Image source: Getty Images.
Refining and chemicals manufacturing companies often operate in difficult market conditions. Not only do margins get squeezed by commodity price volatility and slowing demand, but the Environmental Protection Agency has put these companies in its crosshairs. As a result, Phillips 66 (PSX 1.09%) and CVR Energy (CVI +0.39%) have experienced significant earnings volatility over the years. However, Phillips 66 has made a concerted effort to tame this volatility by investing in adjacent industries that provide more stable income. That is one of the many reasons why long-term investors should prefer its stock over CVR's.
Phillips 66 101
While Philips 66 is a refining company at its core, the company owns $50 billion in assets across four distinct business segments: midstream, chemicals, refining, and marketing and specialties. As the chart below shows, each provides the company with a meaningful amount of earnings:
Data source: Phillips 66. Chart by author. In millions of dollars.
One other thing this chart shows is just how volatile profitability can be in both the chemicals and refining sectors. To combat this volatility, Phillips 66 has invested billions of dollars in growing its midstream business. Last year, for example, these investments enabled the company to build the Freeport LPG Export Terminal, expand storage capacity at its Beaumont Terminal, and participate in a joint venture constructing a major Bakken shale oil pipeline. Meanwhile, its master limited partnership, Phillips 66 Partners (PSXP +0.00%), invested capital in the construction and acquisition of additional midstream assets. Both companies plan to continue expanding this year, with Phillips 66 budgeting $942 million for midstream growth projects while Phillips 66 Partners will invest $381 million of expansion capital.
That said, Phillips 66 isn't forsaking its other segments. It is in the process of significantly expanding its chemicals joint venture, CPChem, which will increase production capacity by one-third. Furthermore, it plans to spend more than $300 million on small, high-return, quick-payout projects at several of its refineries. Finally, it plans to keep expanding and enhancing its fuel marketing business. These investments should allow Phillips 66 to continue generating healthy cash flow, which it can allocate as it sees fit.
Image source: Phillips 66.
CVR Energy 101
CVR Energy, on the other hand, is a holding company that owns stakes in two limited partnerships, CVR Refining (CVRR +0.00%) and CVR Partners (UAN 0.90%). CVR Energy owns the general partner and 66% of CVR Refining's common units, which is an entity that operates two refineries in the mid-continent as well as some complementary logistics assets. Meanwhile, CVR Energy owns the general partner and 34% of CVR Partners' units, which operates two nitrogen manufacturing facilities.
Because of this structure, CVR Energy offers investors some of the same diversification benefits found at Phillips 66, though its size and scale pales in comparison to its larger rival. It also lacks the stable midstream and marketing assets that help reduce earnings volatility, which was a problem for the company last year.
For example, through the first nine months of last year, CVR Refining recorded net sales of $3.2 billion and $26 million in net income, which was a significant drop from the same period of the prior year when it reported $4.2 billion of sales and $413.4 million of net income. Driving the decline are the rising costs of Renewable Identification Numbers (RINs) due to EPA regulations, which CVR Refining cannot offset like Phillips 66 because it does not control the blending and retail sale of its fuel.
CVR Partners also struggled in 2016, reporting a net loss of $12.3 million on $271.4 million in sales, compared to recording $43.3 million of net income on $223.2 million in sales over the first nine months of 2015. A challenging fertilizer pricing environment was the primary culprit driving last year's loss.
Image source: Getty Images.
Why Phillips 66 is the better choice for long-term investors
Phillips 66 has several advantages over CVR Energy. First, it has a sizable scale advantage because it owns 13 refiners across the U.S. and Europe, a large integrated midstream network, as well as investments in two growth-oriented MLPs, a stake in a major petrochemicals and plastics manufacturing venture, an extensive retail marketing network, and a lubricant and specialty products manufacturer. This diversification paid off last year as the integrated refining and retail network, for example, helped mute the impact of the rising cost of RINs.
Meanwhile, several of these segments provide steady cash flow, giving the company sufficient capital to reinvest in growth projects while paying a steadily rising dividend. In addition, because of its greater diversity and scale, Phillips 66 has more ways to grow, evidenced by the growth-focused investments across all four of its segments.
CVR Energy, on the other hand, lacks this stability and visible growth. For example, its MLPs both elected not to pay cash distributions during the third quarter due to their weakening finances. This weakness could cause CVR Energy to reduce or even suspend its dividend in the future while Phillips 66's payout is likely heading higher this year.
All in all, Phillips 66 offers investors a combination of visible growth and stability that makes it a much better option for long-term investors.
