Phillips 66 Earnings: Should Investors Prepare for the Worst?

Phillips 66 (PSX -0.66%) will release its quarterly report on Wednesday, and investors are already bracing for a huge drop in earnings. Yet in the aftermath of its spinoff from ConocoPhillips (COP -0.43%), Phillips 66 has done a good job of weathering the storms that have hit refinery stocks. That could eventually give it a lasting competitive edge over rivals Valero Energy (VLO -0.32%) and Marathon Petroleum (MPC -0.26%), as well as the refining operations of integrated oil giants.

The most surprising thing about Phillips 66 lately is that its share price has continued to soar, setting new record highs despite the earnings challenges it faces. A big part of the reason is that investors expect the earnings declines to be temporary, as widening spreads between U.S. domestic and global oil prices have returned and could bolster profits in 2014 and beyond. Yet investors expect Valero and Marathon to reap even more benefits from favorable pricing conditions than Phillips 66, raising the question of whether the company is in the right place geographically to take maximum advantage of the situation. Let's take an early look at what's been happening with Phillips 66 over the past quarter and what we're likely to see in its report.

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Stats on Phillips 66

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Will Phillips 66 earnings really plunge?
In recent months, analysts have had divergent views about the near-term and long-term prospects for Phillips 66 earnings. They've cut their fourth-quarter estimates by $0.04 per share, but they've boosted their full-year 2014 projections by more than 12%. That has helped push the stock up 16% since late October.

Phillips 66's third-quarter earnings report threw cold water on what had been an incredibly lucrative two-year run for the refining company, as a 40% drop in spreads between crude and refined-product prices contributed to a 65% plunge in earnings per share. In addition, the differences in price between domestic crude and foreign oil also narrowed sharply, further reducing the competitive advantage Phillips 66, Marathon Petroleum, and Valero Energy have over their international rivals.

Yet during the past few months, the Brent-West Texas Intermediate spread has reopened to fairly wide levels. That should help Phillips 66, although the company is somewhat more diversified than some pure-play refining companies because of its chemical and midstream assets. As long as those businesses continue to do well, their gains could help offset any future losses if refining conditions at Phillips 66 start to deteriorate.

Despite some of its geographical disadvantages the company suffers compared with its industry peers, Phillips 66 has worked hard to get access to cheaper domestic crude. The company bought more than 2,000 railcars as well as tankers that have the legal right to transport crude between U.S. ports, allowing it to get low-cost oil from places like the Eagle Ford shale play in Texas to its East Coast refinery in New Jersey. Interestingly, Phillips 66 and Marathon Petroleum think that the U.S. should remove the ban on exporting crude oil, disagreeing with Valero Energy and others that believe that keeping crude within U.S. borders should lead to lower gasoline prices. Given that Valero, Phillips 66, and other refiners export massive amounts of refined products, Valero's argument doesn't jibe with economic theory.

Phillips 66 has made some interesting strategic moves recently. In December, the company said it would sell its Phillips Specialty Products unit to Berkshire Hathaway, with Berkshire exchanging 19 million Phillips 66 shares it already owned for the division. With the $1.42 billion deal, Phillips will end up concentrating more on what it sees as more lucrative opportunities to grow. One of those opportunities is the liquefied petroleum gas plant Phillips 66 expects to build in Freeport, Texas, which could open the door to greater exports of the liquids that shale plays have generated.

In the Phillips 66 earnings report, watch to see how good the fundamentals of the company look. With uncertainty hitting the stock market at large, more predictable plays like energy stocks could hold up better in a market downdraft. At the same time, though, any negative guidance could raise red flags that investors shouldn't ignore.

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