of capital spending and dividends, to pay down debt to achieve and maintain a targeted debt ratio in the 20-30 percent range.
Phillips 66 believes that growing the cash dividend consistently and using free cash flow and divestiture proceeds to buy back stock and pay special dividends are key components in creating value for its shareholders, as they reinforce its focus on capital discipline.
"We expect operating cash flow of $4.7B this year and $4.0B next year to fund capex (excluding equity affiliates) of $1.4B and $1.25B, respectively, and dividends of ~$250M and ~$530M for free cash flow of $3.3B and $2.2B, which can be used to buy back stock and reduce debt," the analyst said.
The integration of R&M, midstream, and chemicals should help boost earnings throughout the business cycle, which will help lessen the impact of commodity price fluctuations on earnings, which are typically very volatile for the pure R&M companies.
"PSX is trading at 6.9x P/E based on 2013 consensus estimates, in line with the R&M peer average of 7.0x. However, we believe the company's exposure to other business segments garner a premium to the pure refining and marketing companies," Gheit added.
Meanwhile, a strong commitment to shareholder returns, such as an above average 2.4 percent dividend yield, should also positively boost the company's valuation multiples.
If the company met its commitment to return cash to shareholders in the form of steady annual dividend increases and share repurchases funded by free cash flow and proceeds from divestitures, it would greatly bolster investors' confidence and boost its share price performance.