Last year was a tough one for Phillips 66 (PSX 1.58%). That's evident by looking at its financial results, where earnings slumped 63.2% versus 2015 due to issues across all its business segments, including an 89% plunge in refining profits. That said, refining earnings are notoriously volatile, which is one reason why Phillips 66 has invested heavily to reduce its exposure to the refining sector. Those investments should start paying off and that's just part of the reason why investors don't need to worry about this stock.
Midstream earnings are ready to ramp
One of the ways Phillips 66 is working to mute the impact of its volatile refining segment is by investing to boost earnings from stable midstream assets. For example, over the past year the company has completed the construction of a 4.4 million barrel-per-month LPG Export Terminal in Texas, financed its 25% share of the Bakken Pipeline project, and increased the storage capacity of its Beaumont Terminal. As these projects come online, capital spending is declining at the same time cash flow is growing, which is providing the company with more money for other uses.
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In addition to that, the company's MLPs Phillips 66 Partners (PSXP +0.00%) and DCP Midstream (DCP +0.00%) are also investing capital on organic growth projects that should deliver incremental earnings in the near future. Phillips 66 Partners, for example, is currently working on completing the western leg of the Bayou Bridge Pipeline, which should enter service later this year. Meanwhile, DCP Midstream recently completed a significant repositioning by combining with its MLP. On top of that, the company recently started a slate of new growth projects that should boost cash flow later this year. These rising earnings from its MLPs, when combined with internally generated growth, should fuel earnings growth in Phillips 66's midstream segment over the next year.
A big chemicals expansion is almost finished
In addition to investing capital to expand its midstream segment, Phillips 66's chemicals joint venture with Chevron (CVX 0.93%), CPChem, has been undergoing a significant capacity expansion to take advantage of cheap supplies from shale. The Phillips 66-Chevron venture is building two 1.1 billion-pound-per-year polyethylene facilities that should come online later this year and a 3.3 billion-pound-per-year ethane cracker, which should enter service by the middle of next year.
Overall, these facilities will grow CPChem's capacity by one-third, which should provide a significant boost to earnings within Phillips 66's chemicals segment over the next year. Further, because the joint venture financed this growth internally, it should start generating substantial excess cash flow when the projects enter service, which it can then distribute to its owners.
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Several catalysts should fuel a rebound in refining earnings
While Phillips 66's refining profits were under pressure last year, there are several reasons to be optimistic that results should improve in the future. For example, one of the issues impacting results last quarter was a major turnaround at its Los Angeles Refinery, which only operated at 45% capacity during the quarter. However, the refinery will be back up to full capacity once it completes the turnaround. In addition to that, the company had some additional costs due to the termination of railcar leases, which are one-time expenses that shouldn't impact earnings in the future. Finally, there was a significant spike in environmental compliance costs last year due to the renewable fuel standards program. However, President Trump has vowed to roll back some of the regulations that have impacted refiners, which could cut compliance costs in the future.
In addition to the removal of those headwinds, Philips 66 has been investing some money to improve the earnings capacity at its refineries by investing in quick payback projects. For example, it is investing capital at its Billing Refinery to increase Canadian heavy crude processing capacity up to 100%, which should lower feedstock costs and improve margins. It is also working on a diesel recovery project at its Ponca City Refinery and modernizing its Bayway and Wood River refineries to increase their clean product yields. As these projects come online, it should lower the company's costs and improve yields, which should enhance earnings, even if market conditions in the refining sector don't get better.
Investor takeaway
Refining can be a tough business, which was clearly the case last year. However, just because Phillips 66 had a down year, doesn't mean it's a sign of things to come. Instead, things are looking up for the company because it has several major projects nearing completion that will grow its non-refining earnings. On top of that, some of the headwinds impacting its refining segment are going away, which along with recent investments should improve results. These visible catalysts are why investors don't need to worry about Phillips 66's future.
