The past several weeks have been brutal. The spread of the coronavirus that's causing COVID-19 has killed thousands of people, and governments are taking actions to arrest the spread that could result in a global recession.
Stock markets are in freefall. By market close on March 17 the Dow Jones Industrial Average, S&P 500, and Nasdaq Composite all had fallen over 25% their highs, marking easily the biggest stock market drop since the Global Financial Crisis more than a decade ago.
It's been even worse for energy stocks. The COVID-19 outbreak is expected to end a decade-long run of quarterly global oil demand growth, with economic activity in China braking hard in January and February as the country aggressively moved to arrest the spread. Less than a month later, a multi-year partnership between Saudi Arabia and Russia came apart at the seams, with both countries saying they were turning abruptly away from market-stabilizing production cuts, and would flood the world's markets with cheap crude oil.
As a result, Brent futures closed below $30 per barrel for the first time since briefly falling below that level in 2016, and is down more than 55% since early January. As a result, oil stocks have been smashed. Global integrated oil and gas giants ExxonMobil (XOM 1.98%), Chevron (CVX 1.64%) and Total SA (TTE 4.35%) have lost 56%, 44% and 53% of their stock values, while independent oil producer ConocoPhillips (COP 3.44%) shares are down 62%.
But if there's one major oil company that has both the capability to outlast any other in a protracted price war, it's Phillips 66 (PSX -0.23%). And with its stock down 61% at recent prices, it's just as discounted as peers that have much greater exposure to oil prices.
And that could make it the biggest winner of the oil market crash, no matter how much longer it lasts.
How Phillips 66 is different from other big oil peers
Unlike the other oil giants listed above, Phillips 66 doesn't operate any oil production. On the one hand, that means it doesn't have any exposure to the upside of higher oil prices that can generate big profits when oil prices are more "normal." For instance, even during a relatively poor quarter for the company, ExxonMobil earned more than $2 billion from its upstream segment (excluding a large asset sale) in the fourth quarter of 2019.
ConocoPhillips, a pure-play oil producer, is a more extreme example of the upside. The company has regularly generated billions in positive operating cash flows, and consistently generating positive free cash flow when crude prices are above $45 per barrel:
But the downside is also substantial. Note how ConocoPhillips' free cash flows were negative and how its operating cash flows fell in early 2016, when crude prices were last in the $30's for any period of time.
Back to Phillips 66: The company doesn't produce oil, buying every barrel that it uses to refine into gasoline, jet and diesel fuel. It also buys a massive amount of natural gas for its petrochemicals business. Since it's not a producer, the company has less downside to declining oil prices.
How Phillips 66 can use falling prices to its advantage
Now to the flip side of its business. Phillips 66 is a major oil buyer, and historically it has done a wonderful job taking advantage of falling crude prices to improve its profitability. In general. refined fuel prices are tied to major benchmarks, primarily Brent, which is a global benchmark.
Phillips 66 has some of the most advanced refineries in the world, that can operate with a variety of different crude oil types (all crude oil is not the same). When crude prices are moving sharply, this can result in opportunities to source lower-cost crude that it can refine at higher margins.
Here's where Phillips 66 could be exposed
As a non-producer, Phillips 66 doesn't have the same massive exposure to the oil crash that other oil companies do. Moreover, there could be opportunities for its refining operations to actually benefit from falling oil prices in the weeks and months ahead.
But there are still impacts to the sharp decline in oil prices, and the greater risk of declining oil demand as the coronavirus pandemic drives the U.S. into likely recession.
First, the company uses natural gas as the primary feedstock for its petrochemicals business, but many of its biggest global competitors -- particularly Middle-Eastern petrochemical manufacturers -- utilize crude oil to make many of the same products. And with oil prices having fallen sharply, those petrochem competitors now have low-cost inputs in their advantage.
As a result, Phillips 66 could see its margins shrink in this important business, which generated almost $900 million in pre-tax income in 2019.
But if there's one thing that could impact Phillips 66 the most in 2020 it's the likely drop in demand for its products. Major oil consuming industries like airlines and cruise lines have seen demand collapse. Over half of America's schools are closed. Millions of people are working from home, furloughed, or at risk of losing their jobs.
The sharp reduction in travel will impact Phillips 66 this year, and the expected recessionary impacts of the efforts to arrest the spread of COVID-19 will further reduce demand for the plastics, rubber, and other products made from its petrochemicals.
Congress is taking actions to help soften the economic blows, but consumer spending is all but certain to fall sharply, and Phillips 66 will feel the impact.
Earn an 8% yield to wait on 255% in potential gains
While it could be a tough year for Phillips 66, it's almost certainly not going to be as bad as what oil-producing peers face. It should have better chances to generate positive operating cash flows, even as demand weakens and margins suffer.
Even if there is a really tough quarter or two, the company has a rock-solid balance sheet, with $1.6 billion in cash and and one of the best credit ratings in the oil patch that should help it easily handle the small amount of debt it has maturing this year.
Put it all together, and Phillips 66 is one of the few oil stocks you can buy that's both positioned to ride out the current price war, and rebound quickly.
What's it worth to investors? Today, shares yield almost 8% at recent prices, if the company can maintain the payout (not a guarantee but more likely than not). Additionally, Phillips 66 shares simply returning to pre-crash levels would result in an incredible 255% in gains. That's the kind of winning potential Phillips 66 represents right now.