Will Phillips 66’s Big Bet on Midstream Pay Off?

Phillips 66’s expanding midstream portfolio should continue to deliver strong earnings growth and insulate the company from volatility in refining margins.

Jun 13, 2014 at 10:22AM

Phillips 66 (NYSE:PSX) is not like most refiners. Formed in 2012 through ConocoPhillips' (NYSE:COP) spin-off of its refining, midstream, and chemicals division, Phillips is much more heavily invested in midstream and chemicals than its downstream peers -- a focus that has provided it with a major competitive advantage over pure-play refiners.

As highlighted by its recent purchase of midstream assets in Texas, the company is investing heavily to further expand its midstream and chemicals business lines. Will this strategy pay off? Let's take a closer look.


Photo credit: Wikimedia Commons

Phillips 66 to purchase Beaumont terminal
Phillips 66 recently announced an agreement to purchase a 7.1 million-barrel storage capacity terminal located near Beaumont, Texas, from a subsidiary of Chevron (NYSE:CVX), the latest move in the company's midstream expansion strategy.

Due to its strategic location, the Beaumont Terminal, which will become the largest terminal in Phillips' portfolio once acquired, is well positioned to benefit from the growing volumes of crude oil being shipped to the US Gulf Coast region.

It provides multiple interconnections with key crude oil and refined product pipelines and features 4.7 million barrels of crude oil storage capacity and 2.4 million barrels of refined product storage capacity, two marine docks and one barge dock, and rail and truck loading and unloading facilities.

Though it's hard to assess the transaction from a valuation standpoint since Phillips 66 did not disclose the terms of the agreement, the purchase should be an incremental positive for the company because it will provide another source of stable income by tapping into the high and growing demand for crude oil and refined product storage capacity in the Gulf Coast region.

Stable, fee-based revenues
The soon-to-be-acquired Beaumont terminal should generate predictable, fee-based revenues, likely from storage service fees, throughput fees, and ancillary service fees, expanding Phillips 66's current portfolio of fee-based midstream assets and providing the company a higher degree of insulation from the historically volatile refining business.

Since customers generally pay service fees for reserving storage space for an agreed-upon volume of product irrespective of the actual storage capacity they end up using or the volume of product throughput, revenues from Phillips 66's Beaumont terminal would likely have virtually no volumetric risk and would therefore be highly predictable.

Further, demand for storage space on the Beaumont terminal will likely be extremely high, based on data from another major Gulf Coast storage terminal operator, Oiltanking Partners (NYSE:OILT). Currently, capacity on Oiltanking's two major terminals -- Beaumont and Houston -- is 95.5% and 99% contracted, reflecting the glut of crude oil and petroleum products in the region.

Growing midstream presence
Phillips' announcement fits perfectly with the company's strategic expansion of its midstream and chemicals businesses, whose improved margins and stronger profitability has been crucial in offsetting the company's relatively weak refining margins in recent quarters. Within five years, midstream and chemicals are expected to account for roughly two-thirds of the company's enterprise value.

This year, Phillips plans to direct roughly 70% of its $4.6 billion capital budget for the year toward these business lines, which feature stronger and more predictable rates of return. Through its 50/50 joint venture with Spectra Energy (NYSE:SE) called DCP Midstream, the company plans to construct an NGL fractionator and a liquefied petroleum gas export terminal along the U.S. Gulf Coast, both of which are slated for completion this year and will be meaningful contributors to EBITDA once they come online.

Improving Gulf Coast refining fundamentals
In addition to a positive outlook for its midstream and chemicals businesses, things also look brighter for Phillips' refining segment thanks to its presence in the Gulf Coast region. Given the current glut of crude oil in the U.S. Gulf Coast area, price differentials between domestic crude benchmarks like Louisiana Light Sweet (LLS) and Brent are expected to widen considerably, which should boost margins at its three Gulf Coast refineries -- Alliance and Lake Charles in Louisiana and Sweeney in Texas.

Investor takeaway
Over the next few years, Phillips 66's growing midstream and chemicals presence should continue to provide the company with a major competitive advantage over its downstream peers. The stronger and more stable incomes associated with these business lines should also insulate the company from any downturns in its refining business. While shares of Phillips aren't exactly cheap -- currently trading at 10.5x forward earnings, a slight premium to its peer group -- the company's 2.40% dividend yield and good prospects for dividend growth could make it a reasonably attractive long-term buy.

Will this stock be your next multi-bagger?

