Phillips 66 (NYSE: PSX) reported strong fourth-quarter financial results on Wednesday, as earnings jumped 17% from the year-earlier period. The quarter's segment results are likely a preview of the company's future, in which its midstream and chemicals businesses will become much larger contributors to earnings and cash flow.
Key drivers of fourth-quarter performance
Fourth-quarter net income at Phillips 66 came in at $826 million, or $1.37 per share, up from $708 million, or $1.11 per share, in the year-earlier period, while net revenue was $43.83 billion, down from $44.62 billion a year ago. The jump in earnings was driven largely by strong performance from its midstream and chemicals businesses, as well as a 32% jump in refined products exports.
Phillips' midstream segment earnings surged 70% year over year to $121 million, led by its transportation business, which benefited from higher throughput fees and volumes. Similarly, chemicals earnings rose by $15 million to $261 million, fueled by its olefins and polyolefins business, which benefited from improved polyethylene margins and higher ethylene volumes.
However, adjusted earnings from Phillips' refining segment plunged 53% to $450 million due to margin contraction in all operating regions except the Gulf Coast. Stronger Gulf Coast margins were a common theme among the other refiners that have reported earnings results so far. For instance, Valero (NYSE: VLO) said that its throughput margin per barrel for the Gulf Coast increased to $12.25 in the fourth quarter, up from $11.08 in the year-earlier period, while Marathon Petroleum (NYSE: MPC) said its gross margins improved to $7.64 per barrel due largely to heavy discounts for Gulf Coast crudes.
Expanding midstream and chemicals presence
Phillips 66' fourth-quarter earnings highlight the beginning of a new trend, in which its midstream and chemical segments will account for a greater share of its growth. Of the company's $4.6 billion budget for 2014, roughly 70% will be directed toward these business lines. And within five years, these segments are expected to represent roughly two-thirds of the company's enterprise value.
The company has already amassed a massive portfolio of midstream assets through DCP Midstream, a 50/50 joint venture with Spectra Energy (NYSE: SE), and plans to invest heavily to expand its midstream presence. This year it will spend $800 million more on its natural gas liquids, or NGL, operations and transportation business lines to build an NGL fractionator and a liquefied petroleum gas export terminal along the Gulf Coast, which will become major contributors to EBITDA once they go into service.
Phillips also boasts a significant chemicals presence thanks to its participation in CPChem, a 50/50 joint venture with Chevron (NYSE: CVX). The company in 2014 will boost its share of CPChem's 2014 capital budget to $1 billion in order to finance the construction of an ethane cracker and two polyethylene facilities that are slated to start up in 2017, as well as to complete and start up a 1-hexene plant in Baytown, Texas, in the first half of this year. These facilities will benefit heavily from their access to low-cost feedstocks such as ethane.
As for Phillips' refining segment, its midcontinent refineries should continue to benefit from access to discounted inland and Canadian crudes, while its three Gulf Coast refineries will likely see improved profitability in 2014 as major pipeline additions and expansions boost the availability of cost-advantaged crudes in the region. And the company's extensive investments in rail loading facilities and tank cars should allow its less geographically advantaged refineries to also reduce feedstock costs.
The Phillips advantage
Phillips 66' heavy investments in its midstream and chemicals segments will continue to provide a major competitive advantage over its downstream peers, as well as insulation from the traditionally volatile refining business. Meanwhile, margins at its Gulf Coast refineries have improved significantly over recent quarters and should remain strong as the region is inundated with cheap domestic oil.
With a P/E ratio only slightly higher than peers focused exclusively on downstream, and with a dividend payout ratio that's still very low despite the 95% increase in its quarterly dividend over the past year, Phillips still looks like an attractive stock to buy and hold for the long term.
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