Phillips Petroleum
A diamond in the rough?

by Jeff Fischer (TMFJeff@aol.com)

ALEXANDRIA, VA (Feb. 23, 1999) -- Continuing down our list of oil candidates, today we hit Phillips Petroleum Co. (NYSE: P). First, here is the list and the results so far:

Baker Hughes (NYSE: BHI) -- CUT
BP Amoco (NYSE: BPA) -- IN ROUND 2
Exxon Mobil (NYSE: XON, MOB) -- IN ROUND 2
Kerr-McGee (NYSE: KMG) -- CUT
Pennzoil-Quaker State (NYSE: PZL) -- IN ROUND 2
Phillips and Ultramar Diamond Shamrock (NYSE: P, UDS)
Sunoco (NYSE: SUN)
Texaco (NYSE: TX)
USX/Marathon and Ashland (NYSE: MRO, ASH)

Three companies have been cut and three have passed into round two. Let's see what Phillips, a company that is entering a joint merger with Ultramar Diamond Shamrock, can offer us. We'll first consider Phillips alone.

Description: Phillips Petroleum explores for, produces, refines, transports, and markets oil products as well as natural gas. Phillips has three U.S. oil refineries and sells Phillips 66 gasoline at 6,500 outlets in 26 states (including one near you). These businesses will soon merge in a joint venture, called Diamond 66, as Phillips merges operations with Ultramar Diamond Shamrock's downstream business. (Remember what downstream is from our study? Refining, transporting, and marketing.)

Phillips has oil and gas holdings in 26 countries (one country for every state that it has gasoline outlets in, coincidentally) and it conducts exploration and production in six countries: Canada, China, Nigeria, Norway, the U.K., and the U.S. The company's chemical unit produces petrochemicals and plastics. For the year ended in December, revenues fell to $11.5 billion from $15.2 billion the previous year due largely to low oil prices.

They key elements that we focus on for this overview are: 1) How does the market value the company? 2) How profitable are its chosen operations? 3) How does the company finance operations? 4) And what does management do with the money that it earns?

With 254 million shares outstanding and a share price of $38.70, Phillips has a market capitalization of $9.83 billion (just multiply the first two numbers). Phillips recently had $120 million in cash and $3.4 billion in long-term debt, making its enterprise value $13.1 billion. That's what you'd pay, in effect, to buy the entire company -- because you'd acquire the debt, too. The company has a book value of $18.20 per share, so it trades at just over two times book, baby. (Say that like you mean it.)

Profitability. Let's consider the company's return on capital employed, or ROCE:

                    At December 31    At December 31
                         1998             1997
(in millions)
Total debt              $4,273            3,009
  stockholders' equity  $4,224            4,814
  ROCE (annualized) %    4.6              14.0
Looking over the numbers, we have a healthy 14% ROCE in 1997 -- a return up there with Exxon (NYSE: XON) -- and a fair 4.6% ROCE in 1998. That's not so bad considering what happened to oil prices and to most oil companies last year. Meanwhile, Phillips had net profit margins of 5% last year.

Leverage. The company has significant debt, with a long-term debt-to-equity ratio of about 0.80 (long-term debt is $3.4 billion, with shareholder equity at $4.2 billion). Although Phillips is significantly cash flow positive, it will probably finance future growth with debt or stock due to its low cash balance. Most likely, the company will continue to attempt to grow (and compete) through acquisition and mergers using equity as its weapon. Ultramar is probably just one significant step in this direction.

Use of Cash Flow. Cash is used, in part, to pay the company's 3.4% dividend yield. The stock is $1 above a 52-week low, so a share buyback could be a possibility, although the debt will probably keep it from happening to any great degree over the next five years.

Snapshot. Click here to investigate a Phillips company snapshot, key financials, SEC filings, the Fool message board, and more.

Click here if you're bored and want some entertainment regarding the dreaded Y2K issue.

Conclusion. We need to consider Ultramar Diamond tomorrow, put the pieces together, and then see if Phillips can make round two. (Da da da dum! Da da da dum!) That was suspense music. We'll leave the final vote up to you, again, after tomorrow's column. So learn more about Phillips by considering the shapshot link above, to start.

To close, a reminder that we sent $100 to Mellon Bank (NYSE: MEL) and $40 to Johnson & Johnson (NYSE: JNJ) yesterday. We hope that if you're Drip-investing monthly, you're able to regularly send much more than us! Hopefully we'll see you on the Drip Companies or Basics message board.

Fool on!

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