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Does Phillips 66 Stock Reflect a Strong Earnings Model?

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Phillips 66 (PSX) stock has been rising in the current quarter. The stock has risen 11% sequentially. The stock rose due to stronger refining conditions, which are impacted by the upcoming IMO regulation. Also, a marginal decline in Phillips 66’s third-quarter earnings supported the stock.

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Phillips 66’s marginal fall in earnings

Phillips 66’s earnings fell slightly by about 3% in the third quarter despite lower refining earnings. The company’s adjusted earnings from the refining segment fell 34% in the third quarter. However, higher profits in other segments supported the company’s overall earnings.

In comparison, Valero Energy’s (VLO) total earnings fell 29% YoY in the third quarter. The fall was driven by a 24% YoY decline in the refining segment’s operating profits. Read MPC, VLO, and PSX: Who Surprised Wall Street in Q3? to learn more.

Volatile refining earnings

Phillips 66’s refining earnings have been volatile. The earnings have ranged from a quarterly loss to over $2.0 billion in quarterly profits in the past seven quarters.

The volatility is because refiners rely heavily on refining margin for profits. The margins depend on various industry conditions like supply-demand for refined products, refining cracks, crude oil prices, and oil spreads.

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Phillips 66’s stable income stream

The marginal fall in Phillip 66’s earnings, despite weaker refining earnings, was due to higher profits in the midstream, chemicals, and marketing segments. The segments’ earnings rose 41%, 2%, and 29%, respectively, in the third quarter. Combined, the company’s midstream, chemicals, and marketing segments contributed about $1.2 billion to its third-quarter earnings.

The contribution from these segments has remained fairly rangebound in the past seven quarters. Since the first quarter of 2018, the segments have added $0.8 billion–$1.2 billion every quarter. They have created a stable income stream for the company.

Robust downstream model

So, the stability in the midstream, marketing, and chemicals segments’ earnings made Phillips 66’s earnings model somewhat resilient to refining earnings’ volatility. The company utilizes the supply chain to take advantage of every molecule processed. The company’s high complexity refining assets, widespread midstream assets, and vast retail network help it optimize its supply chain.

During the third-quarter earnings conference call, Phillips 66’s chairman and CEO, Greg Garland, said, “During the quarter, we were able to optimize product supply across our integrated logistics network in multiple regions to capture favorable market conditions.”

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The company looks well-placed for IMO 2020 due to the supply chain. The regulation will require shippers to use low-sulfur fuels. So, refiners that have capabilities to produce the fuel will benefit. Notably, refiners who can process sour crude oil will benefit more. In the current quarter, refining cracks and oil spreads are widening due to the changing regulatory environment.

Integrated model

Phillips 66 has created a strong model by investing in assets across the value chain. The company invests in refining assets that provide a competitive edge in terms of more and faster returns. Also, the company looks at a project’s benefits like feedstock flexibility or better yield of high-value products. In the midstream segment, the company invests in assets that complement its refining footprints. Meanwhile, in the chemicals segment, the company invests in assets that differentiate it from peers.

In the first nine months of 2019, Phillips 66 spent $2.2 billion in capital expenditure. Among the total, $1.3 billion was in the midstream segment, $0.6 billion was in the refining segment, and the rest was in other segments. The chemical segment’s capex, represented by the stake in Chevron Phillips Chemical, was self-funded in the year.

So, Phillips 66’s capex activities have successfully created an integrated and diversified downstream earnings model. The model partially shields the company from fluctuating refining earnings.

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