Is Spending More the Right Move for Phillips 66?

Phillips 66’s latest decision to boost capital spending to accelerate development of two major midstream projects should pay off in the long run.

Jul 11, 2014 at 12:06PM

Phillips 66 (NYSE:PSX) announced Wednesday that it will boost its 2014 capital spending program and return additional cash to shareholders through a share buyback program. The increased spending will go mainly toward accelerating the development of two key midstream projects. Let's take a closer look at why the company's moves should improve shareholder value over the long run.

Ig Refining

Photo credit: Phillips 66

Phillips to boost spending and buy back more shares
Phillips will boost its 2014 capital spending by $1.2 billion, bringing its total capital budget for the year to $3.9 billion. The additional capital will go toward accelerating the development of the Sweeny Fractionator One and Freeport Liquid Petroleum Gas Export Terminal, as well as to finance the recently announced acquisitions of the Beaumont Terminal and Spectrum Corporation, a specialty lubricants company, Phillips said.

The company will also pursue an additional $2 billion share repurchase program. That brings its total share repurchase authorization since the third quarter of 2012 to a whopping $7 billion. As of the first quarter of 2014, Phillips had bought back $3.2 billion of its own shares. It also continues to return more cash to shareholders through increases in its quarterly dividend, which it raised by 28% in May.

While the budget and schedule for the Sweeny fractionator and the Freeport LPG terminal remain unchanged, according to a company spokesman, the increased budget will allow the company to fund a greater portion of these projects with cash, as opposed to debt or other more costly forms of funding.

Big boost to EBITDA
The company expects to bring the Sweeny fractionator online in the third quarter of next year, while the Freeport LPG export terminal is expected to commence operations in mid-2016. Both projects should pay off handsomely for the company as they will provide a big boost to EBITDA immediately after startup.

In the first year of service, they should generate a combined EBITDA of $490 million and an estimated profit of $210 million. This should help the company's midstream segment generate an estimated $1.5 billion in EBITDA by 2017.

The fractionator, which will be located in Old Ocean, Texas, near the company's Sweeny refinery, will separate natural gas liquids into components, such as ethane, propane, and butane. It will supply some 100,000 barrels per day of these purity NGLs to petrochemical and heating markets.

The Freeport LPG export terminal, which will be located at Phillips 66's existing marine terminal in Freeport, Texas, will initially export some 4.4 million bbl/month of LPG sourced from the company's Sweeney fractionator, as well as from its nearby Gulf Coast Fractionators site and Enterprise Products Partners' (NYSE:EPD) Mont Belvieu fractionator.

Both projects are part of the company's midstream growth strategy and will benefit from two main factors. First is the continued strong growth in natural gas liquids production, which feeds demand for fractionation and export facilities, and second is their competitive location along the Gulf Coast outside of Mont Belvieu.

This location advantage positions the export terminal perfectly to supply growing international demand for fuels like propane and butane. Indeed, fuel exports have been a bright spot for Phillips 66 in recent quarters, helping offset weaker margins in its refining business. By 2016, the company expects to boost its fuel export capacity to 550,000 barrels per day, up from 410,000 barrels per day last year.

Investor takeaway
By increasingly focusing its investments on its midstream and chemicals segments, which feature stronger and more stable margins than its historically volatile refining segment, Phillips' revenues should become more stable over time. This should provide greater security to its dividend, as well as a major competitive advantage over its downstream peers that are focused exclusively on refining.

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Arjun Sreekumar has no position in any stocks mentioned. The Motley Fool recommends Enterprise Products Partners. 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.

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