While Phillips 66 has a competitive advantage over its peers, there's a huge difference between a good stock and a stock that can make you rich. The Motley Fool's chief investment officer has selected his No. 1 stock for 2014, and it's one of those stocks that could make you rich. You can find out which stock it is in the special free report "The Motley Fool's Top Stock for 2014." Just click here to access the report and find out the name of this under-the-radar company.

Arjun Sreekumar owns shares of OILTANKING PARTNERS LP. The Motley Fool recommends Chevron and Spectra Energy. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

1 Key Step to Get Rich

Our mission at The Motley Fool is to help the world invest better. Whether that’s helping people overcome their fear of stocks all the way to offering clear and successful guidance on complicated-sounding options trades, we can help.

Feb 1, 2016 at 4:54PM

To be perfectly clear, this is not a get-rich action that my Foolish colleagues and I came up with. But we wouldn't argue with the approach.

A 2015 Business Insider article titled, "11 websites to bookmark if you want to get rich" rated The Motley Fool as the #1 place online to get smarter about investing.

"The Motley Fool aims to build a strong investment community, which it does by providing a variety of resources: the website, books, a newspaper column, a radio [show], and [newsletters]," wrote (the clearly insightful and talented) money reporter Kathleen Elkins. "This site has something for every type of investor, from basic lessons for beginners to investing commentary on mutual funds, stock sectors, and value for the more advanced."

Our mission at The Motley Fool is to help the world invest better, so it's nice to receive that kind of recognition. It lets us know we're doing our job.

Whether that's helping the entirely uninitiated overcome their fear of stocks all the way to offering clear and successful guidance on complicated-sounding options trades, we want to provide our readers with a boost to the next step on their journey to financial independence.

Articles and beyond

As Business Insider wrote, there are a number of resources available from the Fool for investors of all levels and styles.

In addition to the dozens of free articles we publish every day on our website, I want to highlight two must-see spots in your tour of fool.com.

For the beginning investor

Investing can seem like a Big Deal to those who have yet to buy their first stock. Many investment professionals try to infuse the conversation with jargon in order to deter individual investors from tackling it on their own (and to justify their often sky-high fees).

But the individual investor can beat the market. The real secret to investing is that it doesn't take tons of money, endless hours, or super-secret formulas that only experts possess.

That's why we created a best-selling guide that walks investors-to-be through everything they need to know to get started. And because we're so dedicated to our mission, we've made that available for free.

If you're just starting out (or want to help out someone who is), go to www.fool.com/beginners, drop in your email address, and you'll be able to instantly access the quick-read guide ... for free.

For the listener

Whether it's on the stationary exercise bike or during my daily commute, I spend a lot of time going nowhere. But I've found a way to make that time benefit me.

The Motley Fool offers five podcasts that I refer to as "binge-worthy financial information."

Motley Fool Money features a team of our analysts discussing the week's top business and investing stories, interviews, and an inside look at the stocks on our radar. It's also featured on several dozen radio stations across the country.

The hosts of Motley Fool Answers challenge the conventional wisdom on life's biggest financial issues to reveal what you really need to know to make smart money moves.

David Gardner, co-founder of The Motley Fool, is among the most respected and trusted sources on investing. And he's the host of Rule Breaker Investing, in which he shares his insights into today's most innovative and disruptive companies ... and how to profit from them.

Market Foolery is our daily look at stocks in the news, as well as the top business and investing stories.

And Industry Focus offers a deeper dive into a specific industry and the stories making headlines. Healthcare, technology, energy, consumer goods, and other industries take turns in the spotlight.

They're all informative, entertaining, and eminently listenable ... and I don't say that simply because the hosts all sit within a Nerf-gun shot of my desk. Rule Breaker Investing and Answers contain timeless advice, so you might want to go back to the beginning with those. The other three take their cues from the market, so you'll want to listen to the most recent first. All are available at www.fool.com/podcasts.

But wait, there's more

The book and the podcasts – both free ... both awesome – also come with an ongoing benefit. If you download the book, or if you enter your email address in the magical box at the podcasts page, you'll get ongoing market coverage sent straight to your inbox.

Investor Insights is valuable and enjoyable coverage of everything from macroeconomic events to investing strategies to our analyst's travels around the world to find the next big thing. Also free.

Get the book. Listen to a podcast. Sign up for Investor Insights. I'm not saying that any of those things will make you rich ... but Business Insider seems to think so.

Compare Brokers