The worldwide economic system is not in nice form. Germany formally entered a recession, Chinese language reopening is sluggish, and financial development indicators within the US trace at a recession.
In gentle of those developments, I imagine that large worth might be present in cyclical areas that supply good yields and capital beneficial properties the second financial expectations backside.
Certainly one of my favourite areas to search for these qualities is refining – or power downstream. Phillips 66 (NYSE:PSX), one in all America’s largest refining shares with a big chemical footprint, is presently buying and selling 16% beneath its 52-week excessive after shedding 9% of its worth because the begin of the yr.
The corporate is now yielding near 4.5%, which might flip into a good higher yield because of the aforementioned financial challenges. That is what I wrote in my prior article:
Whereas I imagine that the inventory is 50% beneath its honest worth, I don’t rule out one other transfer decrease in gentle of financial challenges and the percentages of traders de-risking their portfolios.
Moreover, the corporate’s enterprise is making nice progress and seeing sturdy long-term demand.
On this article, I’ll make the case so as to add PSX shares on weak point if the market affords one other alternative.
So, let’s get to it!
What Units Phillips 66 Aside
Established in 2011 on account of a spin-off from ConoccoPhillips, Phillips 66 embodies a fusion of midstream and downstream operations.
Final yr, the USA accounted for 81% of the corporate’s income, whereas the UK contributed 10% to its general gross sales. The income was generated throughout the next segments:
- Advertising and marketing & specialties, constituting 66% of whole gross sales.
- Refining, contributing 25%.
- Midstream operations 9%
Phillips 66 oversees the operation of 12 refineries, boasting a mixed internet crude throughput capability of 1.9 million barrels per day.
What distinguishes Phillips 66 from its rivals is its in depth chemical footprint. A pivotal side of that is the corporate’s 50-50 three way partnership with Chevron, generally known as Chevron Phillips Chemical Firm LLC (CPChem).
Headquartered in Texas, CPChem specializes within the manufacturing and advertising and marketing of ethylene and different olefin merchandise utilized in industrial processes.
Ethylene, a key part produced primarily by way of the cracking of hydrocarbon-based uncooked supplies akin to ethane, propane, butane, naphtha, and gasoline oil, is used within the manufacturing of plastics like polyethylene and polyvinyl chloride. As an observer within the chemical trade, I’ve witnessed a notable surge in demand for superior, high-quality chemical compounds akin to ethylene.
Moreover, CPChem manufactures and markets aromatics, styrenics, and specialty chemical merchandise, together with benzene, cyclohexane, styrene, polystyrene, organosulfur chemical compounds, solvents, catalysts, and chemical compounds utilized in drilling and mining.
In the USA alone, the corporate bought over 30,000 million kilos of chemical compounds final yr.
Over the previous 5 years, PSX shares have returned simply 0.3%. Each its friends Valero Vitality (VLO) and Marathon Petroleum (MPC), have outperformed the power sector by a considerable margin.
The issue is that PSX is not as environment friendly as its friends. It additionally has a a lot bigger footprint in chemical compounds. Because the pandemic, the most important earnings have been made in refining, which benefited from shutdown capacities and a rebound in demand. Therefore, extra money went into MPC and VLO than PSX.
Now, these tailwinds are turning into headwinds.
Headwinds Are Mounting
Earlier this month, Bloomberg reported that US refiners are more and more turning to monetary hedging methods to safe earnings amid the diminishing chance of a summer time gas demand enhance and the potential for run cuts.
Business gamers, together with refiners, have raised their bearish quick positions in gasoline to a minimum of 200,000 contracts this yr, up from a mean of 180,000 within the second half of the earlier yr.
The decline in refiners’ revenue margins (as seen beneath), pushed by financial weaknesses within the US and China, has resulted in elevated hedging exercise.
International demand for diesel, typically thought of a measure of business exercise, can be weakening. Recessionary fears have induced a big drop in US gasoline demand, lowering hope for a robust summer time season.
Refining utilization charges stay wholesome within the low 90% vary, which is accompanied by above-average upkeep operations, in response to my sources.
The excellent news is that regardless of headwinds, Phillips 66 is doing effectively and is anticipated to see nice enhancements in its core enterprise.
Phillips 66 Stays In A Good Spot
The corporate had an awesome begin to this yr. Within the first quarter, PSX reported spectacular monetary and working outcomes, attaining adjusted earnings of $2 billion or $4.21 per share, marking a report first quarter.
In accordance with the corporate, and in gentle of the aforementioned feedback from Bloomberg, its refineries are presently working at excessive utilization to fulfill demand and reap the benefits of market alternatives in the course of the summer time driving season.
The corporate additionally supplied outlook info for the second quarter, together with expectations of a mid-90s world O&P utilization price within the Chemical compounds section and a mid-90s worldwide crude utilization price within the Refining section.
