A practice I adopted a couple of years ago is to occasionally re-read earnings releases and conference-call transcripts for companies that I follow. Not only can you find things that you missed, but it's also a chance to revisit the details before earnings kick up again. It's been a couple of months since energy giant Phillips 66 (NYSE:PSX) reported earnings for 2014, and after revisiting its earnings, I found some key things that you might have missed. Whether you're a current shareholder or considering buying, it's worth knowing these things about the company.
Growth won't be from refining business
Phillips 66 is largely known as a refiner and marketer, which is fair, considering that 65% of the company's adjusted earnings in 2014 came from the refining segment and the marketing and specialties segment that sells the refined products. This segment of the business is likely to remain a steady and strong contributor to the bottom line for decades to come.
However, Phillips 66 is investing more money in growing its smallest segment -- midstream -- in 2015. Last year, the company spent $2.7 billion on capital growth projects. On the earnings call, CEO Greg Garland stated that 65% of its $4.6 billion capital program -- that's $2.9 billion -- is "dedicated to growing our Midstream businesses." He continued: "Most of the projects in this plan are in flight and are largely anchored by fee-based contracts. You should expect regular updates from us regarding the progress made in expanding our midstream footprint [and] growing our chemicals business while enhancing returns in refining and returning capital to our shareholders."
In short, management sees the big opportunity in the U.S. to expand its pipelines to help connect all of the new oil and gas plays not currently near a pipeline. Considering that a massive amount of domestically produced oil is being shipped via rail -- about a 40-fold increase in the past decade or so -- at a higher cost versus pipelines, there's a lot of market opportunity for midstream expansion.
Factor in the company's share of capital spending in growth projects by joint ventures such as DCP Midstream (pipeline and gathering JV with Spectra Energy) and CPChem (chemicals JV with Chevron), and the midstream growth investment jumps to $3.4 billion, almost all of which is projects already under way and largely already backed by long-term take-or-pay contracts.
Second in growth investment is CPChem, with $1.26 billion in expanding the chemicals business, which produced the second-most adjusted income of any of the company's segments last year.
Refining focus is on improving returns
The refining business is at its best when refineries are operating at the highest possible utilization rate, and the refiner is able to purchase "advantaged" crude oil at a discount to Brent, the international benchmark price that is largely responsible for gasoline and other refined product prices. Right now, there's a wide spread between most domestic crudes and Brent:
Phillips 66's disadvantage -- though it can run cheaper American crudes in its refineries -- is that it must pay higher shipping costs to get crude from places such as the Bakken shale in North Dakota to its East and West Coast refining operations, versus refiners with operations in the middle of the country. And since building a new refinery for $10 billion or more is out of the question, the company is instead making small investments to improve the efficiency and profitability of its operations. This is why the company is spending only $352 million in capital improvements on its refining operations.
Actually, the midstream investments will benefit the company's refining operations expansion, especially projects that connect the Bakken and Eagle Ford plays to major pipelines.
Buying like Buffett
I've been impressed with how well Greg Garland and his management team have allocated capital, especially their focus on consistent per-share returns growth, versus growth that doesn't net additional returns to shareholders. With this in mind, management has aggressively bought back and traded assets for shares since going public in 2012. In 2014 alone, the company invested $2.7 billion in share buybacks, including trading away part of its chemicals business to Berkshire Hathaway for about $1 billion in shares.
I get the impression that Garland isn't planning to slow down, either. When an analyst on the earnings call questioned whether the company would be more "conservative" on share buybacks in 2015 based on the market environment, Garland had this to say (emphasis mine):
We always hesitate to get too far out in front, but as long as we're trading below intrinsic value, we're going to buy shares, and if the share price is lower, we're going to buy more. We've been pretty consistent about that.
The company still had $2 billion on its buyback authorization at the end of 2014, and considering that its stock bottomed out at pretty attractive valuations in mid-January, I wouldn't be surprised to learn that it bought shares more aggressively in Q1 of this year than at the end of 2014. Sometimes the best investment management can make with excess capital is its own stock.
None of these three things are really surprising, but they really emphasize what's great about Phillips 66 and its management. Not only are they focused on strengthening the business for the long term, as evidenced by investing in the best growth prospects in the right segments of the business, but they're also doing it by maintaining a strong capital position that allows the company to invest in growth, even when facing the worst commodity market in years.
Jason Hall owns shares of Berkshire Hathaway and Phillips 66. The Motley Fool recommends Berkshire Hathaway, Chevron, and Spectra Energy. The Motley Fool owns shares of Berkshire Hathaway. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.