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Is Phillips 66 Wasting Your Money?

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Stock buybacks are generally considered a bullish signal on Wall Street. They return capital to shareholders, while declaring management's belief that its own cheap shares are its best return on investment. As long as profits remain consistent, share repurchases can even increase earnings per share, by dividing the same amount of earnings among a smaller pool of shares outstanding.

But don't forget -- a company isn't obligated to repurchase shares just because it announced its intention to do so. So don't use the announcement as a reason to buy by itself,. Rather, use it as a launching pad for additional research.

More, more, more!
A year ago, the oil refining industry was anything but a refined opportunity, and oil companies were looking to divest themselves of their refining businesses. Marathon Oil spun off Marathon Petroleum, Sunoco was shedding its refining assets, and Murphy Oil sold its refineries to Valero (NYSE: VLO  ) .

Now, 12 months on, the refineries are showing profits and doing better than the oil companies in some cases, with Marathon Petroleum reporting a strong quarter while Marathon Oil saw profits drop 61% -- in part because of the loss of the refining business -- while Tesoro and Western Refining (NYSE: WNR  ) also reporting better-than-expected results. Even Sunoco's refining operations returned to profitability just as it prepares to sell the business to Energy Transfer Partners (NYSE: ETP  ) .

A large part of the explanation is that natural gas remains cheap and the fuel source is a key component of the refining process. Because there's something of a glut in crude oil but prices for gasoline remain relatively high, refineries are paying less for their input costs but receiving premiums on their output. They're even able to export their gasoline and still make a profit.

Get your kicks on Route 66
Certainly, Phillips 66 (NYSE: PSX  ) couldn't have found a better time to go public. The country's largest independent refinery business was spun off from ConocoPhillips (NYSE: COP  ) in May, landing in the middle of one of the best pricing environments since 2007. It generated almost $1.2 billion in profits in the second quarter, or $1.86 per share, even though revenues were down 10.5% to $47.8 billion. Adjusted profits that exclude one-time costs such as the sales of assets and debt retirement came in at $2.23 per share, some $0.55 more than what analysts had anticipated.

On the back of the strong showing, Phillips 66 says it will be buying back $1 billion worth of stock, though no timeframe was provided for repurchasing the shares. With the stock just north of $38 a share, what are the chances this is a good level to begin buying the stock?

Gray clouds forming?
Phillips was able to earn $12.56 on average for each barrel of gasoline and other petroleum products produced, compared with $9.49 per barrel last year. As mentioned, that was predicated on low crude and natural gas prices and relative high prices at the pump.

While natural gas has started rising, Phillips anticipates that the pricing environment won't change all that much in the foreseeable future. It had previously considered selling off its Gulf Coast Alliance refinery, but now that conditions are so positive, it will be hanging on to it for the foreseeable future. It says domestic prices for crude will remain below international sources for years.

At just five times trailing earnings and eight times estimates, it seems cheap, particularly when you add in analyst EPS growth estimates. Even more importantly, its enterprise value trades at a very cheap six times its free cash flow. Not only should Phillips 66 be buying its stock, but perhaps investors ought to as well. As the Fool's Rich Smith (who goes by the name TMFDitty on Motley Fool CAPS) says: "5x earnings for 7% growth and a 2% divvy? Where do I sign up?"

I've also rated Phillips to outperform on CAPS, but tell me in the comments box below whether you agree the pricing imbalance will be a long-lived affair.

Waste not, want not
Dividends can help investors smooth out the bumps of cyclical industries like refining with a regular quarterly payments. Check out the Fool's new free report "Secure Your Future With 9 Rock-Solid Dividend Stocks," where you'll find one drug developer and eight other promising companies. Get your free copy.

Fool contributor Rich Duprey holds no position in any company mentioned. Check out his holdings and a short bio. The Motley Fool owns shares of Western Refining. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days. The Motley Fool has a disclosure policy.

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10/24/2016 4:01 PM
COP $42.24 Up +0.70 +1.69%
ConocoPhillips CAPS Rating: ****
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VLO $56.16 Up +0.40 +0.72%
Valero Energy CAPS Rating: ****
WNR $29.98 Down -0.63 -2.06%
Western Refining CAPS Rating: ****