Moreover, heading into the gasoline driving season, US gasoline inventories are at their lowest degree in roughly ten years. In accordance with the corporate, octane spreads have additionally proven power. On the diesel facet, early within the yr, demand was weaker as a result of a hotter winter, nevertheless it has firmed up, particularly within the Mid-Continent planning season.
Turnaround bills within the Refining section are anticipated to be between $100 and $120 million. Company and Different prices for the second quarter are projected to be between $260 and $290 million, reflecting greater curiosity prices related to latest financing actions.
The pending buy-in of DCP Midstream’s publicly held frequent items is anticipated to shut in the course of the second quarter, supported by senior unsecured notes and a delayed draw time period mortgage.
By shopping for DCP Midstream, the corporate expects to generate a minimum of $300 million in synergies by 2025. The corporate owns this challenge with midstream large Enbridge (ENB).
PSX additionally made large progress in its renewable gas and chemical companies. For instance, the San Francisco refinery is being transformed into one of many world’s largest renewable gas services. This conversion will considerably scale back emissions from the power and allow the manufacturing of decrease carbon-intensity transportation fuels. The Santa Maria facility was safely shut down in February to advance the challenge, with business operations anticipated to start within the first quarter of 2024.
The Rodeo facility, upon completion, may have a renewable gas manufacturing capability of over 50,000 barrels per day.
Moreover, Within the Chemical compounds section, CPChem is pursuing a portfolio of high-return tasks, together with the development of a second world-scale 1-hexene unit in Texas and the enlargement of propylene splitting capability on the Cedar Bayou facility.
These tasks are anticipated to start out within the second half of 2023. Moreover, CPChem and Qatar Vitality are collectively constructing world-scale petrochemical services on the US Gulf Coast and in Qatar, with start-up anticipated in 2026.
PSX Shareholder Distributions
Since July 2022, Phillips 66 has returned $3.7 billion to shareholders by way of share repurchases and dividends. The corporate stays on monitor to attain its goal of returning $10 to $12 billion over the 10-quarter interval between July 2022 and year-end 2024.
Since 2013, the corporate has grown its dividend by 17% per yr. Over the previous 5 years, that quantity has declined to six.9%, which remains to be spectacular, on condition that we’re coping with a present yield of 4.4%. In February, the corporate hiked its dividend by 8.2%. The payout ratio is at simply 18%.
In accordance with the corporate:
Our built-in diversified portfolio offers us with the power to generate sturdy money movement, return substantial money to shareholders and put money into essentially the most enticing tasks. We stay dedicated to working excellence and disciplined capital allocation as we execute our technique.
One motive why PSX is ready to distribute a lot money to shareholders is its wholesome stability sheet. The corporate has an A3/BBB+ rated stability sheet, $14.7 billion in out there liquidity, and no main maturities till 2025. Its 2023E internet leverage ratio is 1.0x EBITDA.
With that in thoughts, analysts anticipate Phillips 66’s free money movement to average within the years forward as world margins come down as a result of new capability additions.
Nonetheless, even in response to these estimates, the corporate is anticipated to keep up a double-digit free money movement yield, which paves the way in which for steady dividend development and buybacks.
It additionally signifies that the valuation stays enticing, as PSX shares at the moment are buying and selling at roughly 8x 2024E free money movement.
Conservatively talking, I might apply a 10x a number of, which signifies a 28% upside to $120 per share. $120 is the present analyst consensus estimates.
My longer-term goal is $150, which – I imagine – is a good goal the second financial development expectations backside.
If I have been available in the market for extra high-yield power publicity within the refining/chemical enterprise, I might be a purchaser beneath $90.
As I wrote in my prior article, the inventory might fall to the $70 to $80 space if financial situations deteriorate additional.
Phillips 66 presents a compelling alternative for traders looking for worth and yield within the refining and chemical sector. Regardless of financial challenges and headwinds within the trade, PSX has a robust long-term outlook and is making vital progress in its core enterprise.
The corporate’s in depth chemical footprint, together with the three way partnership with Chevron Phillips Chemical Firm LLC (CPChem), units it other than rivals and positions it effectively for the rising demand for superior chemical compounds.
Whereas PSX has confronted effectivity and profitability challenges in comparison with its friends, latest monetary and working outcomes point out optimistic momentum.
The corporate’s dedication to shareholder distributions, demonstrated by share repurchases and rising dividends, additional sweetens the deal.
With a wholesome stability sheet and enticing valuation, PSX affords a possible upside of 28% to $120 per share and a longer-term goal of $150.
Traders all for high-yield power publicity within the refining/chemical sector ought to think about shopping for beneath $90 whereas being conscious of the potential for additional draw back if financial situations worsen.